Foreign Taxes Paid Deduction: What You Need to Know
If you’re an American who works abroad, you may be eligible for a foreign taxes paid deduction. This deduction can help offset the amount of taxes you owe to the U.S. government on your foreign income.
Here’s what you need to know about claiming this deduction:
Who is Eligible?
To claim the foreign taxes paid deduction, you must meet three requirements. First, you must be a U.S. citizen or resident alien who earned income from sources outside of the United States. Second, you must have paid income tax to a foreign country or U.S. possession on that same income. Finally, the tax paid must not have been refunded or reimbursed by anyone else.
If all three criteria are met, then you can claim this deduction when filing your federal tax return.
What Qualifies as Foreign Income?
The IRS defines foreign income as any money earned while working abroad in another country or territory (such as Puerto Rico). This includes wages and salaries, self-employment earnings, rental income and royalties.
It’s important to note that if your employer is based in the United States but sends you overseas for work purposes, only the portion of your salary that was earned while physically working outside of the country will qualify for this deduction.
How Much Can You Claim?
You can deduct either actual taxes paid (up to a certain limit) or use an IRS-provided table that estimates how much tax would have been owed on that same income had it been earned in America instead.
The maximum amount of foreign taxes allowed for credit against US taxable income is limited by Section 904(a)(2) and varies depending upon whether “general” category income or “passive” category (e.g., portfolio interest) items are involved. The limitation applies separately with respect to each qualified business unit (“QBU”) operated by an individual taxpayer during his/her taxable year(s).
It’s worth noting that the foreign taxes paid deduction can only be claimed on income that was subject to tax in both the United States and a foreign country. Additionally, you cannot claim this deduction if you choose to take a foreign tax credit instead.
How Do You Claim the Deduction?
To claim the foreign taxes paid deduction, you’ll need to complete Form 1116 (Foreign Tax Credit) and attach it to your federal income tax return. This form requires detailed information about your foreign earnings and the taxes paid.
If your total foreign taxes paid are less than $300 ($600 for married couples filing jointly), then you may be able to skip this form altogether and claim the deduction directly on Schedule A of Form 1040.
It’s important to keep accurate records of any taxes paid while working abroad so that you can accurately report them when filing your U.S. tax return.
Final Thoughts
The foreign taxes paid deduction is a valuable tool for Americans who work abroad. By offsetting some of the amount owed in U.S. taxes, it can help ensure that expats aren’t unfairly penalized for earning money overseas.
However, claiming this deduction can be complex, so it’s always best to consult with a qualified tax professional before submitting your forms to ensure everything is filed correctly and all applicable credits are taken advantage of.