If you received foreign income you must report it on your individual income tax return. However, IRS Form 2555 Foreign Earned Income, Form 1116 Foreign Tax Credit, or Schedule A Itemized Deductions may provide income tax benefits.

 

Form 2555:

This form allows an exclusion of up to $97,600 of your foreign earned income if you are a U.S. citizen or a U.S. resident alien living and working in a foreign country. All foreign earned income (for the individual taxpayer) should be combined on to one Form 2555. Up to two Forms 2555 can be e-filed per return, one for each taxpayer.

Note: Once you choose to exclude your foreign earned income, that choice remains in effect for that year and all later years unless you revoke it.

To enter information in the TaxACT program for taking the foreign earned income exclusion on Form 2555:

  1. From within your TaxACT return (Online or Desktop), click on the Federal Q&A tab
  2. Click Other Income to expand the category and then click Foreign earned income exclusions
  3. Click Add to create a new copy of the form or click Review to review a form already created 
  4. The program will proceed with the interview questions for you to enter or review the appropriate information.

The exclusion amount will appear as a negative number on Form 1040, Line 21.

Form 1116:

This form is used to claim a credit for foreign taxes paid.

To enter information in the TaxACT program for taking a credit for foreign taxes paid on Form 1116:

  1. From within your TaxACT return (Online or Desktop), click on the Federal Q&A tab
  2. Click Other Credits to expand the category and then click Foreign tax credit
  3. Click Manual Input to enter the information by category of income on the Form 1116 worksheets which will populate the Forms 1116 in your return. Information entered in the worksheets section include category of income, amount of income, type of income, and the foreign taxes paid or accrued.
  4. Click Add to create a new copy of the worksheet or click Review to review a worksheet already created. 
  5. The program will proceed with the interview questions for you to enter or review the appropriate information

While entering information for each of the different categories of foreign income that apply to your situation, there will be a screen titled Foreign Tax Credit - Additional Entries where you can check the box next to each item that applies in your situation. On the following screen(s) you will be able to enter descriptions and amounts.

Additional information may need to be entered on the Form 1116 (i.e. country of residence, alternative basis related to income source, amount of income from all sources, lump-sum distributions, foreign audit, boycott entry, etc.). Please use steps 1 and 2 above, then click Form Interview to access these interview screens.

The credit will appear on Form 1040, Line 47 and will be limited by your tax liability.

Schedule A:

This form is used to claim various itemized deductions, including a foreign income tax deduction.

To enter information in the TaxACT program for taking a deduction of foreign taxes paid on Schedule A:
  1. From within your TaxACT return (Online or Desktop), click on the Federal Q&A tab
  2. Click Itemized or Standard Deductions to expand the category and then click Taxes Paid
  3. Click Continue or No until you reach the screen titled Itemized Deductions - Other Taxes Paid
  4. Enter a description and amount of the foreign tax deduction

The deduction will appear on Schedule A, Line 8 and will be added to your total itemized deductions on Form 1040, Line 40.

 

NOTE: You may use Form 2555 and Form 1116 on the same return, but cannot use the same earnings (and taxes paid relating to those earnings) on both forms. For example, if your foreign earned income is $118,000, you can only exclude foreign earned income up to $97,600 on the Form 2555 which will reduce your taxable income on the return. The remaining foreign earned income of $20,400 may be used on Form 1116. You would need to determine which amount of the foreign taxes paid are allocable to the $20,400 and only use this portion of the foreign taxes in the calculations on Form 1116.

On the other hand, if you would like to claim a foreign tax deduction instead of the foreign tax credit, then you would use Schedule A instead of Form 1116. Please note: IRS Publication 514 specifically states "as a general rule, you must choose to take either a credit or a deduction for all qualified foreign taxes." This means you cannot take a foreign tax credit and deduction on the same return. To clarify, you can use Form 2555 and Form 1116 on the same return, and you can use Form 2555 and Schedule A on the same return; however, if you claim a deduction you cannot claim a credit and if you claim a credit, you cannot claim a deduction.

An exception to this rule is if you have foreign taxes other than income taxes (e.g. real and personal property taxes). Those foreign taxes are claimed as a deduction on different lines of the Schedule A. Only in this instance would you be able to claim a foreign tax credit and take a deduction.

Generally, it is more beneficial to claim foreign taxes paid as a credit rather than claiming a deduction. You may wish to do a comparison to determine which is best in your situation.

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