Form 1116 — How the Foreign Tax Credit Reduces Your U.S. Taxes Abroad

Form 1116 — How the Foreign Tax Credit Reduces Your U.S. Taxes Abroad (2025 Guide)

If you earn income overseas and pay taxes to a foreign government, Form 1116 (Foreign Tax Credit) is one of the most powerful tools available to lower your U.S. tax bill.
For many expats living in high-tax countries such as Korea, Japan, or most of Europe, the FTC often provides a bigger benefit than the Foreign Earned Income Exclusion (FEIE).

1. What Is Form 1116?

Form 1116 allows qualifying taxpayers to claim a dollar-for-dollar credit on their U.S. return for income taxes paid to a foreign country.
The goal is to prevent double taxation on the same income.

2. Which Foreign Taxes Qualify?

The IRS only allows credits for certain types of taxes:

• Foreign income taxes (earned income, business income)
• Withholding taxes on dividends, interest, royalties
• Capital gains taxes paid abroad

3. How the FTC Limitation Formula Works

You cannot automatically credit 100% of the foreign taxes you paid.
The IRS applies a limitation formula to determine the maximum amount you can credit in the current year.

If your foreign taxes exceed the allowed limit, the extra amount may be carried to other years using the rules below.

4. Carryback & Carryforward Rules

Unused foreign tax credits may be applied to other years:

• 1-year carryback
• 10-year carryforward

This makes the FTC extremely flexible for taxpayers with inconsistent annual income or fluctuating foreign tax burdens.

5. FTC vs. FEIE — Key Differences

Although both reduce U.S. taxes, they work in completely different ways.

6. When the FTC Provides a Bigger Benefit

• You live in a country with high income-tax rates (e.g., Korea, Germany).
• You have foreign passive income (dividends, interest, capital gains).
• Your income exceeds the FEIE cap ($130,000 in 2025).
• You have both earned and investment income abroad.

7. Practical Example

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