The §901 Foreign Tax Credit
"When the UK already took 45% of your $300K, the IRS doesn't get to dip again. The FTC zeros your US tax — and 10 years of unused credit carries forward."
The 60-second pitch
The US is one of two countries that taxes citizens on worldwide income. To stop the obvious double-tax problem (UK takes 45%, then US takes another 24%?), the IRS gives you a dollar-for-dollar credit for income tax you've already paid to a foreign country. This is a credit, not a deduction — every $1 of UK tax kills $1 of US tax.
The FEIE is a $130K exclusion ceiling. The FTC has no ceiling. If you paid $135K of UK tax on $300K of UK earned income, you get a $135K US credit — wiping out your entire US tax liability on that income with $55K of credit left over to carry forward 10 years (or back 1 year).
The key rule of thumb every expat needs: if your country's marginal rate beats the US rate, use FTC. If it doesn't, use FEIE. And there's a third move: use both. FEIE on the first $130K, FTC on the residual. The two can be coordinated on one return.
The form is unloved (1116 is the IRS's least-favorite child) but the math is brutal in your favor when rates are high.
Real-world example
The setup. Priya, US citizen, accepts a consultant cardiology post at a London teaching hospital. Salary £235,000 (~$300,000) in 2025. UK marginal rate stacks: 20% on £37K, 40% on £88K, 45% on the rest, plus 2% NIC on the top. Effective UK income tax + NIC: ~45% = $135,000.
The FEIE path (rejected). She could exclude $130K under §911. The remaining $170K would be taxed at the US "stacked" rates that would have applied to $300K — top bracket 32–35%, US tax of ~$50,000.
The FTC path (chosen). She skips §911 entirely. US tax on $300K of foreign-source income: ~$78,000 federal. Then she files Form 1116 (passive vs. general category) and claims a credit for $135K of UK tax paid. The §904(a) limitation caps the current-year credit at the US tax on foreign-source income — so she uses $78K of the $135K and the credit zeros out her US tax. US tax owed: $0.
The carryforward. She has $57,000 of unused FTC ($135K paid – $78K used). Under §904(c), that excess credit carries back 1 year and forward 10 years — a future asset she can use when she moves back to the US, has lower foreign-tax years, or has foreign-source investment income.
Vs. FEIE comparison. FEIE path: ~$50K US tax + $135K UK tax = $185K total. FTC path: $0 US tax + $135K UK tax = $135K total + $57K credit carryforward asset. FTC saves $50K cash this year, plus a $57K future tax asset.
The step-by-step checklist
- Confirm the foreign tax is creditable. Must be an income tax (or a tax in lieu of income tax) imposed by a foreign country. Not creditable: VAT, sales tax, social-security-style contributions in countries without a totalization agreement, voluntary payments.
§901(b), Reg §1.901-2. - Pick: credit vs. deduction. §901 lets you elect credit (almost always better) or deduction (Schedule A miscellaneous). Election made annually; can flip year to year.
- Categorize income by basket. §904(d) splits foreign-source income into separate baskets: (i) passive (interest, dividends, capital gains), (ii) general (wages, active business), (iii) GILTI, (iv) foreign branch, (v) lump-sum distributions. One Form 1116 per basket. Credits do not cross baskets.
- Decide: FEIE only, FTC only, or both. Most high-tax-country expats run the math both ways. If foreign rate > US rate, FTC standalone is usually optimal. If you're under the exclusion cap and the foreign rate is low, FEIE wins.
- Coordinate FEIE + FTC carefully. §911(d)(6) — you cannot claim FTC on the foreign tax that relates to the excluded portion. The credit is computed on the non-excluded residual only. Tax software does this on the §904 limitation worksheet.
- Compute the §904(a) limitation. Per-basket cap = (foreign-source taxable income in basket ÷ worldwide taxable income) × pre-credit US tax. You can never credit more than the US tax that would have applied to the foreign income.
- File Form 1116 (or 1118 for C corps). Individuals with <$300 ($600 MFJ) of foreign tax from passive-category 1099-DIV/INT can skip Form 1116 and claim directly on Schedule 3 — but only in the passive basket.
- Document the foreign tax paid. Foreign payslips, year-end tax slips (P60 in the UK, T4 in Canada, Lohnsteuerbescheinigung in Germany, 退職所得の源泉徴収票 in Japan), foreign returns filed, proof of payment / withholding.
- Bank the carryback / carryforward. §904(c) — 1-year carryback, 10-year carryforward. Track unused FTC by basket on each year's Form 1116. Apps and preparers lose this regularly; the schedule is its own asset.
- Re-source via treaty if needed. Some treaties let you "re-source" certain US-source income as foreign-source for §904 purposes (e.g., US-source income that the treaty country also taxes). Form 8833 disclosure.
- Watch the "haircut" on creditable taxes. Foreign tax must be "compulsory" — if a treaty or foreign law gives you a refund or reduction you didn't take, that part is not creditable. §901(b)(1), Reg §1.901-2(e)(5).
- Year-end translation. Foreign taxes are translated to USD at the average exchange rate for the year (cash-basis taxpayers) or at the rate on the accrual date. Pick a method and stick to it.
IRS code & authority
- IRC §901 The foreign tax credit. Elective; foreign income tax (or tax in lieu of) is credited dollar-for-dollar against US tax on the same income.
- IRC §902 (repealed by TCJA) Indirect FTC for dividends from foreign subs — replaced by §245A participation exemption / §960 deemed-paid FTC on Subpart F & GILTI inclusions.
- IRC §904(a) The overall FTC limitation. Credit cannot exceed (foreign-source income ÷ worldwide income) × pre-credit US tax.
- IRC §904(c) Carryback & carryforward — 1 year back, 10 years forward, per basket.
- IRC §904(d) Separate-basket rules — passive, general, GILTI, foreign branch, etc.
- IRC §911(d)(6) The FEIE/FTC coordination rule — no FTC on foreign tax allocable to the excluded portion of foreign earned income.
- IRC §960 Deemed-paid credit for Subpart F & GILTI / NCTI inclusions (corporate context).
- Reg §1.901-2 Defines what foreign levies qualify — the "income tax" / "in lieu of" tests. Final regs revised 2022; controversial creditability changes.
- Reg §1.904-4 through 1.904-6 Sourcing & basket-allocation rules; expense allocation under §861 to determine foreign-source taxable income.
- Form 1116 Individual FTC computation. One per separate-category basket.
- Form 1118 Corporate FTC computation.
- Form 8833 Treaty-based return position disclosure — required for treaty re-sourcing claims.
Audit risk flags
- Non-creditable foreign levies treated as creditable. Common offenders: French CSG/CRDS (now creditable post-2019 IRS reversal), Brazilian PIS/COFINS (NOT creditable), Israeli National Insurance (depends on totalization), VAT (never creditable). Defense: Cross-check each line of the foreign payslip against IRS country-specific guidance / Rev. Rul. listings.
- Wrong basket allocation. Putting wage income in the passive basket or dividend income in the general basket is the most common audit hit. Defense: Each Form 1116 must reflect the §904(d) basket correctly. Wages = general. Most portfolio income = passive. CFC inclusions = GILTI basket.
- FEIE + FTC double-counting. Claiming the credit on the foreign tax that already wiped out US tax on the excluded $130K. Defense: Use the §911(d)(6) worksheet — allocate foreign tax proportionally between excluded and non-excluded income, only credit the non-excluded portion.
- Missing the §904(a) limitation. Software sometimes lets you claim 100% of foreign tax even when foreign-source income is a tiny fraction of worldwide. Defense: Verify the limitation fraction on the 1116 worksheet line 19–20 area.
- Improper expense allocation under §861. Itemized deductions, interest expense, and standard deduction must be apportioned between US-source and foreign-source income — reducing the foreign-source numerator and therefore the credit. Defense: Don't skip the §861 allocation lines on Form 1116; the IRS does check.
- Foreign tax not yet paid (accrual issues). Cash-method taxpayers can only credit foreign tax actually paid in the US year. If you accrue Q4 UK tax due in April, timing mismatches happen. Defense: Elect the accrual method for FTC purposes under §905(a) — irrevocable, but matches the year of accrual.
- Carryforward bookkeeping lost when you change preparers. The 10-year carryforward lives on a schedule attached to each year's 1116, but new preparers sometimes don't pick it up. Defense: Maintain your own carryforward tracker. The unused credit can be worth tens of thousands.
When NOT to do this
- You live in a 0% or very low-tax country (UAE, KSA, Bermuda, Bahamas, Monaco). No foreign tax = no credit. Use FEIE instead.
- You're under the FEIE cap and your foreign rate is low. If you earn $80K in a 15% country, the $12K FTC won't fully offset the ~$10K US tax — but FEIE will erase the entire $80K. FEIE wins.
- Your foreign tax is on capital gains and your US capital-gains rate is 0% / 15%. The §904 limitation will allow only a small credit, and the foreign tax may be effectively wasted. Consider treaty re-sourcing or just accepting the foreign tax as the final cost.
- You qualify for the participation exemption under §245A. C-corp dividends from foreign subs may be 100% deductible — no FTC needed because there's no US tax to credit against.
- You're claiming refundable child tax credit + EITC. The FTC is non-refundable. If your US tax is already $0 from refundable credits, the FTC has nothing to offset.
- The foreign country imposes only "soak-up" taxes. Some country systems impose a higher rate explicitly designed to soak up the US credit. Treasury has called these out as not "compulsory" and disallows the credit (Reg §1.901-2(e)(5)).
Run the FEIE-vs-FTC math side by side
PilePilot's Books agent ingests your foreign pay stubs (UK P60, Canadian T4, etc.), computes both scenarios, and tells you which strategy saves more — plus tracks your §904(c) carryforward by basket year-over-year.
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Disclaimer. This page is educational and not tax advice. The FTC requires correct basket allocation, §861 expense apportionment, and creditability verification by foreign levy. Errors can deny the credit entirely or reduce it materially. Work with a tax professional who handles expat / international returns before filing Form 1116.