A foreign tax credit (or deduction) allows a citizen who earned income in another country to reduce the amount of domestic income taxes owed if the foreign government has already taxed the income abroad.
Workers who earn income in a foreign country may be entitled to a credit or deduction on their domestic income taxes if they show that this income was already taxed by the foreign government where the income was earned. In the US, there are at least three types of foreign income tax exemptions, with a foreign tax credit being one of them.
Ex-patriot workers can take a Foreign Earned Income Exclusion up to $100,800 (in 2016), which reduces the amount of their income which will be subject to income taxes in the US, but it will be taxed at the brackets applicable if the exclusion had not been taken. They may also be eligible for a foreign housing credit, which will increase their total exclusion amount by up to $30,000 or more if they are paying a substantial amount for housing abroad, or if the company is paying for it but it is part of the employee’s reported income.
The Foreign Tax Credit can be taken instead of these two options, or, if the individual has earned income over and above those exclusions which has also been taxed abroad already, they can apply the Foreign Tax Credit to reduce the amount of domestic income tax owed.
Tax credits reduce dollar-for-dollar the amount of taxes owed, while deductions reduce the amount of taxable income considered. Tax credits are often categorized as non-refundable, meaning you can’t get an actual refund using them and you usually can’t carry them forward. The Foreign Earned Income Credit is a non-refundable credit.
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