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IRS Issues Final Rules on Foreign Tax Credit

December 23, 2019

Attention to those who claim foreign tax credits: the IRS and Treasury Department have released final regulations on the foreign tax credit. Read up on how the changes may affect you.

The Internal Revenue Service and Treasury Department released their final regulations on a major international tax provision, the Foreign Tax Credit. Here’s what you need to know if you claim foreign tax credits.

What is the foreign tax credit?

The foreign tax credit is a non-refundable tax credit for income taxes paid or accrued to a foreign country or U.S. possession if you are subject to U.S. tax on the same income. Alternatively, you may also take an itemized deduction for the foreign taxes.

Who can claim the credit?

Anyone who meets the below four tests can qualify for the credit:

  1. The tax must be a legal and actual foreign tax liability
  2. The tax must be imposed on you
  3. You must have paid or accrued the tax, and
  4. The tax must be an income tax (or a tax in lieu of an income tax)

Typically, only income taxes paid or accrued to a foreign country or a U.S. possession (Puerto Rico and American Samoa) will qualify for the foreign tax credit.

The complex mechanism of the foreign tax credit is designed to prevent someone from claiming a credit for more than he/she would have paid in the U.S. on the foreign income.

How do you claim the credit?

You can claim a foreign tax credit only for foreign taxes on income, war profits, or excess profits, or taxes in lieu of those taxes. Your foreign tax credit is the amount of foreign tax you paid or accrued or, if smaller, the foreign tax credit limit.

As an individual taxpayer you can claim the credit on Form 1116. Form 1116 will not be needed if all of the following requirements are met.

  1. All of your foreign source gross income is passive income (e.g. interest and dividends);
  2. All the income and any foreign taxes paid on it were reported to you on a qualified payee statement such as Form 1099;
  3. Your total creditable foreign taxes aren't more than $300 ($600 if married filing a joint return).

If you choose to forgo Form 1116 you cannot carry back or carry over any unused foreign tax to or from this tax year.

What do the final regulations address?

The final regulations were issued on December 2nd.

The TCJA changed several provisions in the Foreign Tax Credit, including…

  • Inclusion of the foreign branch income and Global Intangible Low-Taxed Income (GILTI) limitation categories. Check out our blog, International Tax Update: What is the GILTI Provision?
  • Systemic changes to U.S. taxation of foreign income that impacts the Foreign Tax Credit calculation. These systemic changes include the introduction of a participation exemption through a dividends received deduction for certain dividends in section 245A and the introduction of GILTI, which subjects to current U.S. taxation foreign earnings that would have been deferred under previous law.
  • Changed how taxable income is calculated for purposes of the Foreign Tax Credit limitation by disregarding certain expenses and repealing the use of the fair market value method for allocating interest expense.
  • Repeal of section 902, which allowed deemed-paid credits in connections with dividend distributions based on foreign subsidiaries' cumulative pools of earnings and foreign taxes.

Click here to view the final regulations on the Foreign Tax Credit in full.

Questions? Contact our International Tax Team.

The TCJA…So Many Changes, So Many Questions…we can help you navigate this huge tax overhaul! Visit our Tax Reform Center for everything you and your business need to know, now.

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