American companies who do business abroad or foreign nationals who do business and make money while in the United States are required to pay taxes on their income. However, tax laws are immensely complex, and depending on where income is earned, an individual’s residency for tax purposes, or the structure of the income producing business, it may be necessary to pay taxes both in the United States and abroad. In some cases, this could lead to double-taxation of income, particularly if earned income is moved between bank accounts in multiple countries without careful consideration of the taxes consequences. Thankfully, with careful planning it is possible to substantially minimize, if not entirely avoid, paying taxes twice on the same income. One major way to avoid being double-taxed on income, is to take advantage of a foreign tax credit. In order to maximize your savings and claim the largest credit, you will need to learn about how the foreign tax credit works and plan accordingly. Here is what you need to know about the foreign tax credit.
How the Foreign Tax Credit Works
Many business owners and corporate accountants are unaware of just how immensely complex international tax matters can be. However, because you may be required to pay income taxes abroad, you may be able to alleviate some of your domestic tax burden.
The first and arguably most important thing you should know: the tax credit is only available on foreign sources of income that you would have to claim on your U.S. tax return, and is therefore not available for taxes paid to a foreign country that do not simultaneously result in U.S. income tax liability. However, U.S. companies who earn income abroad and are required to pay taxes on that income in the country where the income was earned could possibly qualify for this credit.
How much of the taxes paid can you claim a credit for? The answer depends heavily on the tax rate of the country in question. If the country has a tax rate that is equal to or higher than the U.S. tax rate, then the U.S. tax credit will offset your full U.S. tax liability for the income produced in the foreign country and taxed in the foreign country. If the country in question has a lower tax rate than the U.S., then the credit is limited to the rate and amount of foreign taxes actually paid. In other words, if your U.S. tax rate is 20 percent, and your tax rate abroad is 15 percent, then you can claim a tax credit for the 15 percent you paid abroad, but you would owe taxes for the remaining five percent in the U.S.
It is important to note, not all income qualifies for the foreign tax credit. However, the list is rather broad. According to section 901(b) of the U.S. Tax Code, you can claim a credit for “any income, war profits, and excess profits taxes paid or accrued… to any foreign country or to any possession of the United States.” This means any taxes you pay on any profits or income you make as a result of your business dealings abroad can potentially be applicable for a credit. Additionally, the second part of that code is what surprises many people about this credit: it also applies to business done in U.S. territories and holdings, which are not subject to the same taxes and taxation laws as the United States proper. This includes territories like Puerto Rico, Guam, the U.S. Virgin Islands, and more.
Speak with an Attorney
The foreign tax credit is immensely complex, and these are just a few of the basics for qualification that you should know. It is highly advised that you bring your specific situation to an international tax attorney for individualized advice through a consultation. An attorney can better advise you how the tax laws of the United States and any foreign jurisdiction in which you conduct business will intertwine and how you can utilize this relationship to maximize your tax credit and reduce your tax liability to the fullest legal extent.
Castro & Co.’s highly-experienced international tax law team can provide you with an abundance of knowledge to help you keep your business running successfully and legally. We are thorough in our research and we are proud of our profession. We recognize the responsibility we carry, and we do everything we can to keep our client’s needs and best interests first, no matter how big or small their tax issue, or what kind of business they run. We strive to develop long-lasting relationships with our clients by helping them navigate the immensely complex waters of international tax law cases and giving them the confidence that their accounting will be done properly.
Get assistance with your international tax law issue by calling Castro & Co. today at (888) 595-5088, starting with a free initial consultation!