Which foreign taxes are eligible for a credit?

June 12, 2023

Navigating the complexities of tax law is complicated for businesses operating domestically. When your operations extend beyond national borders, the intricate tax law maze becomes exponentially more complex.

The possibility of obtaining tax credits for certain foreign taxes introduces another layer of difficulty that can appear daunting to businesses.

However, these tax credits represent a crucial avenue for cost-saving and maximizing returns. The expertise of accountants with international experience is invaluable for running a successful international business.

The right accounting firm will ensure you take full advantage of the tax credits available to your business while eliminating the stress and hassle that typically accompanies such intricate tax processes.

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What is the Foreign Tax Credit (FTC)?

The Foreign Tax Credit (FTC) is a non-refundable tax credit for income taxes paid to a foreign government due to foreign income tax withholdings.

The FTC is available to businesses to avoid or mitigate double taxation, meaning: tax on the same income in two different jurisdictions.

Not all foreign taxes qualify for the FTC, which makes understanding the intricacies and qualifications vital. There are two key determining factors:

  1. The tax must be a true levy - an enforced contribution, not a voluntary one.
  2. The tax must be imposed upon income, war profits, or excess profits or on taxes that are an alternative to income taxes.

The limitations and carryovers in FTC

While the Foreign Tax Credit can provide significant financial benefits, it is important to understand that limitations exist. The foreign tax credit businesses can claim cannot exceed the total U.S. tax liability on foreign-source taxable income.

This limit ensures that taxpayers cannot use the FTC to reduce their U.S. tax liability below what it would have been if they had only U.S. source income.

When taxpayers have paid or accrued more in foreign taxes than what is allowed as a credit in the current year, there are provisions for a carryback or carryover of these excess credits to other tax years.

Categories of foreign income

To further navigate the complexity of the FTC, one must understand the categories of foreign income. For the purposes of the FTC, the IRS divides income into different categories, such as:

  • Passive income, including dividends, interest, rents, royalties, and annuities
  • General income includes anything not defined as passive

These categorizations can significantly impact the amount of FTC that an entity can claim.

The IRS calculates tax on each type of income separately and will not move the foreign tax credit between categories.

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How to claim the FTC

Claiming a Foreign Tax Credit involves filing IRS Form 1116 with your U.S. tax return.

This form computes the foreign tax credit and substantiates the credit to the IRS. Maintaining a meticulous record of the taxes you have paid in foreign countries is essential, as the burden of proof falls on the taxpayer.

The process can be quite complex, especially for businesses operating in multiple foreign jurisdictions. A professional tax consultant in your corner can be an enormous help in efficiently navigating the process.

Reasons why professional tax guidance matters

Ensuring you've claimed all eligible foreign tax credits is no small feat, and it can easily become overwhelming, especially when you're trying to run a business.

A tax professional is pivotal. Not only can they help ensure that you're accurately claiming all eligible FTCs, but they can also assist with strategic planning to maximize these credits in the future.

Professional tax consultants can also help businesses understand the implications of tax treaties between the U.S. and other countries. These treaties often provide additional tax benefits or exemptions of which a company may not be aware. They can also guide businesses through the complexities of the carryover and carryback provisions to ensure that no potential benefit is left unclaimed.

Schedule a consultation with Accountants Without Borders to learn what foreign taxes are eligible for credit.

Taking advantage of foreign tax credits can significantly impact a business's bottom line, offering potential savings to fuel growth and expansion.

You don't have to navigate the complex landscape of international tax law alone. At Accountants Without Borders, we deliver results tailored to your business. From strategic planning to initiating change, our tax consultants are eager to help you navigate the intricacies of international tax law.

Contact us to experience the peace of mind from knowing your international tax strategy is in expert hands.

Image of a skyscraper where the business takes advantage of the foreign taxes eligible for credit.