Publication 54 - Tax Guide For U.s. Citizens And Resident Aliens Abroad - 2006 Page 32
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If you are covered by an employer retirement
income taxes allocable to the excluded part. You
Your only foreign source income for the
plan at work, your deduction for your contribu-
find the taxes allocable to your excluded wages
year is passive income (dividends, inter-
tions to your traditional IRAs is generally limited
by applying a fraction to the foreign taxes paid
est, royalties, etc.) that is reported to you
based on your modified adjusted gross income.
on foreign earned income received during the
on a payee statement (such as a Form
This is your adjusted gross income figured with-
tax year. The numerator (top number) of the
1099-DIV or 1099-INT).
out taking into account the foreign earned in-
fraction is your excluded foreign earned income
•
Your foreign taxes for the year that qualify
come exclusion, the foreign housing exclusion,
received during the tax year minus deductible
for the credit are not more than $300
or the foreign housing deduction. Other modifi-
expenses allocable to that income (not including
($600 if you are filing a joint return) and
cations are also required. For more information
the foreign housing deduction). The denomina-
are reported on a payee statement.
on IRAs, see Publication 590.
tor (bottom number) of the fraction is your total
•
foreign earned income received during the tax
You elect this procedure.
year minus all deductible expenses allocable to
If you make this election, you cannot carry back
that income (including the foreign housing de-
or carry over any unused foreign tax to or from
Taxes of Foreign
duction).
this year.
If foreign law taxes both earned income and
Countries and
some other type of income and the taxes on the
Separate limit. You must figure the limit on a
other type cannot be separated, the denomina-
U.S. Possessions
separate basis with regard to each of the follow-
tor of the fraction is the total amount of income
ing categories of foreign source income (see the
subject to foreign tax minus deductible ex-
instructions for Form 1116).
You can take either a credit or a deduction for
penses allocable to that other type of income.
•
income taxes paid to a foreign country or a U.S.
Passive income.
If you take a foreign tax credit for tax on
possession. Taken as a deduction, foreign in-
•
!
income you could have excluded under
High withholding tax interest.
come taxes reduce your taxable income. Taken
your choice to exclude foreign earned
CAUTION
•
as a credit, foreign income taxes reduce your tax
Financial services income.
income or your choice to exclude foreign hous-
liability. You must treat all foreign income taxes
•
ing costs, one or both of the choices may be
Shipping income.
the same way. You generally cannot deduct
considered revoked.
•
some foreign income taxes and take a credit for
Certain dividends from a domestic interna-
others. However, regardless of whether you
tional sales corporation (DISC) or former
Credit for Foreign
take a credit for foreign income taxes, you may
DISC.
be able to deduct other foreign taxes. See De-
Income Taxes
•
Certain distributions from a foreign sales
duction for Other Foreign Taxes, later.
corporation (FSC) or former FSC.
There is no rule to determine whether it is to
If you take the foreign tax credit, you may have
•
your advantage to take a deduction or a credit
to file Form 1116 with Form 1040. Form 1116 is
Any lump-sum distributions from employer
for foreign income taxes. In most cases, it is to
used to figure the amount of foreign tax paid or
benefit plans for which a special averaging
your advantage to take foreign income taxes as
accrued that can be claimed as a foreign tax
treatment is used to determine your tax.
a tax credit, which you subtract directly from
credit. Do not include the amount of foreign tax
•
Section 901(j) income.
your U.S. tax liability, rather than as a deduction
paid or accrued as withheld federal income
•
in figuring taxable income. However, if foreign
Certain income re-sourced by treaty.
taxes on Form 1040, line 64.
income taxes were imposed at a high rate and
The foreign income tax for which you can
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All other income not included above (gen-
the proportion of foreign income to U.S. income
claim a credit is the amount of legal and actual
eral limitation income).
is small, a lower final tax may result from deduct-
tax liability you pay or accrue during the year.
ing the foreign income taxes. In any event, you
The amount for which you can claim a credit is
should figure your tax liability both ways and
Figuring the limit. In figuring taxable income
not necessarily the amount withheld by the for-
then use the one that is better for you.
in each category, you take into account only the
eign country. You cannot take a foreign tax
You can make or change your choice within
amount that you must include in income on your
credit for income tax you paid to a foreign coun-
10 years from the due date for filing the tax
federal tax return. Do not take any excluded
try that would be refunded by the foreign country
return on which you are entitled to take either the
if you made a claim for refund.
amount into account.
deduction or the credit.
To determine your taxable income in each
Subsidies. If a foreign country returns your
category, deduct expenses and losses that are
Foreign income taxes. These are generally
foreign tax payments to you in the form of a
definitely related to that income.
income taxes you pay to any foreign country or
subsidy, you cannot claim a foreign tax credit
Other expenses (such as itemized deduc-
possession of the United States.
based on these payments. This rule applies to a
tions or the standard deduction) not definitely
subsidy provided by any means that is deter-
Foreign income taxes on U.S. return. For-
related to specific items of income must be ap-
mined, directly or indirectly, by reference to the
eign income taxes can only be taken as a credit
portioned to the foreign income in each category
amount of tax, or to the base used to figure the
on Form 1040, line 47, or as an itemized deduc-
by multiplying them by a fraction. The numerator
tax.
tion on Schedule A. These amounts cannot be
(top number) of the fraction is your gross foreign
Some ways of providing a subsidy are re-
included as withheld income taxes on Form
income in the separate limit category. The de-
funds, credits, deductions, payments, or dis-
1040, line 64.
nominator (bottom number) of the fraction is
charges of obligations. A credit is also not
your gross income from all sources. For this
allowed if the subsidy is given to a person re-
Foreign taxes paid on excluded income.
purpose, gross income includes amounts that
lated to you, or persons who participated in a
You cannot take a credit or deduction for foreign
are otherwise exempt or excluded. You must
transaction or a related transaction with you.
income taxes paid on earnings you exclude from
use special rules for deducting interest ex-
tax under any of the following.
penses. For more information on allocating and
•
apportioning your deductions, see Publication
Limit
Foreign earned income exclusion.
514.
•
Foreign housing exclusion.
The foreign tax credit is limited to the part of your
Exemptions. Do not take the deduction for
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total U.S. tax that is in proportion to your taxable
Possession exclusion.
exemptions for yourself, your spouse, or your
income from sources outside the United States
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dependents in figuring taxable income for pur-
Extraterritorial income exclusion.
compared to your total taxable income. The al-
poses of the limit.
lowable foreign tax credit cannot be more than
If your wages are completely excluded, you can-
your actual foreign tax liability.
not deduct or take a credit for any of the foreign
Recapture of foreign losses. If you have an
taxes paid on these wages.
Exemption from limit. You will not be subject
overall foreign loss and the loss reduces your
If only part of your wages is excluded, you
to this limit and will not have to file Form 1116 if
U.S. source income (resulting in a reduction of
cannot deduct or take a credit for the foreign
you meet all three of the following requirements.
your U.S. tax liability), you must recapture the
Page 32
Chapter 5 Exemptions, Deductions, and Credits
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