Foreign Tax Credit: How To Avoid Double Taxation on International Income

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If you earn income outside the U.S. — whether from working abroad, investing internationally or receiving foreign retirement income — you may face taxes from two countries on the same dollars. The foreign tax credit exists to prevent that outcome.

When used correctly, this credit reduces your U.S. tax bill dollar for dollar for income taxes you already paid to a foreign government. For some taxpayers, that can mean saving hundreds or even thousands of dollars each year.

Below is a complete guide to how the foreign tax credit works, who qualifies, how it’s calculated and how to claim it correctly under current IRS rules.

Quick Answer: What Is the Foreign Tax Credit?

The foreign tax credit is a direct credit against your U.S. income tax for foreign income taxes you paid or accrued.

Unlike a deduction, which reduces taxable income, a credit reduces your tax bill one dollar for every dollar of qualifying foreign tax paid.

Example:If you owe $5,000 in U.S. tax and paid $3,000 in qualifying foreign income taxes, the credit reduces your U.S. tax to $2,000.

Why the Foreign Tax Credit Exists

The Internal Revenue Service taxes U.S. citizens and resident aliens on worldwide income, regardless of where it’s earned.

Without the foreign tax credit, the same income could be taxed:

• Once by the foreign country, and
• Again by the United States

This situation is known as double taxation, and the foreign tax credit is designed specifically to prevent it.

Who Qualifies for the Foreign Tax Credit 

The credit is available to a broad range of taxpayers — not just expats.

U.S. Taxpayers With Foreign Income 

Any U.S. citizen or resident alien who pays income tax to a foreign country can claim the credit.

Wages earned abroad qualify if a foreign country withheld income taxes. Self-employment income earned abroad also qualifies. Retirement or pension income may qualify if foreign sources withhold taxes on distributions.

Investors With Foreign Taxes Paid 

You don’t need to live or work abroad to benefit. Many investors pay foreign taxes without realizing it.

Dividends from international stocks often have foreign taxes withheld at the source. Mutual funds and ETFs with foreign holdings pay foreign taxes on international dividends and interest, reporting your share on Form 1099-DIV, Box 7.

Which Foreign Taxes Qualify for the Foreign Tax Credit?

Foreign Tax Credit vs Foreign Earned Income Exclusion

If you work abroad, you may hear about two different tax benefits. They are not the same, and you generally can’t use both on the same income.

Key Differences at a Glance

Which Option Makes Sense for You 

Low-tax or no-tax foreign country with earnings under $130,000: The exclusion often makes more sense.

High-tax foreign country: The credit typically provides better results. When foreign rates exceed U.S. rates, the credit eliminates your U.S. tax liability.

Both earned and investment income: Use both strategies–exclusion for earned income and credit for investment income.

For retirement or passive investment income, use the credit since the exclusion doesn’t apply.

How the Foreign Tax Credit Is Calculated

The IRS limits the credit so it only offsets U.S. tax on foreign-source income.

The Limitation Formula

Maximum credit =U.S. tax x (Foreign-source taxable income ÷ Total taxable income)

You can claim the lesser of:

• Foreign taxes actually paid, or
• The IRS limitation amount

Unused credits aren’t lost. You can:

• Carry them back one year, or
• Carry them forward up to 10 years

Foreign Tax Credit Examples 

Here’s how the credit works in different taxpayer situations. 

Example for an Expat Worker 

Sarah works in Germany, earning $140,000 annually. Germany withholds $42,000 in income taxes. Her U.S. tax liability on that income would be $28,000 before any credits.

Using the Foreign Earned Income Exclusion: Sarah excludes $130,000. Her remaining balance was taxed at higher marginal rates. She cannot claim foreign tax credits on excluded income. 

Using the Foreign Tax Credit: Sarah claims the full $42,000 in foreign taxes against her $28,000 U.S. tax liability. The credit eliminates her U.S. tax bill completely, and she can carry forward the excess $14,000 credit to future years.

The foreign tax credit provides better results here because Germany’s tax rates exceed U.S. rates.

Example for an Investor 

Michael owns international mutual funds that paid $1,200 in foreign taxes on his behalf in 2025. His Form 1099-DIV reports this in Box 7. His total U.S. tax liability is $15,000.

Michael claims the $1,200 foreign tax credit, reducing his U.S. tax liability to $13,800. Since the amount is under $300 ($600 for joint filers), he can claim it directly on Schedule 3 without filing Form 1116. 

How To Claim the Foreign Tax Credit 

Claiming the credit requires specific forms and documentation, though smaller amounts have simplified filing options.

Most taxpayers claim the credit using Form 1116 (Foreign Tax Credit). This form requires detailed reporting of foreign income, taxes paid, and calculations to determine your allowable credit.

For smaller amounts — under $300 ($600 married filing jointly) — you may claim the credit directly on Schedule 3 without Form 1116, but only if the income is passive (dividends, interest, royalties) and reported on a U.S. tax form.

These are the documents you’ll need:

• Foreign tax returns.
• W-2s.
• 1099 forms showing foreign taxes withheld.
• Foreign bank statements showing withholding.
• Proof of payment to foreign tax authorities.

Remember: The calculations can become complex with multiple income sources or countries. The limitation must be calculated separately for different income categories. If you have substantial foreign income, consulting a tax professional experienced in international taxation often proves worthwhile.

Common Foreign Tax Credit Mistakes

Here are the most frequent errors to avoid:

• Claiming non-qualifying taxes: Property taxes, VAT, and sales taxes don’t qualify regardless of amount. Only income taxes and certain taxes other than income tax are eligible.
• Double-dipping with exclusions: You can’t claim a foreign tax credit on income you’ve excluded using the foreign earned income exclusion.
• Missing carry-forward opportunities: If your foreign taxes exceed the limitation in one year, carry those credits forward for up to ten years.
• Misreporting investment income. Check Box 7 of Form 1099-DIV, as many overlook this line.

Does the Foreign Tax Credit Increase Audit Risk? 

Nobody wants to get audited, so this is a common concern, but the reality is more nuanced than many taxpayers assume.

Filing for the foreign tax credit does not automatically increase audit risk. The IRS expects international taxpayers to claim this credit when they’re eligible. 

What triggers scrutiny: 

• Claiming unusually large credits relative to income.
• Inconsistent reporting across years without explanation.
• Claiming credits on clearly non-qualifying taxes.

To file accurately, keep detailed documentation of all foreign income and taxes, file all required international information returns (FBAR and Form 8938), report foreign income consistently with foreign tax returns, and correctly categorize income types.

Legitimate foreign tax credits backed by proper documentation should not trigger an audit. The credit exists for taxpayers with international income, so take advantage of it if you qualify.

Final Take to GO

The foreign tax credit is one of the most valuable tools available to U.S. taxpayers with international income. By allowing a dollar-for-dollar reduction for qualifying foreign income taxes paid, it prevents double taxation and protects your after-tax returns.

If you earn income or hold investments abroad, reviewing your eligibility for the foreign tax credit could make a meaningful difference in your tax bill.

Data is accurate as of Jan. 27, 2026, and is subject to change.

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