Form 1116: the foreign tax credit

1How it works

You report your worldwide income on your U.S. return, then take a credit for the foreign income tax you paid on it. The credit is limited to the U.S. tax on your foreign income, so it can't reduce tax on U.S. income.

2Income categories

Credits are figured separately for different kinds of income, mainly general (wages, business income) and passive (interest, dividends). Extra credit in one category can't be used against another. That's one reason a Form 1116 takes care to prepare.

3Carryovers

Unused foreign tax credit can be carried back one year and forward ten. If you live somewhere with high taxes and later move somewhere lower, those carryovers can cover future U.S. tax.

4Credit vs. exclusion

• Higher-tax country: the credit is often better and keeps more options open.
• Lower-tax country: the exclusion usually saves more.
• Both: you can use both in one year, but not on the same income.

Catching up on past years? The credit works on late returns too, including under the Streamlined Foreign Offshore Procedures, which is why many people abroad owe little or nothing when they catch up. See IRS tax amnesty options for expats.

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