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U.S.Taxationof
AmericansAbroad

Contents|Chapter1|Chapter2|Chapter3|Chapter4|Chapter5|Chapter6|Chapter7|Chapter8

Chapter4ForeignTaxCredit
CashVersusAccrualMethod|ForeignTaxesEligibleforCredit|DisallowanceofCreditAllocabletoExempt
Income|LimitationonCredit|CarrybackandCarryoverofUnusedCredits|PlanningforUseofExcessCredits

Alloraportionofanexpatriate'sincomemaybesubjecttotaxinaforeignjurisdictionasaresultofeitherthe
individual'sresidenceorpresenceintheforeigncountry.SinceU.S.citizensandresidentsaresubjecttoU.S.taxon
theirworldwideincome,theexpatriatemaybesubjecttotaxbothintheforeigncountryandintheUnitedStates.The
foreigntaxcreditprovisionsoftheInternalRevenueCode(IRC)aredesignedtoeliminatethedoubletaxationof
foreignsourceincomebyallowingacreditagainstU.S.taxforqualifyingforeigntaxes.Thiscreditisgenerallylimited
totheU.S.taxontheindividual'sforeignsourceincome,anditcannotexceedtheactualforeigntaxpaidoraccrued.
Itshouldalwaysbekeptinmindthatdoubletaxationreliefisalsoprovidedintaxtreaties.Individualswhoincurtax
inacountrywithwhichtheUnitedStateshasenteredintoataxtreatyshouldconsidertherelevanttreatyprovisionsin
additiontotheIRC.AlistoftreatycountriesisprovidedinAppendixA.
Anindividualmayeitherdeductforeigntaxespaidasanitemizeddeductionorelecttoclaimthemasacredit.
Generally,thecreditoptionismorebeneficial,sinceitcanresultinadollarfordollarreductionintaxliability.
However,sinceitisanannualoption,thedecisionshouldbebasedonallthefactsavailableandreviewedeachyear.
TheelectiontoclaimtheforeigntaxasacreditismadebycompletingForm1116(ComputationofForeignTax
Credit)andincludingitwiththetaxreturn.

CashVersusAccrualMethod
Althoughmostindividualsreportincomeanddeductionsunderthecashreceiptsanddisbursementsmethodwhen
theyfiletheirreturns,theforeigntaxcreditmaybeclaimedusingeitherthecashoraccrualmethod.Ifthecash,or
"paid,"methodiselected,theforeigntaxavailableforcreditisthetotalamountofqualifyingforeigntaxesactually
paidduringtheyear.Iftheaccrualmethodiselected,ataxpayerclaimstheforeigntaxcreditintheyeartherelated
incomeisreportedandinwhichtheforeigntaxliabilityaccrues,regardlessofwhenitisactuallypaid.Oncethe
accrualmethodiselected,itmustbeusedinsubsequentyears.Ataxpayermaychangefromthepaidmethodtothe
accrualmethodandclaimcreditbothforforeigntaxes"paid"foraprioryearandtaxes"accrued"butunpaidforthe
currentyear.

PlanningPoint:
Theaccrualmethodofclaimingtheforeigntaxcreditmaybebeneficialifthetaxpayerisresidinginacountrythat
doesnotrequirepaymentoftaxuntilayearaftertheliabilityarises.Conversely,whenanindividualalreadyhas
sufficientforeigntaxcredits,thecashmethodmaybepreferableinordertoaddanadditionalyearormoretothe
foreigntaxcreditcarryoverperiod.
Itshouldbenotedthatthecreditmaynotbeclaimedforforeigntaxattributabletoayearinwhichanelectionto
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deductforeigntaxeswasmadeintheU.S.return.
Someforeigntaxjurisdictionsdeterminetaxableincomeusingayearthatisotherthanacalendaryear.TheIRStakes
thepositionthatforeigntaxesaccrueonthelastdayofthetaxableyearofsuchforeignjurisdictions.Thismaycause
theaccrualmethodofclaimingforeigntaxcreditstobedisadvantageoustoindividualslivingincountriesthathave
taxableyearsotherthanthecalendaryear.
Example
AnindividualmovestoLondon,England,onMay1,2003.UnitedKingdomincometaxesforindividualsare
determinedbasedonataxableperiodbeginningApril6ofoneyear,andendingApril5ofthefollowingyear.Forthe
yearendedApril5,2004,theindividualincursaU.K.taxliabilityof15,000,noneofwhichispaidduring2003.
BasedontheIRSposition,noforeigntaxcreditcanbeclaimedintheindividual's2003U.S.returnbecausenothing
hasbeenpaidandbecausethetaxdoesnotaccrueforforeigntaxcreditpurposesuntilApril5,2004.

PlanningPoint:
Toavoidtheoutcomeoftheexampleabove,individualslivingincountrieswithfiscalyearendsshouldgenerally
utilizethecashmethodforclaimingforeigntaxcreditsandmonitortheirforeigntaxpaymentstoensurethedesired
amountispaidduringtheU.S.returnyear(calendaryear).
Top

ForeignTaxesEligibleforCredit
Foreigntaxesthatareeligiblefortheforeigntaxcreditincludeincometaxes,warprofitsandexcessprofitstaxes,and
taxespaidinlieuofanyofthese.Thetaxmustbeimposedbyaforeigncountryoritspoliticalsubdivisions,orbya
U.S.possession.Theemployeeportionofforeignsocialsecuritytaxesisgenerallyconsideredtobeforeignincometax
availableforthecredit.Socialsecuritytaxesarenotcreditable,however,ifpaidtoacountrywithwhichtheUnited
Stateshasasocialsecuritytotalizationagreement(seeAppendixB).Otherforeigntaxes,suchasrealestatetaxes,sales
taxes,luxurytaxes,turnovertaxes,valueaddedtaxes,andwealthtaxes,arenotcreditable.Determiningwhethera
foreigntaxiscreditableornotmaybedifficult,andacompetenttaxadvisershouldbeconsultedtodetermineifthe
foreigntaxqualifiesforcredit.
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DisallowanceofCreditAllocabletoExemptIncome
Otherwiseallowableforeigntaxespaidoraccruedcanbeusedascredits,excepttotheextentthattheforeignincome
taxwasimposedonforeignsourceearnedincomeexcludedfromgrossincomeundersection911.Thetheoryofthis
statutorilyimposeddenialofdoublebenefitsruleisthatanindividualshouldnotbeabletobothexcludeearned
incomefromtaxationandclaimcreditforforeigntaximposedonsuchincome.Thecomputationofthedisallowance,
ornoncreditabletax,isasfollows:
Amountsexcludedundersection
911(a)lessdeductibleexpenses
allocabletosuchamounts
Foreignearnedincomeless
deductibleexpensesallocableto
suchincome

Foreigntaxespaid
x oraccruedonforeign
earnedincome

Iftheforeigntaxisimposedonearnedincomethatisexcludedandonsomeotherincome,andthetaxesontheother
amountcannotbesegregated,anallocationmustbemade.
Examples
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1.For2003,anindividualresidentinGreeceearns$90,000andpays$8,000inGreektaxonsuchincome.She
claimsaforeignearnedincomeexclusionof$80,000andahousingexclusionof$10,000.Herentireincome
isthereforeexemptfromtax.Accordingly,allofherGreektaxesaredisallowedandthereforeareineligible
foruseasaforeigntaxcredit.
2.Thesameindividualdoesnotelecttoclaimahousingexclusion.Sincenotallofherincomeisexemptfrom
U.S.taxation,theforeigntaxcreditdisallowanceiscomputedasfollows:
Exemptincome
80,000
Totalforeignearned
income$90,000

$8,000
Foreign
$7,111
x taxon = Disallowed
earned
foreigntax
income

PlanningPoint:
Theforeignearningsexclusionsweremadeelectivesothatindividualslivinginhightaxforeigncountrieswouldnot
bepenalizedbytheforeigntaxcreditdisallowancerules.Individualslivinginhightaxcountriesshouldconsidernot
electing,orrevokingifpreviouslyelected,theforeignearningsexclusionsinordertomaximizeforeigntaxcreditsand
carryoversorcarrybacks.
Caveat:Althoughthetaxbenefitoftheforeignearningsexclusionsmaybeminimalonemploymentincomefor
individualsinhightaxforeigncountries,apotentialsideeffectonunearnedincomeshouldnotbeoverlooked.The
combinedexclusionsmayreducetheoveralltaxableincometothepointwhereinvestmentincomeistaxedateithera
verylowrateornotatall.Thus,acurrenttaxsavingsmayhavetobeweighedagainstpossiblefutureuseofhigher
foreigntaxcreditcarryoversiftheexclusionsarenotelected.
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LimitationonCredit
Theportionoftheforeigntaxesthatisnotdisallowedcanbeclaimedasacredit,subjecttolimitations.Theamountof
creditallowableinataxableyearislimitedtothelesseroftheactualforeigntaxespaidoraccrued(afterdisallowance)
ortheamountofU.S.taxonforeignsourcetaxableincomefortheyear.TheamountofU.S.taxattributabletoforeign
sourcetaxableincomeisdeterminedasfollows:
Limitationon
U.S.tax
credit(U.S.tax
x before = attributedto
credits
foreignsource
Totaltaxableincome
taxableincome)
Foreignsource
taxableincome

Taxableincomeinthisfractiondoesnotreflectpersonalexemptions,butitreflectsitemizeddeductions.
Sincethelimitationisbasedonacalculatedtaxon"net"foreignsourceincome,itisapparentthatmaximizingforeign
sourceincomehastheeffectofincreasingthelimitationandreducingtheU.S.tax(assumingsufficientcreditsare
available).Foreignsourceincomeincludesearningsfromservicesperformedabroad,movingexpensereimbursements
(undercertaincircumstances),andcertainotherkindsofincomearisingabroad,includingdividendsfromsomeforeign
corporations,foreignpensions,andannuities.
Specialrulesapplytotwocategoriesofincome.First,capitalgainsaregenerallysourcedbasedonthelocationofthe
residenceofthepersonrealizingthegain.However,gainfromasaleofpersonalpropertyoutsidetheUnitedStatesby
aU.S.citizenorresidentalienwillnotbeconsideredforeignsourceunlessaforeignincometaxofatleast10percent
ofthegainisactuallypaid.
Second,passiveforeignsourceinterestincomesubjecttoforeignwithholdingtaxat5percentormore(high
withholdingtaxinterest)andotherpassiveforeignsourceincomearesubjecttoseparateforeigntaxcreditlimitations
designedtoallowcreditwithineachcategoryonlyforforeigntaxesactuallyimposedonincomeineachcategory.
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Thus,excessforeigntaxesincurredonearningsmaynotbeutilizedagainsthighwithholdingtaxinterestorother
passiveincomefromforeigninvestments.
U.S.sourcedeductionsarealsobeneficialfromthestandpointofmaximizingthelimitationandincreasingtheforeign
taxcredit.Mostdeductionsareconsideredtobegeneralinnatureandthereforemustberatablyapportionedbetween
foreignsourceandU.S.sourceincome.However,deductionsthataredirectlyrelatedtoaclassofincomeareallocated
againstsuchincome.Forexample,investmentadvisoryfeespaidtomanageaportfolioconsistingentirelyofU.S.
securitieswouldnormallybeconsideredtobeadeductiondirectlyallocabletoU.S.sourceincome.
Thefollowingisasimplifiedcalculationoftheforeigntaxcreditlimitation.
Example
AmarriedexpatriatewithtwochildrenlivesinBrussels,Belgium.Hehas$114,000ofcompensationincome,
includingallowances,and$6,000ofU.S.sourcedividendandinterestincomein2003.Hespentanumberofwork
daysintheUnitedStates,towhich$6,000ofhiscompensationincomewasallocatedasU.S.sourceincome.His
Belgiantaxliabilityfor2003was$28,000,allattributabletosalary,and$25,000wasdisallowedasallocableto
excludedincome.His2003U.S.incometaxandforeigntaxcreditwouldbecomputedasfollows:

Earnedincome
Dividendsandinterest
Grossincome
Percentageoftotal(rounded)
Foreignearnedincomeexclusion
Housingexclusion(assumed)
Adjustedgrossincome
Itemizeddeductions
(apportionedbasedon
grossincomepercentages
beforeexclusions)
Taxableincome,
beforepersonalexemptions

Foreign
Source

Total

U.S.
Source

$114,000
$6,000

$108,000

$6,000
$6,000

$120,000

$108,000

$12,000

100%
(80,000)
(10,000)

90%
(80,000)
(10,000)

10%

$30,000

$18,000

$12,000

(8,000)

(7,200)

(800)

$22,000

$10,800

$11,200

(12,000)
Personalexemptions

$10,000

Taxableincome

$1,000

U.S.tax,beforecredits

Theforeigntaxcreditwouldbecalculatedasthelesserof(1)actualforeigntax
availableforeachcredit,$3,000($28,000less$25,000),or(2)thelimitation,
whichwouldbecomputedasfollows:

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Foreignsourcetaxableincome

Totaltaxableincomebefore
personalexemptions

$10,800

$1,000
x
=$491
U.S.tax
$22,000

Thetaxpayer'sU.S.taxafterforeigntaxcreditandthestatusofhisforeigntaxcreditsareasfollows:
GrossU.Stax
Foreigntaxcredit
NetU.S.taxdue
Foreigntaxincurred
Disallowed(allocabletoexcludedincome)
Usedasacreditin2002
Availableforcarrybackandcarryover

$1,000
(491)
$509
$28,000
($25,000)
(491)
$2,509

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CarrybackandCarryoverofUnusedCredits
Foreigntaxcreditsthatexceedthelimitationmaybecarriedbacktwotaxableyearsandforwardfivetaxableyears.The
excesscreditmustfirstbecarriedbacktotheearliesttaxableyear,andthenforwardtoeachsucceedingtaxableyear.Foreign
taxcreditscarriedtoaparticulartaxableyeararetreatedasforeigntaxesthatarepaidoraccruedbythetaxpayerinthatyear.
Furthermore,theiruseissubjecttothelimitationcalculationforthatyear.
Iftheforeigntaxisdisallowedinanyyearduetoitsallocationtoexcludedincome,theforeigntaxcreditisforfeitedandis
notavailableforcarrybackorcarryover.
Foreigntaxcreditscarriedtoanotheryeararenotattributabletoforeignearnedincomeexcludedinthatyear.Theforeigntax
creditwouldthereforenotbesubjecttothedisallowanceformulainthecarryoveryear.
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PlanningforUseofExcessCredits
Anexpatriatewhowasabroadforanextendedperiodmayhaveincurredexcessforeigntaxcredits(notallowedinfull,due
tolimitation)resultingfromassignmentsinhightaxforeigncountries.TheseexcesscreditsmaybeusedtoreducetheU.S.
taxliabilityifcarriedovertoayearwithforeignsourceincomethathasnotbeentaxedbyaforeigncountryorthatwas
taxedataratelowerthantheU.S.rate.Generatingforeignsourceincomewithinthecarryforwardperiodmaybeparticularly
usefulafterreturningtoliveintheUnitedStates.Somepossibilitiesforthisare:
Taxablepensionandprofitsharingdistributionsattributabletoemployercontributionswhileforeignservicesare
performed
Stockoptionincomeattributabletoforeignservicecompensationand
Businesstripsabroad,eitherbeforeoraftermovingtothelocationoftheforeignassignment.Incomewouldbe
attributedtotheworkdaysabroadandwouldbeconsideredforeignsourceincomeandprobablynottaxedina
foreigncountry.
Itisimportanttonotethatgeneratingforeignsourceincomewhilelivingabroadwillnotnecessarilybenefitataxpayer
becausetheforeigncountryofresidencemaytaxtheincomeatrateshigherthanintheUnitedStates.Localtaxrulesmust
alwaysbeconsiderediftaxplanningiscontemplatedandifitinvolvestheuseofexcessforeigntaxcredits.

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endeavortoprovideaccurateandtimelyinformation,therecanbenoguaranteethatsuchinformationisaccurateasofthedateitisreceivedorthatitwillcontinuetobe
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situation.
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