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Foreign Tax Credit • U.S. citizens and residents compute their U.S. taxes based on their worldwide income. This sometimes results in U.S. citizens having to pay tax twice on the same income: once to the U.S. government and once to the government of the foreign country where the income was earned.
Foreign Tax Credit • The foreign tax credit was created to help taxpayers avoid this double taxation. It allows taxpayers to take a tax credit for taxes paid to a foreign government on foreign source income that is subject to U.S. tax. Like other nonrefundable credits, the foreign tax credit allows taxpayers to take a dollar-for-dollar reduction in the amount of U.S. tax owed. However, there are cases in which not all taxes paid to a foreign government on foreign-sourced income can be used in the computation of the credit.
Four tests must be met to qualify for the credit • The tax must be imposed on the taxpayer • The taxpayer must have paid or accrued the tax • The tax must be a legal and actual foreign tax liability, and • The tax must be an income tax
