# How foreign tax credit works?



## vogener83

Hello,

I'm preparing my amended tax returns (3 years). The first year has been done and I received the surprise that I owe taxes to the US ($5,000), even after paying higher taxes in the foreign country for the income obtained there. 

So, I don't understand the purpose of a dual taxation agreement to avoid you paying taxes in both countries.

My accountant told me that there is a foreign tax credit limit, and then you can carry over the remaining as a credit. But again, this remaining credit can't be applied to the next year due to the "foreign tax credit limit"... Isn't it crazy?

Please, can you help me understand how that credit limit is calculated?

Does it matter the place where you were living while gaining the foreign income? I was living in the US, but now I'm living in Germany.

If from now on I continue living in Germany will this situation help me avoid paying double taxes or I will have to pay taxes in Germany and taxes to the US?

Thanks so much,
vogener


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## Bevdeforges

I'm moving this post over to the Expat Tax section. There is quite a bit of information there that may be of use to you.
Cheers,
Bev


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## Bevdeforges

Without knowing precisely what your situation is, it's hard to understand what your accountant means about the foreign tax credit "limit."

But basically, with the foreign tax credit, you pay taxes to the country in which you are residing. Then you do your US taxes, and figure out how much tax you would owe. You then take a tax credit against your US tax liability for the income taxes you paid to your country of residence.

Now, there are a couple of mitigating factors to consider. The main one is the tax treaty - in your case, the US-German tax treaty - which spells out what sorts of income are taxable by which country. Ultimately, the idea is supposed to be that you wind up paying tax to the country from which the income came, though there are always exceptions to that rule.

But the other big consideration is that for US tax purposes, you can take a tax credit only for "income taxes" as recognized by the IRS. 

And, another consideration is the type of income you have. If you are working in Germany, you could also simply "exclude" your salary income, using the FEIE (Foreign Earned Income Exclusion) and if you do that, then the Foreign Tax Credit only applies to "unearned" (i.e. passive) income like interest, dividends and rents.

That's just a basic introduction to the subject. Take a look around this section of the forum, as there are lots of threads that deal with the FTC and FEIE.
Cheers,
Bev


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## vogener83

Thanks, I'll take a look in that section


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## vogener83

Hello,

I've been taking a look to some information about the tax credit limit and is quite complicated how they calculate everything.

Anyway, the thing is that before amending my tax return, the US refunded me $500 on US income. After amending my tax return including my foreign income, I have to pay $5,000!!! In my foreign country I paid about 38% in taxes, I believe a higher percentage than the one applied in the US system. But even after that, you have to pay to the US!!! Totally unfair...

Thanks


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## Bevdeforges

Just had a look at the IRS material on the FTC limit and it seems that you're limited to the proportion of your foreign income to your total income. So, if your foreign income is 30% of your total income (US plus foreign), your FTC limit is 30% of your total US tax liability no matter how much foreign tax you paid on that foreign income.

https://www.irs.gov/individuals/international-taxpayers/foreign-tax-credit-how-to-figure-the-credit
or you can take a look at IRS Publication 514 on the FTC to see if there might be any other option available to you.
Cheers,
Bev


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## JustLurking

vogener83 said:


> ... the US refunded me $500 on US income.


It sounds like this is the result of a year in which you received both US source and non-US source income?

Under the US/Germany treaty, articles 14 and 15, each country can fully tax income sourced in that country, and the other country gives a credit. This operates both ways. So... if you have a mix of US source and German source income, you can only get US foreign tax credit based on the ratio of those two. In other words, the US will fully tax your US source income portion, and allow you a foreign tax credit for the tax on the non-US part.

However, the reverse should also apply, so that Germany ought to allow you a foreign tax credit for the US tax you paid on the US source part of your income. In short, then, you should be able to obtain a credit against your German tax for anything you wind up paying in US tax on US source income that is also taxable in Germany.

Now... you mention amending back for three years. It is possible that the year giving rise to the US tax is just the year in which you moved out of the US, when you would have had US source income before departing? In that case, while you are entitled to a German tax credit on US tax for this year, it may be tricky to obtain because of the time lag -- depends on how long Germany allows you to go back and amend past returns.


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## Bevdeforges

Not sure how taxes work in Germany, but it isn't always the case that you get a direct dollar-for-dollar (or euro-for-euro) credit against taxes paid in the "other" country. And, normally speaking, the source country is given "first dibs" on taxing the income, leaving the taxpayer to deal with the "other" country's mechanism for "avoiding double taxation."

Just as an example, France grants tax credit in the amount of the French tax the foreign income generates (for foreign source income that is not taxed in France under treaty provisions), without regard to whatever taxes you paid in the source country.

I think part of the issue may be that the OP was resident in the US at the time that the foreign income was received. 
Cheers,
Bev


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## JustLurking

Bevdeforges said:


> I think part of the issue may be that the OP was resident in the US at the time that the foreign income was received.


Perhaps, although I somehow got the opposite impression -- that the OP was in Germany while receiving some US source income, making that part fall within both the US and German tax nets. In that case the US gets first dibs, as you say, but Germany should allow a credit to avoid double-tax on the 'overlap'.

My _guess_ is that this is a transitional year thing, and won't occur in future. Can't tell from the information supplied, though.


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## javcp

I recently filed the last 3 years. I´m Spain / US citizen. I´m paying in Spain 35% taxes. I run both scenarios FTC and FEIE. No US income. 100% from Spain. FEIE is a better option. With FTC I had to pay because of the AMT (form 6251). With FEIE you owe $0, but you have less foreign tax credits which obviously I didn´t care.
By the way, you need a US credit card if you want to purchase any commercial SW to prepare previuos years taxes.
Good luck!


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## Bevdeforges

javcp said:


> By the way, you need a US credit card if you want to purchase any commercial SW to prepare previuos years taxes.
> Good luck!


And, it can vary from one vendor to the next as to what constitutes a "US credit card." I have a credit card issued in the US from a US bank, but some vendors reject it because my billing address is here in France. 
Cheers,
Bev


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## vogener83

Thanks everybody for your valuable answers!


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