What does the foreign tax credit actually do?

The foreign tax credit lets a US taxpayer offset US tax dollar-for-dollar with income taxes paid to a foreign country on the same income. Because the US taxes its residents and citizens on worldwide income, foreign profits would otherwise be taxed twice — once abroad and once at home. The credit is the primary tool for preventing that.

Should I claim the foreign tax credit or deduct foreign taxes instead?

A credit reduces your US tax dollar-for-dollar, while a deduction only reduces taxable income — so a credit is almost always more valuable. You must choose one method for all creditable foreign taxes in a given year; you can't credit some and deduct others. Occasionally a deduction wins when the credit is heavily limited, but that's the exception.

What is the foreign tax credit limitation?

The credit can't exceed the US tax that would apply to your foreign-source income — computed roughly as US tax times foreign-source taxable income over total taxable income. This stops the credit from wiping out US tax on US-source income. Foreign taxes above the limit aren't lost: they generally carry back 1 year and forward 10.

What are the foreign tax credit baskets?

The limitation is computed separately for categories ("baskets") of income — including passive income, general category income, GILTI, foreign branch income, and treaty-resourced income. Baskets stop high-taxed income in one category from freeing up credits against low-taxed income in another. Corporations report the computation by basket on Form 1118.

BACK TO RESOURCES

Outbound Tax

The Foreign Tax Credit: How US Businesses Avoid Being Taxed Twice

Earn income abroad and both the foreign country and the US want to tax it. The foreign tax credit is how you avoid paying twice — but the limitation, the baskets, and Form 1118 decide how much of that credit you actually get to use.

SMAART Tax Team

February 24, 2026

7 min read