Research Tax Topic: Foreign Tax Credit.
The United States taxes its residents on a worldwide basis.S resident's income is tax even though it is earned in another country. For that reason, taxpayers are permitted to claim a credit for foreign taxes paid on foreign income. If you work in a country other than the one where you live, and if both countries impose income taxes on earned income, then you should be familiar with the concept of a "foreign tax credit". Foreign tax credit is a tax break available to most U.S taxpayers. .
The U.S and major countries of the world are part of the tax treaties that prevent citizens and businesses that work in multiple countries from being subject to double taxation in both the home and host country. No country provides an unlimited foreign tax credit. For instance, the U.S. tax code provides for a tax credit for taxes paid to other countries but only up to the amount of taxes that would have been paid to the U.S. on the same income. .
The IRS provides two methods for claiming the foreign tax credit. The first method is to claim the foreign taxes reported in 1099-DIV, 1099-INT, or on the statement provided by the broker, as an itemized deduction. That tax amount will increase your itemized deductions, which will lower your taxable income amount and finally produce a smaller tax bill. For example, in an average tax rate of 25%, you save $25 for every $100 of foreign tax paid. The second method for claiming foreign tax is as a tax credit. Tax credits cut your tax bill dollar for dollar because you subtract them directly from the final tax you owe. For example, claiming the foreign tax credit save you $100 for every $100 of foreign tax paid and in a 25% tax bracket that is $75 more than claiming the itemized deduction. Generally, if the U.S. tax rates are higher, the foreign earned income exclusion is better than the foreign tax credit. .
The U.S. foreign tax credit is not limited to taxes on earned income.