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What is a Tax Credit?
A tax credit provides a dollar for dollar reduction of current income tax liability. For example, a tax credit of $100 will reduce your tax liability by $100. In contrast, a tax deduction lowers the amount of income that is taxable, and the benefit would be measured by the individual’s marginal income tax bracket. For example, an individual in the 25% marginal tax bracket receives a tax deduction of $100, the overall tax savings is $25. Generally, a tax credit is more beneficial for tax purposes than a tax deduction.
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What is the Foreign Tax Credit?
Double taxation on foreign income is a problem for US citizens living abroad when they file their US income tax return each year. A US citizen who paid or accrued taxes to a foreign country on foreign sourced income and is subject to US tax on the same income, may be able receive a tax credit, known as the foreign tax credit, for the taxes paid to the foreign country.
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What are the requirements to claim the Foreign Tax Credit?
The following tests must be met for any foreign tax to qualify for the foreign tax credit on a US citizen’s income tax return:
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The tax must be imposed on the US citizen;
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The US citizen must have paid or accrued the tax;
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The tax must be the legal and actual foreign tax liability; and
- The tax must be an income tax.