Foreign Tax Credits
Foreign tax credits are non-refundable tax credits for income taxes paid to a foreign government as a result of foreign income tax with-holdings. The foreign tax credit is available to anyone who either worked in a foreign country or has investment income from a foreign source. In order to prevent double taxation, taxation regimes around the world generally provide a credit mechanism.
The U.S. allows a foreign tax credit for:
- Foreign income taxes paid directly by a U.S. corporation (imposed as withholding taxes or on operating branches)
- Foreign income taxes attributable to dividends paid from 10% or more owned foreign subsidiaries
U.S. taxpayers whose foreign-earned income is taxed twice will have their income tax amount reduced once in the country where the income is earned and then again in the U.S.. The objective of the foreign tax credit is to avoid the double-taxation burden in accordance with the agreement (a taxation treaty) that the U.S. has with many other nations. Normally, the IRS allows a reduction up to the amount the taxpayer paid to the country where the income was earned. The taxpayer doesn't have to live or work overseas because this credit can also be claimed on the foreign income tax paid on returns from a mutual fund based in a non-U.S. territory.