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A foreign tax credit (FTC) is generally allowed for income taxes paid to foreign countries or U.S. possessions, provided the levy is a tax (not a payment for services) and is imposed on net income.
A tax qualifies as a net income tax if it:
- is triggered by a realization event,
- is based on gross receipts,
- allows recovery of significant costs, and
- applies to income with sufficient nexus to the jurisdiction.
Certain withholding taxes may still qualify if they effectively apply to net income. Taxes imposed in lieu of an income tax may also be creditable.
FTC is calculated separately across four income categories:
- Global intangible low-taxed income (GILTI)/net CFC tested income (NCTI)
- Foreign branch
- Passive
- General
This “basket” system limits cross-crediting. Credits are limited to U.S. tax on foreign-source income in each category, with excess credits carried back one year or forward 10 years.
U.S. Income Tax Implications
- FTCs reduce double taxation but are limited by income category.
- Proper income classification is critical to maximize credit utilization.
- Excess credits may be carried back 1 year or forward 10 years.
- Claimed on Form 1118 (corporations) or Form 1116 (individuals), with additional reporting (e.g., Form 5471) as applicable.
Additional Resources:
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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