So, you’ve moved to another country and come to terms with the fact that you need to deal with your taxes differently compared to when you lived in the United States.
One of the first new forms you’ll likely have to tackle is the Internal Revenue Service’s Foreign Tax Credit form. This form helps protect you against paying taxes on the same income twice – once in your new country and again to the U.S. It will determine which foreign, non-refundable taxes, including like mational and local taxes already deducted from your paycheck abroad, that you claim US tax credits for. The Foreign Tax Credit ultimately reduces your tax liability to the IRS and prevents you from being double-taxed on the same income.
There are two ways to claim the Foreign Tax Credit, depending on what type of income was taxed and the kind of documentation that you have:
- Claiming the tax credit on line 48 of Schedule 3
- Submitting Form 1116
Most expats will complete Form 1116 because the income they generate and therefore the taxes they pay on it is greater than the requirements for the Schedule 3. You can only claim the tax credit on line 48 of Schedule 3 if these three criteria are met:
- Your income is from passive sources like interest or dividends and not earned
- The foreign taxes you paid were outlined on a qualified payee statement, the equivalent of a W-2 or 1099 in the U.S.
- You paid less than $300/individual or $600/married jointly filing in foreign income taxes
On the other hand, you can use Form 1116 if:
- You paid a foreign tax liability
- The tax was assessed on your income
- The tax was levied on you as an individual as opposed to a corporation
- The tax was legally applied in a foreign country recognized by the U.S. government
Tips for completing Form 1116
- Before submitting Form 1116, be sure to read all the instructions at the beginning of the document
- Keep in mind that you may need to fill out Form 1116 multiple times. The IRS requires that a different copy of the form be completed and submitted for each category of income. Different categories include Section 951A income; foreign branch income; passive income; general income, which includes wages and salary; Section 901 income; certain income re-sourced by treaty; and lump-sum distributions
- Be prepared to declare your itemized or standard deductions, as these will be tabulated on Form 1116
- Be repared to convert your home country’s currency into U.S. dollars to report it on Form 1116
While Form 1116 is a fairly easy way to reduce tax liability for eligible taxpayers, it is not your only option. The Foreign Earned Income Exclusion is another possibility. If you have questions about the benefits of the tax credits against possible deductions to determine the best financial outcome for your family, consider hiring a tax professional who specializes in expat taxes.