Taxes of Foreign Countries and U.S. Possessions You can take either a credit or a deduction for income taxesimposed on you by a foreign country or a U.S. possession. Taken as adeduction, foreign income taxes reduce your taxable income. Taken as acredit, foreign income taxes reduce your tax liability. You must treatall foreign income taxes in the same way. You generally cannot deductsome foreign income taxes and take a credit for others. SeeDeduction for Other Foreign Taxes, later. There is no specific rule that will let you choose the moreadvantageous method. If foreign income taxes were imposed at a highrate, and the proportion of foreign income to U.S. income is small, alower final tax may result from taking the foreign income taxdeduction. In any event, you should figure your tax liability bothways and then use the one that is better for you. In most cases, it isto your advantage to take foreign income taxes as a tax credit, whichyou subtract directly from your U.S. tax liability, rather than as adeduction in figuring taxable income. You can make or change your choice within 10 years from the duedate for filing your U.S. tax return for the tax year for which youmake the claim. The terms "foreign country" and "foreign taxes" alsorefer to possessions of the United States and the income taxes imposedby these possessions. See Foreign Country, in chapter 4. Foreign income taxes.These are generally income taxes you pay to any foreign country. The foreign income tax you can claim is the amount of foreignincome tax that is the legal and actual tax liability you pay oraccrue during the year. The amount you claim is not necessarily theamount of tax withheld by the foreign country. You cannot take aforeign tax credit or deduction for income tax you paid to a foreigncountry that would be refunded by the foreign country if you made aclaim for refund. Subsidies.If a foreign country returns your foreign tax payments to you inthe form of a subsidy, you cannot claim these payments as taxesqualified for the foreign tax credit. This rule applies to a subsidyprovided by any means that is determined, directly or indirectly, byreference to the amount of tax, or to the base used to figure the tax. Some ways of providing a subsidy are refunds, credits, deductions,payments, or discharges of obligations. The credit is also not allowedif the subsidy is given to a person related to you, or persons whoparticipated in a transaction or a related transaction with you. Foreign income taxes on U.S. return.Foreign income taxes can only be taken as a credit on Form 1116 ora deduction on Schedule A. These amounts cannot be included aswithheld income taxes on Form 1040, line 57. Foreign taxes paid on excluded income.You cannot take acredit or deduction for foreign income taxes paid on income that isexempt from tax under the foreign earned income exclusion, the foreignhousing exclusion, or the possession exclusion. If your wages arecompletely excluded, you cannot deduct or take a credit for any of theforeign taxes paid on these wages. If only part of your wages is excluded, you cannot deduct or take acredit for the foreign income taxes allocable to the excluded part.You find the taxes allocable to your excluded wages by applying afraction to the foreign taxes paid on foreign earned income receivedduring the tax year. The numerator (top number) of the fraction isyour excluded foreign earned income received during the tax year minusdeductible expenses allocable to that income (not including theforeign housing deduction). The denominator (bottom number) of thefraction is your total foreign earned income received during the taxyear minus all deductible expenses allocable to that income (includingthe foreign housing deduction). If foreign law taxes both earned income and some other amount (forexample, unearned income, earned income from U.S. sources, or a typeof income not subject to U.S. tax), and the taxes on the other amountcannot be segregated, the denominator of the fraction is the totalamount of income subject to foreign tax minus deductible expensesallocable to that income. If you take a foreign tax credit for tax on income you could haveexcluded under your choice to exclude foreign earned income or yourchoice to exclude foreign housing costs, one or both of the choicesmay be considered revoked. Credit forForeign Income Taxes If you take the foreign tax credit, you may have to file Form 1116with Form 1040. Use Form 1116 tofigure the amount of foreign tax paid or accrued that you can claim asa foreign tax credit. Do not include the amount of foreign tax paid oraccrued as withheld federal income taxes on Form 1040, line 57. Limit The foreign tax credit is limited to the part of your total U.S.tax that is in proportion to your taxable income from sources outsidethe United States compared to your total taxable income. The allowableforeign tax credit cannot be more than your actual foreign taxliability. accommodation in PontaExemption from limit.You will not be subject to this limit and will not have to fileForm 1116 if you meet all three of the following requirements. Your only foreign source income for the tax year is passiveincome (dividends, interest, royalties, etc.) that is reported to youon a payee statement (such as a Form 1099-Div or1099-INT). Your foreign taxes for the tax year that qualify for thecredit are not more than $300 ($600 if filing a joint return) and arereported on a payee statement. You elect this procedure for the tax year. If you make this election, you cannot carry back or carry overany unused foreign tax to or from this tax year. Separate limit.You must figure the limit on a separate basis with regard to eachof the following categories of income (see the instructions for Form1116). Passive income. High withholding tax interest. Financial services income. Shipping income. Certain dividends from a domestic international salescorporation (DISC) or former DISC. Certain distributions from a foreign sales corporation (FSC)or former FSC. Any lump-sum distributions from employer benefit plans forwhich the 5- or 10-year tax option is used to determineyour tax. Section 901(j) income. Income re-sourced by treaty. All other income not included above (general limitationincome). Figuring the limit.In figuring taxable income in each income category, you take intoaccount only the income that you must include in income on yourfederal income tax return. Do not take any excluded income intoaccount. To determine your taxable income in each category from sourcesoutside the United States, deduct expenses and losses that aredefinitely related to that income. Other expenses (such as itemized deductions or the standarddeduction) not definitely related to specific items of income must beapportioned to the foreign income in each category by multiplying themby a fraction. The numerator (top number) of the fraction is yourgross foreign income in the separate limit category. The denominator(bottom number) of the fraction is your gross income from all sources.For this purpose, gross income includes amounts that are otherwiseexempt or excluded. You must use special rules for deducting interestexpenses. For more information on allocating and apportioning yourdeductions, see Publication 514. Exemptions.Do not take the deduction for exemptions for yourself, your spouse,or your dependents in figuring taxable income for purposes of thelimit. Recapture of foreign losses.If you have an overall foreign loss and the loss reduces your U.S.source income (resulting in a reduction of your U.S. tax liability),you must recapture the loss in later years when you have taxableincome from foreign sources. This is done by treating a part of yourtaxable income from foreign sources in later years as U.S. sourceincome. This reduces the numerator of the limiting fraction and theresulting foreign tax credit limit. Foreign tax credit carryback and carryover.The amount of foreign income tax not allowed as a credit because ofthe limit can be carried back 2 years and carried forward 5 years. More information on figuring the foreign tax credit can be found inPublication 514. Deduction forForeign Income Taxes Instead of taking the foreign tax credit, you can deduct foreignincome taxes as an itemized deduction on Schedule A (Form 1040). You can claim a deduction only for those foreign incometaxes paid on income that is subject to U.S. tax. You cannot claim adeduction for foreign taxes paid on income you exclude under theforeign earned income or housing exclusions. Example.You are a U.S. citizen and qualify to exclude your foreign earnedincome. Your excluded wages in Country X are $70,000 on which you paidincome tax of $10,000. You received dividends from Country X of $2,000on which you paid income tax of $600. You can claim a deduction for the $600 tax payment because thedividends relating to it are subject to U.S. tax. Because the wagesare exempt from U.S. tax, you cannot claim a deduction for the incometax of $10,000. If only a part of your earnings are excluded, see the earlierdiscussion under Foreign taxes paid on excluded income. Deduction forOther Foreign Taxes You can deduct real property taxes you pay that are imposed on youby a foreign country. You take this deduction on Schedule A (Form1040). You cannot deduct other foreign taxes, such as personalproperty taxes, unless you incurred the expenses in a trade orbusiness or in the production of income. On the other hand, you generally can deduct personal property taxeswhen you pay them to U.S. possessions. But if you claim the possessionexclusion, see Publication 570. The deduction for foreign taxes other than foreign income taxes isnot related to the foreign tax credit. You can take deductions forthese miscellaneous foreign taxes and also claim the foreign taxcredit for income taxes imposed by a foreign country.