Form 1116: Claiming the Foreign Tax Credit

Form 1116 is one tax form every U.S. expat should learn to love, because it’s one of two ways Americans working overseas can lower their U.S. tax burden. You file it to claim the Foreign Tax Credit (FTC), which reimburses expats for taxes paid to a foreign country dollar-for-dollar.

Because this form is so important to expats, we broke it down to help you understand what it’s for, how to file it, and considerations you should think about before filing.

Want to skip ahead to filing? Start with H&R Block today and we’ll make sure your taxes are done right. No matter where in the world you are, we’ve got a tax solution for you — whether you want to DIY your expat taxes or file with help from an advisor.

What is IRS Form 1116?

What’s the purpose of Form 1116? The IRS states you should file Form 1116 to claim the foreign tax credit if you are an individual, estate or trust, and you paid or accrued certain foreign taxes to a foreign country or U.S. possession.

Basically, many Americans living and working abroad have found themselves in the same dilemma: They’re required to pay taxes not only to the U.S., but also their new host country. To lower the tax burden and avoid double-taxation, the U.S. government gives these citizens a few credits, exclusions, and deductions they can use:

Options Americans overseas have for avoiding double taxation

To avoid double taxation as an American living abroad, you have a few tax-reducing or offsetting choices when filing:

• Deduct your foreign taxes on Schedule A, like other common deductions.
• Use Form 1116 to claim the Foreign Tax Credit (FTC) and deduct the taxes you paid to another country from what you owe to the IRS.
• Use Form 2555 to claim the Foreign Earned-Income Exclusion (FEIE), which, if you qualify, lets you exclude some or all of your foreign-earned income from your U.S. taxes.

Big factors U.S. expats should consider when choosing between the FEIE or the FTC include:

• Your income type and source
• Your housing expenses
• Your future plans for life and work abroad
• Your dependents and their U.S. citizen status
• Whether you pass the Bona Fide Residency test or the Physical Presence Test
• Your current country of residence and its local tax laws
• Your foreign tax liability to your country of residence

It is possible to use the credit and the exclusion together to get the best outcome. Leave it to one of our Tax Advisors to do a deep dive into your information and figure out which option would be best for you.

Who files tax form 1116? Requirements to qualify for the Foreign Tax Credit

Common questions we get are “do I need to file Form 1116?” and “what are the requirements to file Form 1116?”

Firstly, no, you don’t need to file Form 1116 every year — not doing so doesn’t lead to penalties, you just miss out on the benefit of getting a tax credit. Whether you should file depends on your situation.

Secondly, the IRS sets limitations on who qualifies for the FTC. You’re eligible if you are an individual, estate, or trust, and you paid or accrued certain foreign taxes to a foreign country or U.S. possession.

Before completing Form 1116 on your taxes, you must meet the four following criteria:

• The tax must have been imposed on you.
• You must have paid or accrued the tax.
• The tax must be a legal and actual foreign tax liability.
• The tax must be an income tax (or a tax in lieu of an income tax).

You can’t choose to pay foreign taxes and then claim the FTC — you must have been legally obligated to pay.

How the Foreign Tax Credit is calculated on tax form 1116

Each case is different, but in general, to calculate your foreign tax credit for individuals, you’ll take your foreign sourced taxable income divided by your total taxable income before exemptions. Then you’ll take that number, multiply it by your total U.S. tax obligation, and you’ll generally get your available foreign tax credit.

As an added perk, you can use the difference between foreign taxes paid and your FTC as a carryover credit to apply to the next year’s taxes.

Form 1116 Foreign Tax Credit examples (including the Foreign Tax Credit carryover and Income Thresholds)

Calculating your allowable amount can be difficult, so let’s go through two Form 1116 examples:

Let’s say you’re an American who moved to Japan for a teaching job. You have a Japanese income of $50,000 and paid $20,500 in taxes to the Japanese government. You also have $10,000 of ordinary U.S. trust income. In the end, you have a U.S. tax liability of $13,200.

To calculate your Foreign Tax Credit amount, you’d take:

$50,000 (Foreign sourced taxable income)

Divided by

$60,000 (your total taxable income)

= .83

You’d then take that result (.83) and multiply it by your U.S. tax liability ($13,200) = $11,000

So, in this example, you could receive up to an $11,000 credit on your U.S. taxes.

What if you don’t use your entire credit? The good news is you can carry over the difference between $20,500 (Japanese taxes paid) and $11,000 (your allowable foreign tax credit), and you can carry that over for up to 10 years. In this case, your carryover amount would be $9,500.

Here’s an example of how the tax credit carryover would work in practice:

Say you’ve left Japan, and now have teaching job in UAE. In UAE there’s no income tax. So, say you earned the same income of $50,000, and another $10,000 in trust. At the end of the tax year, you still owe $13,200 in U.S. taxes. This time you wouldn’t even have to recalculate—your allowable FTC would be $11,000 and you can use that $9,500 carryover credit to lower your U.S. tax obligation to $3,700.

Not fond of heavy math or computation worksheets? It may be best for you to file with a Tax Advisor and let them do the hard work for you.

Form 1116 vs Form 2555

Many expats ask us if they should file Form 1116 or if they should file Form 2555 to claim the Foreign Earned Income Exclusion instead. They both work to prevent double-taxation on income earned abroad, but the FEIE deducts your foreign income from your yearly tax filing and the FTC lets you claim a dollar-for-dollar credit on taxes already paid to a host country. While we wish we could give you a black and white answer of which is best for you, it’s not as simple as that—it will depend on a variety of factors, including (but not limited to) your:

• Income
• Housing situation
• Dependents and current life status
• Country of residence’s tax laws
• Qualifications
• Future plans

It’s possible to use the credit and the exclusion together to get the best outcome, and our Tax Advisors always do a deep dive into your information to figure out which option would be best for you.

What to know about filing Form 1116

First, you need to make sure you qualify. If you do, then you’ll need to make sure you’ve converted the amount of tax you paid into U.S. dollars. Then, you’ll classify your income into categories:

• General: For earned income such as wages and salaries.
• Passive: For investment income such as interest, capital gains, and dividends.

General and passive tax credits are calculated separately, as are the credits from the other categories. Any unused credits first carry back to the prior year and then carry forward for ten years to offset U.S. taxes on that category of foreign sourced income. You should note that you cannot apply carryover credits from one category to another. For example, you can’t use carryover credits from wages on capital gains.

Foreign Tax Credit rules put limitations to what foreign taxes can be included. The following taxes can’t be offset with the FTC:

• Taxes paid to a country designated as supporting international terrorism
• Taxes on excluded income (such as the foreign earned income exclusion)
• Taxes for which you can only take an itemized deduction
• 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 United States has a social security agreement

You can see detailed IRS Form 1116 instructions and IRS Publication 514 on the IRS’ website, or you can just leave it to the experts at H&R Block and let us handle the heavy lifting.

How to file Form 1116

Form 1116 includes four sections:

• Part 1 calculates taxable foreign income
• Part 2 lists taxes paid in both the foreign currency and their equivalent in U.S. dollars
• Part 3 calculates the FTC for the income category
• Part 4 totals all credits from all income categories

H&R Block Expat Tax Services makes it simple to claim the Foreign Tax Credit online. You have the option to file yourself with our made-for-expats DIY tool or get assistance from one of our experienced Expat Tax Advisors.

1. Head over to our Ways to File page and choose to either File with an Advisor or File Yourself.
2. Register online and complete your Tax Organizer. Once you’ve chosen your tax filing method, you will get your estimated price and complete your personal Tax Interview. After you have provided your information, you’ll be provided a checklist of documents to upload for your specific situation, including Form 1116.
3. If you chose to file with an Advisor, we’ll match you with the right one for your specific situation. Once you’ve completed a brief questionnaire and, we will match you with your Advisor. Your personal Tax Advisor will review your documents, prepare your return, and provide a personal consultation if needed.
4. Review, approve, and pay for your tax return. When your tax return is completed, you’ll be asked to review and pay for your return via your secure client account.
5. We file your return with the IRS. Finally, we’ll file your completed return with the IRS. In the rare case of an audit or if the IRS has questions about your return, we’ll help provide answers and support. After filing, your tax return will be stored in your secure online account, where it will be safe and easy to access, whenever you need.

Need help filing Form 1116 for the Foreign Tax Credit? Trust the experts at H&R Block

No matter where in the world you are, we’ve got a tax solution for you — whether you want to be in the driver’s seat with our DIY online expat tax service designed for U.S. citizens abroad or want to let one of our experienced Tax Advisors take the wheel. Head on over to our Ways to File page to choose your journey and get started. Want to learn more? Check out the top 20 things you should know about taxes for expats.