How Foreign Tax Credits Work

If you're an American who is making money in another country, there are some steps you can take to keep from being taxed twice.

As it becomes easier and easier to travel from one place to another, signs of an increasingly globalized society are cropping up everywhere. Gone are the days when folks used to hop aboard an ocean liner for weeks at a time to get from one continent to another. Now, it's by fast and cheap(ish) air travel. With this freedom to move comes the similar freedom to live wherever you want, whether it's a cabin in Alaska, an apartment in Geneva or a beach in Tahiti.

For Americans who retain their citizenship while living abroad — and those who happen to work for an employer outside of the U.S. — these situations can raise complicated tax issues. Generally, all of the money that a U.S. citizen earns can be taxed by the federal government. The good news is that the feds allow many taxpayers to avoid being taxed twice on money earned outside of the country. The foreign tax credit applies to taxes paid to a foreign country on money earned from a "foreign source" and which would otherwise be subject to taxation in the U.S. [sources: IRS, IRS].


The Internal Revenue Service warns on its website that "foreign tax credit laws are complex." In the words of Jeff Bridges' character The Dude in "The Big Lebowski," "there are a lotta ins, a lotta outs, a lotta what-have-yous." Whether you're entitled to the credit — and how much of it you can claim — varies widely based on individual circumstances, including the type of income in question and the country in which it was earned. While the following information is a good start at understanding how the credit works, taxpayers who earn money outside of the United States are well advised to seek professional advice before filing their tax returns [sources: IRS, IRS].