Interestingly, American expats do face one particular problem, which is the payment of taxes twice on the same income. However, the internal revenue service does offer American citizens the chance of many tax credits and reductions to prevent the burden cost. For instance, foreign tax credits have been put in place by the government to help taxpayers of the United States reduce their income tax liability on the taxes paid to the government where they reside.
It’s essential to note that not all taxpayers need to use foreign tax credits, especially for American expats staying abroad with no income earnings from any business in the United States. American expats who pay their taxes to the foreign government of their abroad location are qualified to claim the foreign tax credit. Most times, form 1116 makes them eligible for the foreign tax credit.
What Exactly Is a Foreign Tax Credit?
Well, American expats need to know about U.S. taxes to avoid falling short of the rules and regulations guiding tax filing and payments or facing enormous challenges. That’s why knowing about taxes like foreign tax credits can help them to avoid overpaying as well as getting some accrued benefits. Foreign tax credits are refundable or non-refundable credits which are income taxes that U.S citizens pay to the government of the nation they reside in.
It’s a tax break that compensates for taxes paid to countries, and it has some requirements for qualification. Although, claiming the foreign tax credit solely depends on how much an American expat has paid as income taxes to a non- U.S government. However, it’s good to note that for American expats residing in countries that receive more taxes than the U.S., they can use the foreign tax credits to offset their total tax debts owed in the United States.
Qualification Requirements for Foreign Tax Credit
It’s important to note that foreign tax credit eligibility isn’t only for American expats living abroad only, but for everyone who pays foreign taxes. There are specific requirements needed for one to be eligible to get a foreign tax credit.
These requirements include the following:
- Residency in the United States
- Income earnings from foreign origin
- Tax payments made on income from foreign sources
Also, there are types of taxes that mainly qualify for foreign tax credit claims, and they include:
Types of Foreign Tax Credits That You Need to Know About
Foreign tax credits resolve double income taxation that may happen when taxes are paid to the U.S. and foreign governments. Taxpayers need to be aware of the helpful foreign tax credits available.
These foreign tax credits include the following:
1. Direct Foreign Tax Credit
The most common type of FTC available is the direct foreign tax credit and its taxes that are being paid on a foreign source income to the government directly. Direct foreign tax credits are based on the exact amount of taxes paid, and American expats should note that it mustn’t be more than the amount of U.S. taxes paid on foreign source income. To claim the direct foreign tax credits, taxpayers need to file form 1116.
2. Deemed Paid Foreign Tax Credit
A deemed paid foreign tax credit is being by a foreign corporation that a taxpayer of the United States has a 10% possession of the voting stock. It’s a credit that’s dependent on the taxes that a foreign corporation pays on income which the American taxpayer is deemed to have gotten payment as dividends. Anyone claiming a deemed paid foreign tax credit must file form 1118.
3. Companies’ Foreign Tax Credit
When U.S. corporations pay foreign taxes on foreign source incomes, they are eligible to get a credit known as a foreign tax credit for corporations. Foreign tax credit for companies helps them to avoid paying tax twice (to the United States and foreign government). This credit can be claimed on form 1118.
4. Research and Development Foreign Tax Credit
This type of credit is related to expenditures associated with activities involving research and development. Research and development foreign tax credit has been made in a way that Americans operating businesses are encouraged to invest in growth activities (research and development). Only companies that incurred costs related to research both inside and outside the United States are eligible to get the credit.
5. Branch Profits Foreign Tax Credit
The branch profit foreign tax credit is a credit obtained from taxes paid on income made by a foreign branch of a U.S. business. It helps American expats who own businesses in the U.S. and outside to effectively balance tax payments while avoiding double charges (to the foreign government and the United States). To claim this foreign tax credit, American expats must file form 1118.
While being an American expat staying and working abroad may be a suitable lifestyle, knowing the tax requirement is necessary. For instance, having an idea about what foreign tax credits are all about can help to prevent double taxation. Types of foreign tax credits that can be very helpful include direct, deemed paid, and branch profits FTC.