What Is the Foreign Tax Credit?

If your small business earns income from clients overseas or operates internationally, you might get taxed twice—once by the foreign country and again by the U.S. That’s where the Foreign Tax Credit (FTC) comes in.

The FTC is a valuable IRS provision that helps U.S. taxpayers reduce their U.S. tax bill by the amount of qualifying foreign income tax already paid. In this guide, we’ll break down how it works, who qualifies, how to claim it, and how it compares to the Foreign Earned Income Exclusion (FEIE).

What Is the Foreign Tax Credit (FTC)?

The Foreign Tax Credit lets U.S. taxpayers—both individuals and businesses—offset their U.S. tax liability by the amount of income tax paid to a foreign government. It’s designed to prevent double taxation on the same foreign-source income.

If you operate a business in another country or have investments in another country, and you pay taxes, this credit can help you avoid paying taxes twice on the same earnings.

Who Qualifies for the Foreign Tax Credit?

To be eligible for the FTC, you must:

• Be a U.S. citizen, resident alien, or a U.S.-based business 
• Have earned foreign-source income
• Have paid or accrued a legally required foreign income tax
• Not have received a refund or exclusion for that foreign tax

Example: If your U.S. LLC pays income tax to the U.K. for services rendered there, you may qualify for the FTC.

What Types of Taxes Qualify?

Not all foreign taxes are eligible. Only foreign income taxes that meet the following criteria qualify:

• Based on net income
  
  
• Legally imposed and actually paid
  
  
• Paid directly by you, not passed through or credited elsewhere

Note: VAT, sales tax, property tax, and payroll tax do NOT qualify.

How Much Credit Can You Claim?

You can only claim a credit equal to the portion of your U.S. tax liability attributable to foreign income. Here’s the formula:

You cannot use the FTC to get a refund that exceeds your total U.S. tax owed. However, any unused credit can:

• Be carried back 1 year, and
  
  
• Be carried forward for up to 10 years
  

How to Claim the Foreign Tax Credit

For Individuals:

• File IRS Form 1116 with your Form 1040
  
  
• Report:
  • The type of foreign income (e.g., general, passive)
    
    
  • The country the tax was paid to
    
    
  • The exact amount paid or accrued
    
    
• Attach any supporting documentation, such as foreign tax returns or proof of payment

For Businesses:

• Corporations file Form 1118
  
  
• Pass-through entities (LLCs, partnerships, S-corps) may report it differently, depending on structure
  
  
• In some cases, businesses may opt for a foreign tax deduction instead, though it typically provides less benefit than the credit

Bottom Line

If you or your business earns income overseas and are required to pay Foreign Income Tax, the Foreign Tax Credit can help reduce your U.S. tax bill significantly. While the rules are detailed, the savings can be substantial—especially for small businesses expanding globally.

Need help claiming the Foreign Tax Credit? Contact LedgerFi today for international tax support tailored to small business owners. Let’s make sure you don’t pay more than you have to.