Foreign Tax Credit (FTC)

Detailed Explanation

The Foreign Tax Credit under IRC Section 901 provides a dollar-for-dollar reduction of US tax for foreign income taxes paid or accrued. It is the primary mechanism for preventing double taxation when a US person earns income from a foreign source. The credit is computed on Form 1116 (individuals) or Form 1118 (corporations) and applied against US tax liability. Critical limitation: the FTC cannot exceed the US tax attributable to foreign-source income (the "Section 904 limit"). The limit is calculated by taking foreign-source taxable income divided by total taxable income, multiplied by US tax. Foreign income falls into separate "baskets" that are computed independently (each with its own limit): passive category (interest, dividends, capital gains), general category (wages, business income), GILTI category, foreign branch category, and a few specialized buckets. Excess credits in a given year and basket can be carried back 1 year or forward 10 years (carrybacks must be filed within 10 years of the original return). For high-tax-country expats, FTC is usually more beneficial than the FEIE: foreign tax paid on wages often equals or exceeds the entire US tax liability, eliminating it without giving up earned income for IRA contributions. For low-tax-country expats, FEIE may be better. A combined approach (FEIE up to $130K then FTC on the excess) is also available. Election: FTC can be deducted instead of credited (rarely better, since deduction value is at marginal rate vs full dollar credit).