As a US citizen living and working abroad, you may have to pay taxes in both the US and the foreign country where you reside.
To avoid double taxation, the IRS gives Americans living abroad a choice:
- Deduct their foreign taxes on Schedule A, like other common deductions.
- Use Form 1116 to claim the Foreign Tax Credit (FTC) and offset the taxes they paid to another country from whatever they owe the IRS.
- Use Form 2555 to claim the Foreign Earned-Income Exclusion (FEIE), which allows those who qualify to exclude some or all of their foreign-earned income from their U.S. taxes.
In many cases, utilizing the FTC will reduce your U.S. tax liability most efficiently.
What Is the Foreign Tax Credit?
The Foreign Tax Credit is a US tax provision that allows eligible taxpayers to claim a credit for certain income taxes paid to a foreign government. This credit may help reduce double taxation on the same income.
The FTC is a credit rather than a deduction. A credit reduces your tax liability directly, while a deduction reduces taxable income.
Example: How the FTC May Reduce Tax
Assume you earn $100,000 working in the UK:
- UK taxes on this income: $25,000
- US taxes on this income (before credits): $20,000
If the FTC limitation allows the full credit, you could offset the US tax liability, reducing your US tax to $0.
Result: Total tax paid would be $25,000 rather than $45,000.
Foreign Tax Credit Eligibility
Taxes paid to other countries qualify for the FTC when:
- you paid the tax on your income to a local or provincial government
- you were legally obligated to pay the tax
- the tax was imposed on you directly — credits generally cannot be claimed for taxes paid by another person or entity
- you have already paid or accrued the tax
- you did not gain from paying the tax
These taxes include:
- Foreign national income taxes
- Foreign provincial, state, or local income taxes
- Foreign taxes on wages, dividends, interest, and capital gains
- Foreign withholding taxes on investment income
- Foreign taxes on self-employment income
Taxes that cannot be included in the FTC:
- Taxes on income excluded from your U.S. gross income
- Taxes paid to a sanctioned country
- Sales tax, value-added tax, real estate taxes, or luxury taxes paid to a foreign government
- Taxes on foreign mineral, oil, and gas income
- Taxes from international boycott operations
- Taxes related to a foreign tax splitting event
- Social Security taxes paid or accrued to a foreign country with which the U.S. has a Social Security agreement
Key Concept 🔑: If you exclude income using the Foreign Earned Income Exclusion, you cannot also claim the FTC on that same income.
Foreign Tax Credit (FTC) vs Foreign Earned Income Exclusion (FEIE)
Both the FTC and FEIE can reduce US tax for expats, but they work differently. Choosing the right approach can significantly impact your overall tax outcome.
- The FTC provides a credit for foreign taxes paid, while the FEIE allows you to exclude foreign earned income from US taxable income.
- The FEIE income threshold is limited (to $132,900 in 2026) and is indexed annually for inflation (though you may also qualify for an additional housing exclusion).
- The FTC can apply to multiple income types, while the FEIE applies only to earned income.
- The FTC requires foreign taxes to be paid, while the FEIE requires meeting either the Physical Presence Test or Bona Fide Residence Test in order to be claimed
- The FTC is claimed on Form 1116 and the FEIE on Form 2555.
It may be a better option to claim FTCs if foreign tax rates are similar to or higher than US rates, if your income exceeds the FEIE limit, if you can claim credits for dependents, or if you want flexibility in future years.
Or you may seek to claim FEIE if foreign taxes are lower than US rates, if income is below the exclusion amount, or if you have earned income, small amounts of investment income and meet the eligibility tests.
You cannot use both FEIE and FTC on the same earned income, but you may be able to use each on different income streams.
⚖️ Choosing the right approach can significantly impact your tax outcome and SmileTax will always optimize between each outcome for you as part of our service
How to Calculate Your Foreign Tax Credit
Calculating the FTC can be complex and we recommend using an experienced expat tax professional, but the basic steps include:
- Determining foreign taxes paid
- Calculating the FTC limitation
- Completing Form 1116
Foreign taxes must be converted to US dollars using an IRS-accepted exchange rate method, typically the rate on the payment date or an approved average rate.
The FTC is limited to the amount of US tax attributable to foreign income. The general formula is:
US Tax * (Foreign Income / Worldwide Income)
If foreign taxes exceed the limitation, you may be able to carry unused credits back one year and forward up to ten years, subject to IRS rules.
Most expats primarily file Form 1116 claiming foreign tax credits under the General Category and/or Passive Category depending on the type of income earned and the applicable tax rate in the foreign jurisdiction.
Foreign tax refunds, whether known or anticipated, should always be accounted for. If you were to receive an unexpected refund, you could be required to adjust the credit or report a redetermination, depending on the situation.
Common FTC Mistakes
- Claiming credits for non-qualifying taxes such as VAT or property taxes
- Using incorrect exchange rates
- Not separating income categories
- Trying to claim FTC on income excluded under FEIE
- Not tracking carryovers
- Assuming FEIE always produces a better result
- Not reviewing state tax treatment
State Treatment of Foreign Taxes
State rules vary widely. Many states do not allow a credit for foreign taxes, though some may allow deductions or limited relief. If you maintain ties to a US state, reviewing that state’s rules is important.
Record Keeping
Keep documentation such as foreign tax returns, proof of payment, exchange rate calculations, and investment statements. Records should generally be kept for at least three years after filing, though longer retention may be advisable if you have carryovers.
Planning Considerations
Your optimal strategy may change from year to year based on income level, foreign tax rates, investment income, dependents, retirement contributions, and long-term plans.
Evaluating FEIE and FTC annually can help improve your overall tax outcome.
Conclusion
The Foreign Tax Credit is an important tool that may help Americans abroad reduce double taxation and better manage their overall tax situation. While the rules can be complex, understanding how the credit works can make a meaningful difference.
Because every expat’s situation is different, the right approach will depend on your income mix, foreign tax rates, and long-term plans.
SmileTax helps Americans abroad file accurate US tax returns with confidence, combining deep expat expertise with a straightforward and supportive approach. If you want clarity on how the Foreign Tax Credit fits into your situation, professional guidance can help you make informed decisions.