How To Claim The Foreign Tax Credit (FTC) and Foreign Earned Income Exclusion (FEIE)
Many U.S. citizens who live and work abroad often feel confused about the options they have when it comes to saving money on taxes. The two most common approaches are Foreign Tax Credit and Foreign Earned Tax Exclusion, however the qualifying rules for each are many and sometimes not-so-easy to understand. In today’s article we will try to answer one of the most popular questions asked by people in our Facebook Group US Expats Tax Intelligence “Can I Claim Foreign Tax Credit and Foreign Earned Income?” and give more detailed explanation on the requirements.
Foreign Tax Credit (FTC)
We have previously talked about FTC in other articles published on our blog, and there’s even a video you can watch here. In this post, however, we will aim to simplify the process and rules as much as possible.
Foreign Tax Credit can be claimed if you have income that you earn outside of the United States and you also pay income taxes in your country of residence. You can still claim even if you don’t personally earn income abroad but your spouse does and you file jointly. However, there are more requirements you need to cover if you want to claim FTC.
1. Are you legally liable to pay taxes?
For you to be able to claim FTC, you should have earned income abroad and accrued taxes, for which you are liable in the country of residence. An example of that would be any tax that is taken out of your wages.
2. Did you pay actual foreign taxes for which you were liable?
This may sound like a very confusing question. Essentially it means that if you are claiming FTC, the amount you declared as foreign taxes paid to the tax authority in the country of residence is the real amount and you are not expecting refunds. If you receive a refund on the foreign taxes you paid, you wouldn’t be able to get a Foreign Tax Credit.
3. Did you pay income tax or tax in lieu in your country of residence?
First of all let’s clarify what is tax in lieu. It’s taxes you pay on your:
- Gross income
- Gross receipts or sales
- Products or exported units
Any VAT that you pay is not tax in lieu.
If you have answered “no” to question number 3, then unfortunately you cannot claim Foreign Tax Credit. For more information and details on that, please refer to Publication 1116.
4. Did you claim the Foreign Earned Income Exclusion (FEIE) or Foreign Housing Exclusion?
You can’t claim FTC in conjunction with FEIE or Foreign Housing Exclusion. In addition, you need to know that even if you qualified on all other requirements and you haven’t claimed either of these exclusions your FTC can still be limited. By the rule, your Foreign Tax Credit can’t be more than your total taxable U.S. income. Therefore, even if the taxes you paid abroad are more than your total U.S. taxable income you wouldn’t get a refund from the States, however, you carry over any excess amount to future years.
Foreign Earned Income Exclusion (FEIE)
FEIE is another method introduced by the IRS to avoid double taxation. It is generally meant for self-employed individuals who live and work abroad. FEIE does not exempt you from your Social Security tax liability. Tax credits can do that. With the new tax reform, it would be much more beneficial for expats to claim FTC than FEIE, since they can’t be received together. Here’s why:
- There’s quite a lot of uncertainty to the exact changes that are coming with the tax reform.
- Earnings under $100,000 a year qualify for FEIE.
- Adjusted annually.
- Some countries have higher taxes than the U.S., especially after the tax reform.
- Foreign Tax Credits will be worth more because the they can be used upon the taxpayer’s return to the U.S.
We hope that this article was helpful enough to give you the information and clarification you need on claiming FTC and FEIE. If you still have questions related to any of these, you can always ask us in the Facebook Group or directly on email at firstname.lastname@example.org.
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