Chapter 17: How to get “credit” for taxes (foreign) paid to your country of residence

The United States will give you “some” but NOT all credit for non-U.S. taxes paid to your country of residence. In other words, you will NOT get credit for all taxes paid to your country of residence.

In order for you to get “credit” for a tax paid to your country of residence it must be recognized as a “tax” under U.S. law. Even then, then you may or may not get credit for the “tax” paid.

Non-creditable taxes (ouch!) commonly paid to non-U.S. governments

You know the answers.

  1. It includes the “sales tax” or common “VAT” tax that is imposed in many countries (including Europe and Canada). These are very significant sums paid. They are a significant percentage of the total tax you pay to your country of residence. Yet, you will get no credit for them under U.S. law.
  2. Social Security taxes in a country that does not have a “Totalization Agreement” with the U.S. government.

Non-creditable taxes (when filling out your local tax return) that have been paid to the U.S. government

  1. Possibly the brand new and exciting “Obamacare Surtax”! If Americans don’t pay for the medical care of Homelanders, then who else will?
  2. The U.S. capital gains tax on your principal residence.

The point is that the Americans abroad will be subjected to double taxation and the worst of the rules of the United States and your country of residence.

There are two ways to get some “credit” for some of the taxes you have paid to other countries.

1. Taxes that may be taken as “Itemized Deductions” but are not subject to the “Foreign Tax Credit” (Form 1116) rules.

An example of this might be property taxes paid on your principal residence.

2. Taxes that may be taken as “Foreign Tax Credits” (Form 1116)

Earned income: The taxes paid in your country of residence may (in general) be taken as a tax credit ONLY against U.S. taxes imposed on “Earned income”. Think wages, salaries and small business (non incorporated) profits.

Passive income: Passive income includes: dividends, interest and capital gains. In general the non-U.S. taxes that you pay on “passive income” can be taken ONLY as a “tax credit” against U.S. tax imposed on the same income.

Income resourced by treaty: Harder to understand but a separate bucket. Here is an example of how that might work.

“Earned income”, “passive income” and “income resourced by treaty” are treated as separate “baskets of income”. In both cases you an “build up” significant “foreign tax credits” that can be used in other years. This is why you would want to use “Foreign tax credits”. (Plus you will get a better result than using them as an itemized deduction.)