What You Need to Know About Foreign Tax Credits

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 the foreign entity, you may be required to also pay income tax abroad as well. In some cases, this could lead to double-taxation on income, particularly if you move the money you make to a bank account located in that country. Therefore, in order to avoid being double-taxed on some of your income, you may be able 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 some information about the foreign tax credit that you should know.

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 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 to 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 would otherwise be attributed to a source of income in the United States. However, U.S. companies who gain income abroad and are required to pay taxes on that income in the country where they obtained that income could possibly qualify for this credit.

How much of the income 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 that particular income. If the country in question has a lower tax rate than the U.S., then the credit is limited to the difference between the U.S. tax rate and the foreign tax rate. 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, and you would still be taxed for the last five percent in the U.S.

You can only claim a foreign tax credit for certain types of income, 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.” Essentially 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. However, the second part of that code is what surprises many people about this credit as well: it also applies to business done in U.S. territories and holdings, which are not necessarily 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’s highly advised that you bring your specific situation to a DC international tax attorney for individualized advice through a consultation. An attorney can better advise you how the tax laws of your income abroad and the United States 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!
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