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Rev. date: 01/01/2011

Foreign Tax Credit

Tax Topic 856
The foreign tax credit is intended to reduce the double tax burden that would otherwise arise when foreign source income is taxed by both the United States and the foreign country from which the income is derived.
Four tests must be met to qualify for the credit:
  1. The tax must be imposed on you
  2. You must have paid or accrued the tax
  3. The tax must be a legal and actual foreign tax liability, and
  4. The tax must be an income tax
Generally, only income taxes paid or accrued to a foreign country or a U.S. possession, or taxes paid or accrued to a foreign country or U.S. possession in lieu of an income tax, will qualify for the foreign tax credit. Qualified foreign taxes do not include taxes that are refundable to you, used to provide a subsidy to you or someone related to you, that are not compulsory because you could have avoided paying the taxes to the foreign country, or income taxes paid or accrued to any country if the income giving rise to the tax is for a period (the sanction period) during which:
You can choose to take the amount of any qualified foreign income taxes paid or accrued during the year as a foreign tax credit or as an itemized deduction. To choose the deduction, you must itemize deductions on Form 1040, Schedule A. To choose the foreign tax credit you generally must complete Form 1116 and attach it to your Form 1040, or Form 1040-NR.
You can claim the credit for qualified foreign income taxes without filing Form 1116 if all of the following requirements are met:
If you claim the credit directly on Form 1040 or Form 1040-NR without filing Form 1116, you cannot carryback or carryover any unused foreign income tax to or from this year.
If you use Form 1116 to figure the credit, your foreign tax credit will be the smaller of the amount of foreign tax paid or accrued, or the amount of United States tax attributable to your foreign source income. This limit is currently computed separately for passive income and all other income.
If you cannot claim a credit for the full amount of qualified foreign income taxes you paid or accrued in the year, you may be allowed a carryback and/or carryover of the unused foreign income tax. You can carryback for one year or carryover for 10 years the unused foreign tax. For more information on this topic (including taxes paid or accrued in years before 2005) see Publication 514.
You may not take either a credit or a deduction for taxes paid or accrued on income you exclude under the foreign earned income exclusion or the foreign housing exclusion. There is no double taxation in this situation because the income is not subject to United States tax.
For more complete information on the foreign tax credit (including information on whether a particular tax is eligible for the credit), refer to the Instructions 1116, or refer to Publication 514, Foreign Tax Credit for Individuals. If the information you need is not addressed in the instructions or in Publication 514, you may call the IRS International Tax Law hotline. The number is area code 267-941-1000. This is not a toll-free number.