Foreign Tax Credit (FTC)

The foreign tax credit, or FTC, is the main US mechanism for relieving double taxation. It lets a US taxpayer credit income taxes paid or accrued to a foreign country, or a US possession, against the US tax owed on that same income. Because the United States taxes its citizens, residents, and domestic corporations on worldwide income, the same earnings can be taxed once abroad and again at home. The credit removes that overlap. The IRS describes the relief on its Foreign Tax Credit page as available to taxpayers who “paid or accrued foreign taxes to a foreign country or U.S. possession and are subject to U.S. tax on the same income.”

Credit, Not Just a Deduction

A taxpayer can take foreign income taxes either as an itemized deduction or as a credit. The IRS notes that “in most cases, it is to your advantage to take foreign income taxes as a tax credit,” because a credit reduces the actual US tax owed rather than just the income on which it is figured. A credit is therefore worth more, dollar for dollar, than a deduction of the same amount.

What Qualifies

Not every foreign levy is creditable. The IRS states that “generally, only income, war profits and excess profits taxes qualify for the credit.” A foreign value-added tax, a sales tax, or a property tax does not qualify. Where an income tax treaty reduces the foreign rate on the income, only the reduced treaty rate is creditable. Foreign tax paid above what the treaty required is not a qualified tax for FTC purposes.

Which Form

The form depends on the taxpayer.

• Individuals, estates, and trusts claim the credit on Form 1116. Per the IRS About Form 1116 page, you “File Form 1116 to claim the foreign tax credit if you are an individual, estate, or trust, and you paid or accrued certain foreign taxes to a foreign country or U.S. possession.”
• Corporations claim it on Form 1118. The IRS About Form 1118 page states that “Corporations use this form to compute their foreign tax credit for certain taxes paid or accrued to foreign countries or U.S. possessions.”

Why It Matters in Cross-Border Hiring

The foreign tax credit is easy to confuse with a US payer’s withholding duty, but the two are distinct. The credit is claimed by the person who earned the foreign-taxed income, on that person’s own US return. It mostly concerns the contractor, or any US person with foreign-source income, rather than the US company sending the payment.

A US company paying a foreign contractor is a withholding agent dealing with NRA withholding on US-source payments, which is a separate obligation governed by documentation such as the W-8BEN. The contractor is the one who looks to the foreign tax credit to avoid being taxed twice. A US citizen contractor working abroad, for example, pays local income tax in the host country and then credits that tax against their US liability on Form 1116, so the same income is not taxed in full by both governments.

Related Terms

• Income Tax Treaty: allocates taxing rights between two countries and sets the rate that determines how much foreign tax is creditable.
• NRA Withholding: the US payer obligation that is separate from the recipient’s foreign tax credit.

Omnivoo Contract Management handles each cross-border contractor payment at a flat $49 per finalized contract, with fees at cost and no FX markup, and documents the source and tax status of each payment so the parties have a clean record for their own filings.