US Expat Taxes and the Foreign Tax Credit – Form 1116

When you file your US expat taxes you generally get a foreign tax credit on the amount you have paid, but there are some exceptions that are worth noting. For example, if you have paid taxes in any country that has the designation of supporting international terrorism, by the Secretary of State, you are not eligible for the foreign tax credit on your US expat taxes. These countries include North Korea, Iran, and Cuba.

There are other taxes you can’t claim a credit for on your US expat taxes including:

• Financial service income
• Shipping income
• Income from foreign oil & gas
• Dividends from company 10% to 50% foreign owned
• Dividends from domestic international sales corp.
• Foreign trade income

They may not be taken as a foreign tax credit on your US expat taxes but you can do an itemized deduction on your Schedule A and deduct some of the expenses that way.

US Expat Taxes Carry Forwards & Carry Backs

You may be eligible for a foreign tax credit that is greater than your US expat taxes liability, which is calculated using your expat tax return. If this occurs you are allowed to carry the credit back to the tax year, which precedes the current, or you may elect to carry it forward to a maximum of 10 years. Translated – this means you can opt to use the credit in an attempt to get a refund from your previous year’s taxes or opt to use it in the same manner in the future.

US Expat Taxes - The Alternative

If you paid foreign taxes this year, there are two ways that they may have a positive impact on your US expat taxes.

1. The most helpful is by completing a Form 1116, which we discussed in detail on our site in the US Expat Taxes Explained Series.
2. Elect to use Schedule A creating an itemized deduction against your taxes.

The credit is more appealing simply because you can offset your tax liability dollar- for-dollar. Even if you do not itemize your deduction you can opt to take the credit. However, taking the foreign tax as a deduction can result in a higher tax liability on your US expat taxes.

For example, let’s say in 2009 you and your spouse’s adjusted gross income was $120,000 on your expat tax return, and this includes a $15,000 consulting income, while in Europe. Your consulting income resulted in $3000 in foreign taxes, and you claimed $12,000 in itemized deductions as well as a personal exemption of $7300. The taxable income on your US expat taxes before applying the deduction for foreign taxes you paid is $100,700.

If you decide to take the itemized deduction you would have a taxable income of $99,700, which would mean you owe $15,988 in taxes. If you decide to take the foreign tax credit on your expat tax return your taxable income would not change, $100,700, however your tax liability would be reduced to $13,638 rather than $16,638, saving you a whopping $650.

US expat taxes and the rules associated with them are complex and this is designed only as guidance. Be sure you seek professional help from a US expat tax preparation specialist.