The Foreign Tax Credit (Form 1116), explained

The Foreign Tax Credit (FTC), claimed on Form 1116, is the IRS's answer to double taxation. If a foreign government already taxed your income, the U.S. lets you credit that foreign tax — up to the U.S. tax that would have applied to the same income — against your U.S. bill. Dollar for dollar.

It is the most powerful tool most Americans abroad have. It is also more complicated than the Foreign Earned Income Exclusion, which is why a lot of filers default to FEIE even when FTC would save them more money long-term.

This article is the conceptual walk-through of Form 1116. For the high-level FEIE-vs-FTC choice, see FEIE vs. Foreign Tax Credit.

The core mechanic

You take foreign income tax paid (or accrued, if you elect accrual) during the year and credit it against your U.S. tax — up to a ceiling.

The ceiling, called the FTC limit, is:

FTC limit = (foreign-source taxable income / total taxable income) × U.S. tax before credits

In English: you can credit foreign tax up to the share of your U.S. tax bill that corresponds to your foreign-source income. The IRS won't let foreign tax credit shelter your U.S.-source income — only the foreign-source part.

If your foreign tax exceeds the FTC limit, the excess carries forward up to 10 years (and back 1 year). This is the killer feature most filers miss.

What counts as "foreign income tax"

You can claim FTC for any income tax (or tax in lieu of income tax) imposed by a foreign country or U.S. possession, as long as:

• The tax was actually paid (or accrued) by you.
• It was imposed on you specifically — not, say, a value-added tax that everyone pays.
• It was a true income tax, not a soak-up tax, sales tax, property tax, social security tax (with treaty exceptions), or a windfall tax that the U.S. has specifically disallowed.

Yes:

• German Einkommensteuer + Solidaritätszuschlag
• UK Income Tax + capital gains tax
• Japanese national + prefectural + municipal income tax
• Korean 종합소득세
• Canadian federal + provincial income tax
• Spanish IRPF
• French IR + (with some nuance) PUMA / CSG

No (or partial):

• VAT, GST, sales tax
• Property tax / wealth tax (separate credit/deduction rules)
• Social security contributions (treaty-dependent — see below)
• The French CSG/CRDS — historically disputed; the U.S. now allows it as a credit after a 2019 ruling, but check current guidance

For social security taxes, see totalization agreements. Generally, social security contributions are not creditable as income tax, but a totalization treaty may exempt you from one country's social security tax entirely.

The basket system

This is where most filers get lost. The IRS does not let you mix and match all foreign income and tax into one big credit pool. Instead, foreign income is divided into separate categories ("baskets") and you compute a separate FTC limit for each.

The main baskets for individual filers:

1. Passive category income — interest, dividends, capital gains, rents, royalties.
2. General category income — wages, self-employment, and most other active income.
3. GILTI category — global intangible low-taxed income (almost always for owners of foreign corporations; usually not relevant to salaried expats).
4. Foreign branch category — for filers with a foreign branch (sole proprietorship treated as a permanent establishment abroad).
5. Section 951A category, treaty re-sourced income — niche cases.

For a typical salaried expat in Germany with a small foreign brokerage:

• Salary and bonus → General basket
• Bank interest and dividends from German broker → Passive basket
• Capital gains on a fund sale → Passive basket

You compute FTC limits separately for each basket. Excess credit in one basket cannot offset tax in another. This is the rule that makes a single Form 1116 inadequate for most expat returns — you usually need at least two (general + passive).

Worked example

You're a U.S. citizen in Tokyo. 2025 numbers:

• Salary: $150,000 (foreign-source, general basket)
• Japanese tax on the salary: $40,000
• Dividends from a Japanese brokerage account: $5,000 (foreign-source, passive basket)
• Japanese tax on the dividends: $1,000

You don't elect FEIE.

U.S. side: Total income $155,000, standard deduction $14,600, taxable income $140,400, U.S. tax before credits ≈ $26,500.

General basket:

• Foreign-source taxable income (after deductions allocated): ≈ $135,800
• FTC limit = ($135,800 / $140,400) × $26,500 ≈ $25,630
• Japanese tax in basket: $40,000
• Credit used: $25,630
• Carryforward: $40,000 − $25,630 = $14,370

Passive basket:

• Foreign-source taxable income (after deductions allocated): ≈ $4,600
• FTC limit = ($4,600 / $140,400) × $26,500 ≈ $870
• Japanese tax in basket: $1,000
• Credit used: $870
• Carryforward: $130

Combined: $26,500 in U.S. tax fully offset by $26,500 in credits used. U.S. tax owed: $0. Plus $14,500 of unused credits available to absorb future U.S. tax in those baskets for the next 10 years.

That carryforward is real money. A future year with a U.S.-taxable bonus, capital gain, or partial-year repatriation can absorb it.

The carryback / carryforward rules

Excess foreign tax credit:

• Carries back 1 year: you can amend the prior year's 1116 to absorb the credit.
• Carries forward 10 years: applied first-in-first-out against future basket limits.

Track these on Form 1116 Schedule B (added in recent years) — historically, expats lost carryforwards because nobody maintained the basket-by-basket ledger.

If you stop filing FTC and switch to FEIE for several years, your carryforwards just sit there. They expire 10 years after the year they were generated. Switch back to FTC within that window and you can use them.

Cash vs. accrual

You can elect to claim FTC on a paid basis (default) — credit the tax in the year you paid it — or on an accrued basis — credit the tax in the year the income was earned, regardless of when paid.

For most filers, paid is fine. Accrued matters when:

• Foreign tax is assessed in a different year than the income (common in France, Spain, and other countries with annual assessments arriving months after year-end).
• You want to match U.S. and foreign treatment for capital gains timing.

The election to use accrual is binding for all future years; once made, you can't go back to cash without IRS consent.

When you do not file Form 1116

A small simplification: if your total foreign tax paid is $300 or less ($600 MFJ), it's all from passive income reported on 1099s, and you don't itemize, you can take the credit directly on Schedule 3 of your 1040 without filing Form 1116 at all. The IRS calls this the "high-income, simple" exception. Most expats don't qualify because their general-basket tax exceeds $300.

Common mistakes

• Mixing baskets. Filing one Form 1116 with all your foreign income lumped together. The IRS will recompute and disallow.
• Forgetting the carryforward. Filing in year 1 with $14,000 of carryforward and then not tracking it on Form 1116 Schedule B in subsequent years.
• Claiming FTC on FEIE-excluded income. Foreign tax on income you excluded with Form 2555 is not creditable — it's like the income never existed for U.S. tax purposes.
• Crediting non-income tax. Social security contributions (without a totalization treaty), VAT, property tax — none of these are income tax for FTC purposes.
• Wrong sourcing. A bonus paid by a foreign employer for U.S. work days is U.S.-source income, not foreign-source. Re-sourcing requires a treaty position.
• Crediting tax someone else paid. Tax withheld on dividends paid into your account is fine. Tax paid by a corporation you own (other than via GILTI) is not your tax.

Deduction alternative

Instead of claiming a credit, you can elect to deduct foreign income tax as an itemized deduction on Schedule A. This is almost always worse — a deduction at, say, the 22% bracket gives you 22 cents back per dollar of foreign tax, whereas a credit gives you a full dollar back up to the limit.

Deduction is only better if you have so little U.S. tax that the credit goes to waste (FTC is non-refundable — it can take you to $0 but not below) and you can't carry the excess forward to a useful year.

Practical tips

• Use software designed for expat returns. TurboTax handles basic FEIE but Form 1116 — especially with multiple baskets and carryforwards — gets messy. Drake, Lacerte, ProSeries, or expat-focused tools (MyExpatTaxes, OLT) are better.
• Keep your foreign tax assessment documents. Year-end statements, tax notices, withholding certificates — the IRS will ask under audit.
• Track foreign tax paid in USD using the appropriate rate. Generally the spot rate on the date you paid (or accrued).
• Reconcile to your foreign return. If you paid $40,000 of German tax according to your Lohnsteuerbescheinigung, that's what goes on Form 1116 — not your withholding through October.

Next steps

• FEIE vs. Foreign Tax Credit — the strategic choice
• Treaty-based positions — when a treaty changes the answer
• Child Tax Credit from abroad
• Totalization agreements