Foreign tax credit is a nonrefundable tax credit that is designed for people who receive foreign earned income (either from working in a foreign country or foreign investment). As with the taxpayers in the particular country, the foreign government withholds certain amount of their income as a tax. And the foreign tax credit is a tool to help those people reduce their taxes paid to the U.S. federal government.

However, not all taxes paid to a foreign government can be claimed as a foreign tax credit. The taxpayer cannot get the credit under these circumstances: the taxpayer does not pay the tax; the taxpayer does not have a legal and actual foreign tax liability; the tax was not imposed on the taxpayer; the tax is not based on income. For example, if John, an American taxpayer, was imposed a legal and actual property tax by the British government, he could not claim the foreign tax credit as it is not an income tax.

Noticeably, part or even all of the foreign earned income can be excluded from federal income tax. But  a taxpayer cannot claim foreign earned income exclusions while use the foreign tax credit on the same income. He/she could only use one from the two options: foreign earned income exclusions or the foreign tax credit.

To qualify for the foreign tax credit, a taxpayer needs to file Form 1116 along with a tax return. But if he/she meets the requirement for the de minimis exception, he/she can file Form 1040 to claim the foreign tax credit for the full amount of the taxes. Then all the foreign taxes can be paid directly.

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