The Foreign Tax Credit helps prevent double taxation by allowing you to claim a credit for certain taxes paid to a foreign country or U.S. possession. However, not every foreign tax qualifies.
To claim the credit, the tax generally must be an income tax (or a tax that takes the place of an income tax) that you paid or accrued during the tax year.
Foreign Taxes You Can Claim
You may be able to claim a Foreign Tax Credit for the following types of taxes:
Qualifying Tax Types
- Income taxes
- War profits taxes
- Excess profits taxes
These taxes may be paid to:
- A foreign country
- A U.S. possession
- A political subdivision of a foreign country, such as a province, state, city, or local government
Taxes Paid Instead of an Income Tax
Some countries impose taxes that aren't technically called "income taxes" but serve the same purpose. If a foreign tax is imposed in place of an income tax, war profits tax, or excess profits tax, it may still qualify for the Foreign Tax Credit.
U.S. Possessions Treated as Foreign for FTC Purposes
For Foreign Tax Credit purposes, the IRS generally treats taxes paid to the following U.S. possessions as foreign taxes:
- Puerto Rico
- Guam
- Northern Mariana Islands
- American Samoa
Special Rule for the U.S. Virgin Islands
Taxes paid to the U.S. Virgin Islands are handled differently. Instead of claiming those taxes on Form 1116, use Form 8689 to calculate the allowable credit.
Foreign Taxes That Don't Qualify
Certain foreign taxes are specifically excluded from the Foreign Tax Credit. If a tax falls into one of the categories below, you generally can't claim a credit for it.
Taxes You Weren't Legally Required to Pay
You can't claim a credit for:
- Taxes that weren't legally owed
- Amounts that can be refunded by the foreign country
Taxes Reduced by a Foreign Tax Credit
If a foreign country gives you a tax credit that reduces your foreign tax liability, the reduced portion generally isn't eligible for the U.S. Foreign Tax Credit.
Taxes Imposed Because a U.S. Credit Is Available
Some countries may impose a tax because they know a taxpayer can claim a U.S. Foreign Tax Credit. Those taxes don't qualify for the FTC.
Taxes Paid to Certain Foreign Countries
You can't claim a Foreign Tax Credit for taxes paid to countries that:
- Aren't recognized by the United States, or
- Have been designated by the U.S. Secretary of State as supporting international terrorism
Dividend Withholding Taxes When Holding Period Rules Aren't Met
Foreign withholding taxes on dividends may be disallowed if you didn't hold the stock long enough.
Generally, you must hold the stock:
- At least 16 days during the 31-day period surrounding the ex-dividend date for most dividends, or
- At least 46 days during the 91-day period surrounding the ex-dividend date for certain preferred stock dividends that relate to periods longer than 366 days
Certain Taxes Related to Investment or Hedging Transactions
You generally can't claim a credit for:
- Taxes on property when you're required to make related payments on offsetting positions, such as certain hedging arrangements
- Taxes on income, gain, or property that wasn't held for the required period before the income was received
Taxes Returned to You as a Subsidy
If a foreign government effectively returns the tax to you through a subsidy or similar benefit, the tax generally doesn't qualify for the Foreign Tax Credit.
Certain Foreign Oil and Gas Taxes
Some foreign oil and gas extraction taxes don't qualify, particularly when you don't have an economic interest in the underlying oil or gas property.
Taxes Related to Excluded Extraterritorial Income
You can't claim a credit for taxes imposed on income excluded under Form 8873 (Extraterritorial Income Exclusion).
Covered Asset Acquisition Rules
The disqualified portion of foreign taxes connected to a covered asset acquisition isn't eligible for the credit. These rules typically apply to specialized business transactions involving basis adjustments and won't affect most individual taxpayers.
Taxes Disallowed Under Section 965(g)
Any foreign taxes disallowed under Internal Revenue Code section 965(g) aren't eligible for the Foreign Tax Credit.