how the foreign tax credit works
if you paid taxes to a foreign country or u s possession and are subject to u s tax on the same income you can take an itemized deduction or a credit for those taxes reported as a deduction on schedule a of your 1040 or 1040 sr the foreign income tax reduces your u s taxable income conversely the foreign income directly reduces your u s tax liability if you take the credit if you opt for the tax credit you must complete form 1116 and attach it to your u s tax return 1you must take a credit or a deduction for all qualified foreign taxes you can t take the credit for some of your foreign taxes and a deduction for others and you can t claim both a credit and a deduction for the same tax 1taking the credit usually makes financial sense because the amount reduces your actual tax bill instead of just lowering your taxable income the tax break reduces the double tax burden that would otherwise arise if you were taxed on the same income twice generally only income war profits and excess profits taxes are eligible for the credit foreign taxes on wages dividends interest and royalties also qualify the irs specifies that the tax must be a levy that is not payment for a specific economic benefit and it must be similar to a u s income tax you can also claim the credit on foreign taxes that aren t imposed under a foreign income tax law if the tax is in lieu of income war profits or excess profits tax in this situation the tax must be imposed in place of an income tax the country otherwise imposes 2foreign tax is typically imposed in a foreign currency use the exchange rate in effect on the date you paid the foreign tax the tax was withheld or you made estimated tax payments 3other foreign taxes such as foreign real and personal property taxes do not qualify for the foreign tax credit but you may be able to deduct these other taxes on schedule a of your income tax return even if you also claim the foreign tax credit you can deduct foreign real property taxes unrelated to your trade or business however other taxes must be expenses you incur in a trade or business individuals estates and trusts can use the foreign tax credit to reduce their income tax liability additionally taxpayers can carry any unused foreign tax back for one year and then forward up to 10 years 4