The Foreign Tax Credit is almost always better than the Foreign Tax Deduction for U.S. expats with foreign income. Why? Because the credit reduces your U.S. tax dollar for dollar, while the deduction only reduces your taxable income—often resulting in far less tax savings. The Foreign Tax Credit also allows for carryback and carryforward of unused amounts, giving you flexibility to use excess foreign taxes in years where you have more U.S. tax liability.
We’ll break down how each works, when the deduction might apply, and how to make the right choice.
What’s the Core Difference?
The key distinction is how they reduce your U.S. tax liability:
[table “29” not found /]In almost all cases, the Foreign Tax Credit results in a lower U.S. tax bill than a deduction.
What is a Foreign Tax Credit?
A foreign tax credit is a non-refundable credit that you can claim if you’ve paid foreign income taxes. This credit directly reduces the amount of tax you owe to the U.S. government, dollar for dollar. The primary goal of the foreign tax credit is to mitigate the risk of double taxation, ensuring that you’re not taxed twice on the same income.
How the Foreign Tax Credit Works (In Practice)
The FTC, authorized under IRC §901, allows you to subtract the amount of foreign income tax paid from your U.S. tax liability—not from your income.
But it’s not unlimited. The IRS restricts the credit to the amount of U.S. tax attributable to your foreign source income. This is calculated using Form 1116, which applies a limitation formula:
FTC Limit = (Foreign Source Taxable Income ÷ Total Taxable Income) × U.S. Tax Liability
Example: Sarah in France
Sarah is a U.S. citizen who:
- Lives and works full-time in France
- Earns $100,000 in salary from a French employer
- Pays $30,000 in foreign income taxes paid to France
- Has no U.S. income
- Files Married Filing Jointly
Let’s assume her U.S. tax liability before credits is approximately $12,000 (after standard deduction).
Using Form 1116, Sarah allocates 100% of her taxable income to foreign sources. Her FTC limit is therefore: ($100,000 ÷ $100,000) × $12,000 = $12,000 Even though she paid $30,000 in foreign taxes, she can only claim a credit for $12,000 this year.
The remaining $18,000 can be:
- Carried back 1 year (if applicable), or
- Carried forward up to 10 years (IRC §904(c))
✅ Bottom line: With the FTC, she pays zero U.S. tax, and still has $18,000 in FTC to use in future years.
What If Sarah Had Taken the Deduction?
Instead of claiming the FTC, Sarah could deduct the $30,000 in French tax as an itemized deduction on Schedule A. But deductions don’t reduce tax liability dollar-for-dollar.
Here’s the math:
- Her adjusted gross income (AGI) is still $100,000
- Deducting $30,000 brings her taxable income down to $70,000
- On $70,000 of taxable income, her U.S. tax liability is now roughly $8,200
That’s still $8,200 she has to pay to the IRS, despite paying $30,000 to France.
In contrast, the FTC wiped out her entire U.S. tax liability and allowed her to carry forward $18,000 in unused credits.
When Would You Ever Use the Foreign Tax Deduction?
Short answer: almost never. But let’s be precise about when and why the deduction would ever make sense.
Here are the only legitimate scenarios where a U.S. expat might use the foreign tax deduction instead of the credit:
1. The Foreign Taxes You Paid Don’t Qualify for the Foreign Tax Credit
This is the only real reason to consider the deduction.
The IRS doesn’t allow you to claim a foreign tax credit for just any tax you paid abroad. The tax has to meet very specific requirements under Treas. Reg. §1.901-2—namely, it must be:
- A tax imposed in lieu of or on net income
- Levied on you, not your employer or another party
- Paid or accrued in a way consistent with U.S. tax accounting
If the tax you paid doesn’t meet that definition, you’re barred from claiming the FTC. But you might still be able to deduct it as a personal tax expense on Schedule A, if you itemize.
Example:
You paid a wealth tax or gross receipts tax in a country like Switzerland or Uruguay. It’s not an “income tax” under IRS rules, so it’s not creditable—but it might still be deductible if you itemize.
That’s the deduction’s primary use case.
2. You’re Already Itemizing for Other Reasons AND the Tax Isn’t FTC-Eligible
Let’s be absolutely clear: you must itemize deductions to claim the foreign tax deduction. You can’t claim it and take the standard deduction. So this is not a reason to use the deduction—it’s a condition for being able to.
Where the deduction might be worth something is if:
- You’re already itemizing (e.g., high U.S. mortgage interest, large charitable contributions, or state taxes)
- The foreign income taxes paid are not FTC-eligible (see #1)
- You’re looking to pick up every legal deduction you can to reduce taxable income
Otherwise, if you don’t itemize, the foreign tax deduction is off the table. It’s not optional.
How to Use Unused Foreign Tax Credit
If you paid more in foreign income tax than the IRS allows you to claim in a given year (due to the FTC limitation formula), the excess isn’t lost. You can carry back the unused portion to the previous tax year (if you had foreign income then), or carry it forward for up to 10 future years. This is particularly useful for expats whose income and tax rates fluctuate year to year. To claim a carryback or carryover, you must track and report it using Form 1116, and ensure proper categorization between passive and general income baskets.
For a detailed guide on how this works and how to actually claim those unused credits, read our post: Foreign Tax Credit Carryover & Carryback Explained
Work With Us to Get It Right
Choosing between the Foreign Tax Credit and the Foreign Tax Deduction can have a major impact on your U.S. tax liability, especially if you’re dealing with foreign income taxes, foreign business income, or income from multiple countries.
At 1040 Abroad, we help U.S. expats reduce their overall tax burden, avoid double taxation, and stay fully compliant—whether you’ve paid income taxes to a foreign government, need help with Form 1116, or want to use carryovers effectively.
We understand the details—from foreign source income and withholding tax, to how tax treaties and local laws affect your U.S. return.
Let us help you claim every dollar you’re entitled to.
