Form 1116: How U.S. expats claim 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.
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What is IRS Form 1116?
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, the U.S. government gives these citizens a few credits, exclusions, and deductions they can use, including the foreign earned income exclusion and the foreign tax credit. Form 1116 is the form you file to claim the Foreign Tax Credit, and you file with your yearly tax return.
Who files tax form 1116? How to qualify for the Foreign Tax Credit
A common question we get is "do I need to file Form 1116?"
No, you don’t need to—not doing so doesn’t lead to penalties, you just miss out on the benefit of getting a tax credit.
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. There are a few stipulations—the IRS generally uses four tests to determine if you qualify:
- 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
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)
$60,000 (your total taxable income)
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? Upload your tax documents to H&R Block’s online tax portal and let our Tax Advisors do the 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:
- Housing situation
- Dependents and current life status
- Country of residence’s tax laws
- 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
Need help filing Form 1116? Trust the experts at H&R Block
Have more questions? Our experts are here to guide you every step of the way. No matter how complicated your situation is, there’s an Expat Tax Advisor ready to help. Get started with Virtual Expat Tax Preparation from H&R Block today. Want to learn more? Check out the top 20 things you should know about taxes for expats.