What Is a Foreign Tax Deduction?

Solomon Lander

A foreign tax deduction is a way for taxpayers to write off the cost of any tax that they pay to a foreign government. Governments often require citizens to pay tax on any income that they earn regardless of where they earn it, so a foreign tax deduction and the accompanying foreign tax credit help to shield them from experiencing double taxation. For many taxpayers, a foreign tax deduction will work out to be less valuable than claiming the foreign tax credit, but the deduction might cover more foreign taxes than the credit.

Individuals deduct taxes paid to foreign countries if they itemize deductions on Form 1040.
Individuals deduct taxes paid to foreign countries if they itemize deductions on Form 1040.

Instead of a foreign tax deduction, many taxpayers choose to claim a foreign tax credit instead. A deduction reduces taxable income, and a credit reduces the actual income tax that is due, so claiming a credit can be much more valuable. For example, if a taxpayer whose income tax was 25 percent of his or her income deducted $1,000 US Dollars (USD) in foreign tax, it could save him or her $250 USD in income tax. If the taxpayer instead took a foreign tax credit, however, it would reduce his or her taxes owed by $1,000 USD.

The regulations for foreign tax deductions can vary depending on the taxpayer's country and the other country or countries to which he or she paid income tax. Although the standard is a bit nebulous, generally speaking, any tax that is equivalent to income tax is allowed. Some taxes might not be eligible for a deduction or credit, possibly including taxes paid to governments with which the taxpayer's home country does not have diplomatic relations. Although a foreign tax deduction usually is significantly less valuable than a credit, it is still better than claiming nothing. Foreign tax deductions and credits are some of the most complicated parts of filing taxes, so a taxpayer who has paid taxes to a foreign country should consult with a tax professional to determine whether he or she should claim a foreign tax deduction or credit and to ensure that all laws and regulations are followed.

To claim a foreign tax deduction, a taxpayer in the United States needs to itemize deductions on a Schedule A and needs to file the long-form 1040 tax return. The taxpayer also must elect not to take the foreign tax credit. If this is the case, the taxpayer can then write off any eligible foreign taxes that he or she paid on line 8 of the Schedule A and reduce his or her U.S. taxable income by that amount. Taxpayers in other countries might have similar forms that can be filled out with the same type of information.

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