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What is a Foreign Tax Credit?

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  • Written By: Mary McMahon
  • Edited By: O. Wallace
  • Last Modified Date: 23 June 2018
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    Conjecture Corporation
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A foreign tax credit is a credit which is designed to prevent people from paying taxes twice when they declare income earned in a foreign country in their home nations. The mechanics involved in filing a foreign tax credit vary and it is advisable to retain an accountant to assist with tax returns which involve foreign income because there may be special circumstances which complicate the situation. People want to avoid overpaying or underpaying taxes on all their income, not just foreign income, and sometimes navigating the tax forms can be confusing.

In many nations, people need to declare all their income, no matter where it was earned, on their taxes. However, if some or all of the income was earned overseas, presumably the taxpayer has already paid taxes to a foreign government. If the taxpayer paid taxes again on that income, this would result in double taxation, which is deemed unfair. With double taxation, situations could even arise in which people pay for the privilege of earning money overseas.

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Thus, people can use a foreign tax credit to offset the total amount of taxes due. If someone determines, for example, that he or she would owe $12,000 United States Dollars (USD) on foreign income but has already paid $8,000 USD to a foreign government, that person would only need to remit $4,000 to the United States Treasury. Conversely, however, if someone owed $12,000 USD and had paid out $14,000 USD, the Treasury would not issue a refund check, because the taxes were paid to a different government.

It is also possible to take a foreign tax deduction, which will reduce total tax liability. This is possible for people who use itemized deductions on their tax returns. However, it is important to be aware that the foreign tax credit may potentially be more advantageous. An accountant can review the situation and provide specific advice about whether a tax credit or tax deduction would be the best choice.

Different nations have different standards when it comes to applying the foreign tax credit. People who know that they will be earning foreign income may want to consider looking up the related documentation ahead of time so that they know how to declare and handle it on their taxes. People who retain accountants can ask their accountants for advice and may also want to ask if there is anything they can do to streamline the filing process.

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