Paying taxes to multiple countries on the same income feels like getting robbed twice for the same crime. The US taxes your worldwide income even if you live abroad. Other countries tax income earned within their borders. You end up in the middle paying everyone.
The Foreign Tax Credit exists to prevent this double taxation mess. But like most tax rules, it comes with complications and limits that can trip you up if you’re not careful.
Getting this right can save thousands of dollars. Getting it wrong means overpaying taxes to someone.
The Basic Concept Makes Sense
The Foreign Tax Credit lets you reduce your US tax liability dollar-for-dollar for income taxes paid to foreign countries. If you paid $5,000 in German taxes on income that also gets taxed in the US, you can credit that $5,000 against your US tax bill.
This only applies to income taxes. Sales taxes, VAT, property taxes, and other foreign levies don’t qualify for the credit.
The foreign tax must be imposed on you personally. Taxes paid by your employer or withheld from investment accounts might not count unless properly structured.
Not All Foreign Taxes Qualify
The foreign levy must be a tax in the US sense of the word. Some countries call fees or assessments “taxes” but they don’t qualify for the credit.
The tax must be based on income. A flat fee for working in a country doesn’t qualify even if they call it an income tax.
You must be legally liable for the foreign tax. If your employer pays foreign taxes on your behalf as a benefit, those payments might be taxable income to you but don’t generate credits you can use.
Credit Limitations Get Complicated
You can’t credit more foreign taxes than you actually owe in US tax on your foreign income. The credit gets limited to the US tax attributable to foreign source income.
This limitation gets calculated separately for different types of income. Passive income like dividends and interest has one limitation. General income like wages has another.
High-tax countries can create excess foreign tax credits that you can’t use immediately. Low-tax countries might not generate enough credits to offset your full US liability.
Many expats find that properly calculating and claiming the foreign tax credit requires careful planning to maximize the benefit while staying compliant with complex limitation rules.
Timing Matters for Credit Claims
You can choose to claim foreign tax credits in the year you pay the foreign taxes or when they’re assessed. This choice can affect your total tax liability across multiple years.
Some foreign countries have different tax years than the US. You might pay foreign taxes in December for income earned throughout their fiscal year that doesn’t match the US calendar year.
When Credits Beat Exclusions
The Foreign Earned Income Exclusion and Foreign Tax Credit can’t be used on the same income. You have to pick one.
If you live in a high-tax country like Germany or France, the credit often saves more money than the exclusion. You get to offset high foreign taxes against your US liability.
If you live in a low-tax or no-tax country, the exclusion usually works better since there are few or no foreign taxes to credit.
Plan Your Foreign Tax Strategy
Consider your total tax burden across all countries when planning international moves. Sometimes paying slightly more foreign tax generates credits that reduce your overall liability.
The rules are complex enough that professional help often pays for itself in tax savings and compliance peace of mind.
