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You moved to the UK for work. Earned $100,000. Paid $28,000 in UK income tax. Now you're filing US taxes and realize the IRS wants to tax that same $100,000. You're getting taxed twice on the same income.
You hear about the Foreign Tax Credit. It's supposed to prevent double taxation. But when you look at Form 1116, you see pages of calculations, income categories, foreign tax limitations, and something called the "foreign tax credit limit formula." The instructions mention numerators, denominators, and something about foreign tax credit baskets. You're not sure if you're doing it right.
The credit is powerful but complex. Calculate it correctly and you could eliminate your entire US tax bill. Make mistakes and you'll overpay thousands in taxes or face IRS adjustments. And if you can't use all your foreign tax credits this year, you need to know how to preserve them for future use.
Most expats don't maximize their Foreign Tax Credit because they don't understand the calculation mechanics, the limitation formulas, or the carryback and carryforward rules. They leave money on the table by not properly claiming credits they're entitled to, or they lose track of unused credits that could offset future tax bills. Many turn to professional expat tax services to navigate these complexities. Here's how you can calculate the Foreign Tax Credit for 2025, maximize your credit amount, and properly manage unused credits for future tax years.
What is the Foreign Tax Credit?
The Foreign Tax Credit (FTC) is a non-refundable tax credit that allows US citizens and resident aliens to claim a dollar-for-dollar credit against US income tax for foreign income taxes paid to foreign governments. This prevents double taxation when you pay tax on the same income to both a foreign country and the United States.
Who qualifies for FTC
You can claim Foreign Tax Credit if you're a US citizen, US resident alien (green card holder or substantial presence test), you paid or accrued qualified foreign taxes to a foreign country or US possession, the foreign tax was imposed on you (you are legally liable for the tax), and you actually paid or accrued the tax during the tax year.
What foreign taxes qualify
Qualifying foreign taxes include: Foreign national income taxes, foreign state/provincial/local income taxes, foreign taxes on wages and salaries, foreign taxes on self-employment income, foreign capital gains taxes, foreign dividend withholding taxes, foreign interest income taxes, and taxes imposed "in lieu of" income tax (substitute taxes that replace the general income tax).
Non-qualifying foreign taxes include: Value Added Tax (VAT) or sales taxes, property taxes and real estate taxes, estate or inheritance taxes, social security or similar taxes (generally), taxes on excluded income (if using Foreign Earned Income Exclusion on same income), taxes you didn't legally owe, taxes eligible for refund that you haven't claimed, taxes paid to countries under US sanctions (Iran, North Korea, Syria, etc.), and taxes related to illegal activities.
You cannot claim Foreign Tax Credit on the same income you exclude using the Foreign Earned Income Exclusion (FEIE). If you exclude $130,000 under FEIE, you cannot claim FTC on taxes paid on that $130,000. However, if you earn $180,000 and exclude $130,000 with FEIE, you can claim FTC on the taxes paid on the remaining $50,000.
How do I calculate my Foreign Tax Credit?
The Foreign Tax Credit calculation involves determining both the amount of foreign tax you paid and the Foreign Tax Credit limitation—your credit is the lesser of these two amounts. Professional expat tax services can help ensure accurate calculations.
Basic FTC formula
Foreign Tax Credit = Lesser of:
- Total qualified foreign taxes paid or accrued, OR
- Foreign Tax Credit Limit
The FTC limit prevents you from using foreign taxes to reduce US tax on US-source income. The formula is:
FTC Limit = US Tax Liability × (Foreign-Source Taxable Income / Worldwide Taxable Income)
This formula essentially says: you can only credit foreign taxes up to the amount of US tax you would owe on your foreign-source income.
Step-by-step FTC calculation
Step 1: Calculate Foreign-Source Taxable Income
Begin by identifying and separating your foreign-source income from your U.S.-source income. Calculate your worldwide taxable income by adding all income sources together, including wages, rental income, dividends, and capital gains from both foreign and domestic sources. This separation is essential because the IRS requires you to distinguish between different income types when calculating your credit.
Step 2: Calculate Your FTC Limit
The FTC limit determines the maximum credit you can claim and ensures your credit doesn't exceed the U.S. tax owed on your foreign income. Use the IRS foreign tax credit limitation formula: multiply your total U.S. tax liability (before credits) by the ratio of foreign-source income to worldwide taxable income. This calculation produces your FTC limit—the maximum amount of foreign taxes you can use to offset your U.S. tax bill in the current year.
Step 3: Determine Your FTC Amount
Compare the total foreign taxes you actually paid or accrued to the FTC limit you calculated in Step 2. Your allowable FTC is the lesser of these two amounts. If your foreign taxes paid are lower than your FTC limit, you claim the full amount of foreign taxes paid. If your foreign taxes exceed the limit, you can only claim up to the FTC limit for the current year.
Step 4: Calculate Your Final U.S. Tax
Subtract your allowable FTC from your U.S. tax liability before credits to determine your final U.S. tax owed. The FTC can reduce your U.S. tax liability to zero, but it will never result in a refund. Report this final credit amount on Schedule 3 (Form 1040).
Step 5: Calculate Unused Foreign Tax Credits
If the foreign taxes you paid exceed your FTC limit, you have excess foreign tax credits. Calculate this by subtracting the FTC you claimed from the total foreign taxes you paid. These excess credits can be carried back one year to the previous tax year or carried forward up to 10 years to offset future U.S. tax liabilities.
Key Tip: Always maintain detailed records of all foreign taxes paid throughout the year, including payment dates, amounts in foreign currency, and exchange rates used for conversion to U.S. dollars. A foreign tax credit calculator can help with these conversions and computations.
If you have multiple types of foreign income (such as wages, rental income, and dividends), you must complete a separate Form 1116 for each income category, as the IRS requires category-specific calculations. Planning ahead and tracking carryforward credits can help you maximize tax savings across multiple years, especially if you consistently pay higher foreign taxes than your annual FTC limit allows.
Income categories and separate limitations
The IRS requires you to calculate FTC separately for different categories of income, commonly referred to as foreign tax credit baskets. The main categories are:
General Category Income: Most common as it includes wages, salaries, business income, and most other income types. The vast majority of expats use only this category.
Passive Category Income: Interest, dividends, royalties, rents, and annuities. Must be calculated separately from general income.
Other categories: Include specific income types like lump-sum distributions, sanctioned income, and others (rarely applicable to most expats).
If you have $50,000 in general category income and $10,000 in passive income, you must calculate FTC limits separately for each. You cannot use excess credits from one category to offset income in another category (with limited exceptions).
What is Form 1116 and how do I complete it?
Form 1116 is the primary form for foreign tax credit claims. This IRS form is used to calculate and claim your Foreign Tax Credit. Most expats with foreign-source income must file this form with their Form 1040.
You must file Form 1116 if your qualified foreign taxes exceed $300 ($600 if married filing jointly) OR all your foreign-source income is passive income (interest, dividends, etc.). There is a simplified exception for small amounts of foreign tax, but most expats don't qualify.
Form 1116 structure
Part I - Taxable Income or Loss From Sources Outside the United States
Report your foreign-source gross income by category. Enter the country where income was earned (separate forms for multiple countries if needed). Deduct expenses allocable to foreign income. Calculate foreign-source taxable income.
Part II - Foreign Taxes Paid or Accrued
List each foreign tax payment showing date paid, amount in foreign currency, exchange rate used, and amount in US dollars. Include withholding taxes on dividends and interest. Use cash method (when paid) or accrual method (when liability accrued)—must be consistent.
Part III - Figuring the Credit
Calculate the FTC limitation using the formula. Enter US tax liability on Form 1040. Calculate foreign-source taxable income percentage. Apply a limitation formula. Determine allowable credit (lesser of taxes paid or limit).
Part IV - Summary
Enter total credit from this category. If filing multiple Form 1116s (different categories or countries), combine here. Transfer total to Schedule 3 (Form 1040), Line 1.
Multiple Form 1116s
You may need to file separate Form 1116s for different categories of income (general vs. passive), different foreign countries (if elections are made), or foreign-sourced capital gains (may require separate form).
Common situation: Expat with salary (general category) and foreign dividends (passive category) must file two Form 1116s—one for each category—then combine the credits on Schedule 3. Many expats work with expat tax services to handle multiple form requirements correctly.
How to handle unused Foreign Tax Credits
If your foreign taxes paid exceed the Foreign Tax Credit limit, you can't use all your credits in the current year. The good news: these unused credits don't disappear—they can be carried back or forward to other tax years.
Carryback and carryforward rules
Carryback: You can carry excess foreign tax credits back 1 year to the immediately preceding tax year. This may generate a refund if you paid US tax that year.
Carryforward: You can carry excess foreign tax credits forward 10 years to future tax years. Credits must be used in chronological order (oldest first).
Expiration: Unused credits expire after the 10-year carryforward period. Any credits not used within 10 years are lost.
How to claim carryback credits
To carry credits back to the prior year, file Form 1040-X (Amended US Individual Income Tax Return) for the prior year. Attach Form 1116 showing the carryback credit. Calculate the refund due from applying the carryback credit. File within 3 years of original return's due date (including extensions).
Example: In 2025 you have $8,000 excess foreign tax credits. You can file Form 1040-X to amend your 2024 return and apply the $8,000 credit to 2024, potentially generating a refund.
How to track and use carryforward credits
Tracking: Maintain detailed records of unused credits by tax year, category (general vs. passive), and country. Create a spreadsheet tracking unused credits, amounts, and expiration dates.
Using carryforward credits: On next year's Form 1116, complete the carryover section. Apply oldest credits first (FIFO - first in, first out). Credits can only offset tax in the same category they originated from. Continue tracking any remaining unused credits.
Why unused credits accumulate
Unused credits typically accumulate when you live in high-tax countries (UK, France, Germany, Scandinavia with 35-50% rates), earn significant foreign income with limited US income, or have foreign tax rates substantially higher than US rates.
Example situation: Live in Denmark, pay 48% Danish tax, US would charge 24%. Every year you generate excess credits because Danish taxes are double the US rate. These credits accumulate but may be usable if you return to the US, have US-source income, or move to a lower-tax country.
Should I use Foreign Tax Credit or Foreign Earned Income Exclusion?
This is one of the most important strategic decisions for expats. Both tools prevent double taxation, but they work differently and produce different results depending on your situation. Professional expat tax services can help evaluate which strategy works best for your circumstances.
FEIE vs. FTC comparison
|
Factor |
FEIE (Form 2555) |
FTC (Form 1116) |
|
Maximum benefit |
Exclude $130,000 (2025) |
Unlimited credit available |
|
Income types |
Earned income only |
All income types |
|
Best for |
Low-tax countries, income under $130K |
High-tax countries, any income level |
|
Carryforward |
No carryforward |
10-year carryforward |
|
IRA contributions |
Reduces IRA eligibility |
Preserves IRA eligibility |
|
Complexity |
Simpler |
More complex |
|
Future flexibility |
Limited |
More flexible |
When to use FEIE
Use FEIE if you live in a low/no-tax country (UAE, Singapore, Qatar, Monaco), your foreign-earned income is under $130,000, you want simpler tax filing, or you don't have significant passive income.
When to use FTC
Use FTC if you live in high-tax country (UK, France, Germany, Canada, Australia), your income exceeds $130,000, you have significant passive income (dividends, interest, capital gains), you want to preserve IRA contribution eligibility, or you expect to return to US soon (can use carried-forward credits).
Combining FEIE and FTC
You can use both strategies together, which is often optimal for high earners. Exclude first $130,000 with FEIE (Form 2555), then claim FTC on remaining income (Form 1116), allocate foreign taxes proportionally, and use FTC only on non-excluded income.
Example: Earning $200,000 in France
- Exclude $130,000 with FEIE (no tax)
- Remaining $70,000 subject to US tax
- French tax on $200,000: $70,000 total
- Allocate French tax: $45,500 on excluded portion (can't use), $24,500 on included $70,000 (can use for FTC)
- US tax on $70,000: approximately $10,000
- Claim FTC: $10,000 (limited to US tax)
- Excess FTC: $14,500 (carry forward)
- Result: $0 US tax owed, plus $14,500 credits for future
Common Foreign Tax Credit mistakes to avoid
Several common errors reduce your Foreign Tax Credit or create IRS problems:
- Not claiming FTC at all: Many expats don't realize they can claim FTC, especially if also using FEIE. You can claim FTC on income not excluded by FEIE.
- Claiming FTC on excluded income: If you exclude income with FEIE, you cannot claim FTC on taxes paid on that same income. Must allocate properly.
- Wrong income category: Mixing general and passive income creates calculation errors. Must separate categories and calculate independently.
- Forgetting withholding taxes: Foreign withholding taxes on dividends, interest, and other payments qualify for FTC. Many taxpayers forget to claim these.
- Not tracking carryforward credits: Unused credits expire after 10 years if not tracked and used. Create a tracking system to preserve these valuable credits.
- Using wrong exchange rate: Must convert foreign taxes to USD using the exchange rate on the date paid (cash method) or accrued (accrual method). Using year-end rate is incorrect.
- Not filing Form 1116 when required: Filing Form 1040 without attached Form 1116 when required creates IRS processing issues and delays.
- Claiming non-qualifying taxes: VAT, sales taxes, property taxes, and social security taxes don't qualify. Only income taxes qualify for FTC.
How NSKT Global Can Help with Foreign Tax Credit
NSKT Global specializes in Foreign Tax Credit calculations and optimization for Americans living abroad. Our comprehensive expat tax services ensure you maximize every dollar of available credits.
We provide complete FTC calculation and Form 1116 preparation by determining all qualifying foreign taxes paid, properly categorizing income (general vs. passive), calculating FTC limitations accurately, completing Form 1116 for all required categories, and maximizing your allowable credit.
We offer strategic FTC vs. FEIE analysis by evaluating which strategy produces better results for your situation, calculating combined FEIE + FTC approach for high earners, projecting multi-year tax impact of each strategy, and advising on optimal approach based on your income, location, and plans.
We handle carryback and carryforward management by tracking all unused foreign tax credits across multiple years, filing amended returns (Form 1040-X) to claim carryback credits, maintaining detailed carryforward schedules with expiration tracking, and ensuring credits are used in optimal order.
Whether you have straightforward foreign employment income or complex multi-country investment portfolios, our expertise ensures you claim every dollar of US foreign tax credit you're entitled to while maintaining full IRS compliance. Our specialized expat tax services help Americans abroad navigate the complexities of international taxation with confidence.
Frequently Asked Questions
Q: Can I claim both FTC and FEIE on the same income?
No. If you exclude income using FEIE, you can't also claim FTC on that excluded amount. That's double-dipping. But you can use FEIE for the first $130,000 and FTC for income above that—different income, not the same.
Q: Do I need to keep proof of foreign taxes paid?
Yes. Keep foreign tax returns, payment receipts, employer withholding statements, and bank records showing payments. The IRS foreign tax credit documentation requirements are strict—IRS may request proof during audit. Without documentation, they can disallow your credit.
Q: Can I claim FTC for foreign sales tax or VAT?
No. Only income taxes qualify for FTC. Can't credit VAT, sales tax, property tax, or customs duties. It must be tax specifically on income, war profits, or excess profits.
Q: What exchange rate should I use for foreign taxes?
Use IRS yearly average exchange rate for the tax year, found on IRS.gov. You can also use the daily exchange rate on the date you paid the tax. You can't cherry-pick favorable rates. Many expat tax services provide exchange rate conversion assistance.
