The foreign tax credit lets US taxpayers offset foreign income taxes paid against their US income tax, dollar for dollar, so income earned abroad is not fully taxed by both countries. The credit is capped at the US tax on your foreign income, and any excess can carry back one year and forward ten.
This guide explains how the foreign tax credit works for tax years 2025 and 2026: when a credit beats a deduction, how the limitation works with a worked example, how it interacts with the foreign earned income exclusion, how treaties and states treat foreign tax, and what the One Big Beautiful Bill Act (P.L. 119-21) changed for individuals and corporations.
US citizens and resident aliens who pay income tax to a foreign country or a US territory on income the US also taxes can generally claim the credit. Nonresident aliens can claim it only in limited cases.
IRS Publication 514 sets four tests that a foreign tax must meet to qualify:
Value added tax, sales tax and property tax fail the last test. Foreign tax withheld above your treaty rate also fails, so claim the excess back from the foreign tax authority.
You can claim foreign income taxes either as a credit or as an itemized deduction on Schedule A. The Instructions for Form 1116, the form individuals use for the credit, state that, generally, if you take the credit for any eligible foreign taxes, you cannot deduct any part of that year's foreign taxes. The choice applies to all your qualifying foreign taxes for the year.
The credit is usually worth more, since a deduction only lowers taxable income and requires itemizing. Our guide to Form 1040 with itemized deductions shows how Schedule A works if you are comparing the two.
Publication 514 says you can choose the credit, or switch from a deduction to a credit, "at any time during the period within 10 years from the regular due date for filing the return" for the year the taxes were paid or accrued.
| Option | Where it goes | Effect | Carryovers |
|---|---|---|---|
| Credit with Form 1116 | Form 1116, then Schedule 3 (Form 1040), line 1 | Dollar-for-dollar cut in US tax, capped by the limitation | Excess carries back 1 year and forward 10 years |
| Credit without Form 1116 ($300/$600 election) | Schedule 3 (Form 1040), line 1 | Full credit for small passive-income taxes, no limitation | None for that year |
| Itemized deduction | Schedule A (Form 1040) | Reduces taxable income only | None |
| Foreign earned income exclusion | Form 2555 | Removes up to $132,900 of 2026 foreign earned income | Taxes on excluded income are not creditable |
Investors whose only foreign tax is withholding on fund dividends can claim the credit without Form 1116 if all of these conditions from the instructions are met:
You enter the smaller of your total foreign tax or your regular tax on Schedule 3 (Form 1040), Part I, line 1, and the limitation does not apply. You cannot carry foreign taxes to or from a year in which you use the election.
For example (illustrative), a single filer whose brokerage Form 1099-DIV shows $210 of foreign tax paid on an international index fund, with no other foreign income, can enter $210 on Schedule 3 and skip the form entirely.
Above those amounts, individuals claim the credit on Form 1116 and carry the result to Schedule 3 (Form 1040), line 1. The form works category by category. The 2025 instructions list seven categories, and most individuals use two: passive for dividends and interest, and general for wages. The instructions give this example: if you received foreign dividends and foreign wages, "you must complete two Forms 1116." Foreign taxes are converted to US dollars and supported by the foreign return or withholding statement. For the line-by-line mechanics, see our guide to how Form 1116 keeps you from being taxed twice.
The limitation stops foreign taxes from offsetting US tax on US income. Publication 514 states it this way: "Your foreign tax credit cannot be more than your total U.S. tax liability multiplied by a fraction. The numerator of the fraction is your taxable income from sources outside the United States. The denominator is your total taxable income from U.S. and foreign sources."
Written as a formula for each category:
Limit = US tax before credits × (foreign source taxable income in the category ÷ total taxable income)
Your credit for the category is the smaller of the foreign tax you paid or this limit. Because the limit runs category by category, excess passive taxes cannot cover a shortfall in the general category.
One OBBBA change affects this math for older filers. P.L. 119-21 added a $6,000 deduction for taxpayers aged 65 or older, claimed on Schedule 1-A, line 37, for tax years 2025 through 2028. The Form 1116 instructions say this deduction "needs to be removed from taxable income for purposes of computing the foreign tax credit limitation."
This example is illustrative. Maya is a single US citizen who lives in the US. In 2026 she earns $90,000 of US wages and spends part of the year on a UK assignment, earning $40,000 of UK-source wages on which she pays $10,000 of UK income tax. She does not qualify for the foreign earned income exclusion, takes the 2026 standard deduction of $16,100 and has no other income. The 2026 brackets and standard deduction come from the IRS 2026 inflation adjustment release.
| Line item | Amount |
|---|---|
| Total gross income ($90,000 + $40,000) | $130,000 |
| Taxable income ($130,000 minus $16,100) | $113,900 |
| Ratio of foreign to total gross income (40,000 ÷ 130,000, rounded) | 0.3077 |
| Standard deduction apportioned to foreign income ($16,100 × 0.3077) | $4,953.97 |
| Foreign source taxable income ($40,000 minus $4,953.97) | $35,046.03 |
| US tax on $113,900 (2026 single brackets) | $19,934.00 |
| Limitation ($19,934 × 35,046.03 ÷ 113,900) | $6,133.52 |
| UK tax paid | $10,000.00 |
| Credit allowed (smaller of the two) | $6,133.52 |
| Excess foreign tax to carry over | $3,866.48 |
The US tax figure is 10% of $12,400 ($1,240), plus 12% of $38,000 ($4,560), plus 22% of $55,300 ($12,166), plus 24% of $8,200 ($1,968). After the credit, Maya owes $13,800.48 of US income tax. The credit is less than the UK tax because the UK rate on that income (25%) exceeds her average US rate on it (about 17.5%). The $3,866.48 excess carries back to 2025 first, if 2025 has unused general category limitation, then forward.
If Maya had instead deducted the $10,000 on Schedule A with $9,000 of other itemized deductions, her itemized total of $19,000 would beat the standard deduction by only $2,900, saving $696 at her 24% marginal rate. The credit is worth almost nine times as much.
When your foreign tax in a category exceeds the limit, the excess is not lost. The Form 1116 instructions state: "You can carry back 1 year and then forward 10 years any foreign tax you paid or accrued" on income in a separate category that is more than the limitation. You apply the excess to the earliest available year first.
A carryover can only be used in a year where that category has unused limitation. Carryovers are tracked on Schedule B (Form 1116), and Publication 514 says that if you deduct foreign taxes in a year, you cannot take a credit for taxes carried to that year.
If a foreign tax you already claimed later changes through a refund or reassessment, that is a foreign tax redetermination, reported for prior years on Schedule C (Form 1116).
Americans living abroad can exclude foreign earned income on Form 2555. The exclusion is $130,000 for 2025, and the IRS confirms that for tax year 2026, "the foreign earned income exclusion is $132,900." Our guide to the foreign earned income exclusion with Form 2555 covers the residence and physical presence tests.
You cannot use both breaks on the same dollars. Publication 514 states: "If your wages are completely excluded, you cannot take a credit for any of the foreign taxes paid or accrued on these wages." If only part is excluded, the foreign tax allocable to the excluded part is disallowed, using a fraction of excluded earned income over total foreign earned income.
A common pattern is to exclude salary up to the cap and claim the credit on the rest. In high-tax countries, the credit alone can work better, since excess credits carry forward. Expats with foreign accounts should also check their FBAR filing on FinCEN Form 114, which is a separate obligation.
Tax treaties usually cap the rate a foreign country can withhold on dividends, interest and royalties paid to US residents. That cap matters for the credit, because only your legal and actual foreign tax liability qualifies under the four tests. If a foreign payer withholds more than the treaty rate, the excess is a refund claim against the foreign country, and the US credit is limited to the treaty amount.
The Form 1116 instructions also list "certain income re-sourced by treaty" as its own category, which applies when you elect a treaty rule that treats US-source income as foreign source. Each such amount needs its own limitation. Treaty positions that override the Internal Revenue Code may need a treaty-based return position disclosure on Form 8833. Investors in foreign funds should also confirm whether the fund is a PFIC that triggers Form 8621 reporting, since PFIC rules change how the income and its foreign tax are reported.
The federal foreign tax credit does not carry over to state returns automatically, and state credits for taxes paid elsewhere are often limited to other US states. California is one example. The instructions for California Schedule S, the state's credit for taxes paid to other states, tell filers not to include "Taxes paid to any foreign country." As guidance, check the rules in each state where a client files, because a high state tax bill on foreign income may remain even after the federal credit wipes out the federal tax on it.
C corporations claim the credit on a different form. The Instructions for Form 1118 say any corporation that elects the foreign tax credit under section 901 "must complete and attach Form 1118 to its income tax return." It applies the same separate-category approach and also computes section 960 deemed paid taxes on CFC income. Corporate owners of foreign subsidiaries will usually be filing Form 5471 for US owners of foreign corporations alongside it, and a foreign branch may require Form 8858 for foreign disregarded entities and branches.
The One Big Beautiful Bill Act made several changes to the foreign tax credit, most of them aimed at businesses with CFCs. The text of P.L. 119-21 provides:
Treasury published proposed regulations under section 904(b)(5) on September 11, 2026, so the expense allocation rules are not yet final. Our guide to GILTI and Form 8992, now NCTI explains the inclusion itself, and individuals who own CFCs directly may want to review the section 962 election, which lets them claim deemed paid credits.
Does the foreign tax credit apply to VAT or sales tax? No. Only foreign income taxes, or taxes in lieu of income taxes, qualify under the four tests in Publication 514.
Can I claim the foreign tax credit without filing a separate form? Only above the small-amount election. If all your foreign income is passive, reported on a payee statement, and your creditable foreign taxes are $300 or less ($600 married filing jointly), you can enter the credit on Schedule 3 and give up carryovers for that year.
How is the foreign tax credit limit calculated? Multiply your US tax by foreign source taxable income in the category, divided by total taxable income. Your credit is the smaller of that limit or the foreign tax paid.
How long can I carry unused foreign tax credits? Excess foreign taxes carry back 1 year and forward 10 years, applied to the earliest year first. They are tracked on Schedule B (Form 1116).
Can I claim the foreign tax credit and the foreign earned income exclusion together? Yes, on different income. Foreign taxes on wages excluded under Form 2555 are not creditable, so the credit applies to income above the $132,900 cap for 2026 and to other foreign income.
Can I switch from a deduction to the credit after filing? Yes. Publication 514 allows the change within 10 years from the regular due date of the return for the year the foreign taxes were paid or accrued, by filing an amended return.
Foreign tax credit work depends on clean income categorization, currency conversion and carryover tracking across years. Madras Accountancy supports CPA firms and businesses with tax preparation, bookkeeping and advisory work on returns with foreign income, and our overview of international taxation for CPA firms explains how that support fits a firm's review process. To discuss your returns, contact our team.
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