International taxation is complex, but foreign tax credits and income exclusions are key tools for managing global tax burdens. These mechanisms help prevent and provide relief for U.S. taxpayers with foreign income.
Foreign tax credits offset U.S. taxes with those paid abroad, while income exclusions allow certain foreign earnings to be exempt from U.S. tax. Understanding the rules and limitations of these provisions is crucial for effective international tax planning.
Foreign Tax Credits: Purpose and Mechanics
Preventing Double Taxation
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Taxation in the United States - Wikipedia View original
Corporations ineligible for FEIE but may qualify for other international tax provisions (foreign-derived intangible income (FDII) deduction)
Subpart F rules and Global Intangible Low-Taxed Income (GILTI) provisions affect taxation of certain foreign income earned by controlled foreign corporations (CFCs)
U.S. corporations may claim participation exemption (100% dividends received deduction) for specific foreign-source dividends from specified foreign corporations
Corporate international tax planning involves complex interplay of various provisions and deductions
Key Terms to Review (17)
Double Taxation: Double taxation refers to the taxation of the same income or financial transaction in more than one jurisdiction, which often happens with corporations and their shareholders. This concept is crucial when considering the choice of business entity, as it significantly affects the overall tax burden and decision-making in structuring a business.
Foreign Bank Account Report (FBAR): The Foreign Bank Account Report (FBAR) is a form that U.S. taxpayers must file if they have financial interests in or signature authority over foreign bank accounts that exceed a certain threshold. It is designed to combat tax evasion by requiring transparency about overseas financial holdings, connecting it to issues related to foreign tax credits and income exclusions by providing a way for the IRS to monitor unreported income that might be subject to these credits or exclusions.
Foreign Earned Income Exclusion: The foreign earned income exclusion allows U.S. citizens and residents to exclude a certain amount of their foreign earnings from U.S. taxation, promoting work abroad without the burden of double taxation. This exclusion is designed to prevent U.S. taxpayers from being taxed on income earned in a foreign country, which is already subject to foreign tax, ultimately encouraging international work and investment.
Foreign income tax credit: The foreign income tax credit is a provision that allows U.S. taxpayers to reduce their federal tax liability by the amount of foreign taxes paid on income earned abroad. This credit helps mitigate the problem of double taxation, which occurs when the same income is taxed by both the U.S. and a foreign country. By providing this credit, the U.S. government encourages investment and business operations in foreign markets, supporting global economic engagement.
Foreign tax credit: The foreign tax credit is a provision that allows taxpayers to offset their U.S. tax liability with taxes paid to foreign governments on income earned outside the United States. This helps prevent double taxation, ensuring that taxpayers aren't penalized for earning income abroad. By allowing this credit, it encourages investment and business activities in foreign markets, fostering international economic growth.
Form 1116: Form 1116 is a tax form used by U.S. taxpayers to claim the foreign tax credit, which helps to reduce double taxation on income earned abroad. By filing this form, taxpayers can report foreign taxes paid or accrued on foreign-source income, thus potentially lowering their U.S. tax liability. This form plays a crucial role in the context of international taxation, as it ensures that taxpayers are not unfairly taxed on the same income in both the U.S. and the foreign country where the income was earned.
Form 2555: Form 2555 is a tax form used by U.S. citizens and resident aliens to claim the Foreign Earned Income Exclusion (FEIE) and the Foreign Housing Exclusion. This form allows individuals working abroad to exclude a certain amount of their foreign earned income from U.S. taxation, which helps avoid double taxation on income earned outside the United States. The form is vital for those who meet specific qualifications, such as the bona fide residence test or the physical presence test.
General business credit: The general business credit is a tax credit available to businesses that can be used to offset various tax liabilities. This credit encompasses a variety of specific credits that can benefit businesses in reducing their overall tax burden, allowing them to invest more into their operations or pass savings onto customers. Understanding how general business credits interact with other tax provisions, such as foreign tax credits and income exclusions, is crucial for maximizing tax efficiency.
Housing exclusion: Housing exclusion refers to the tax provision that allows U.S. citizens and resident aliens to exclude a certain amount of capital gains from the sale of their primary residence from taxable income. This exclusion can significantly reduce the taxable gain on the sale of a home, encouraging homeownership and investment in residential real estate.
Internal Revenue Code Section 901: Internal Revenue Code Section 901 allows U.S. taxpayers to claim a credit for foreign taxes paid or accrued on income earned outside the United States. This provision is crucial for mitigating the double taxation that can occur when foreign governments tax U.S. citizens on the same income, thus encouraging international business and investment.
IRS Form 8938: IRS Form 8938 is a tax form used by certain U.S. taxpayers to report their foreign financial assets. This form is part of the Foreign Account Tax Compliance Act (FATCA) and is required for individuals with specified foreign financial assets that exceed certain thresholds. Filing this form helps the IRS track offshore accounts and ensures compliance with tax laws related to foreign income and assets.
Permanent establishment: A permanent establishment refers to a fixed place of business through which an enterprise conducts its activities in a foreign country, leading to the taxable presence of that enterprise in that jurisdiction. This concept is crucial in determining how a business is taxed internationally, affecting the allocation of profits and compliance with local tax laws. It often influences tax treaties and the availability of foreign tax credits, impacting strategic business decisions regarding where to operate and how to manage international tax liabilities.
Tax Cuts and Jobs Act: The Tax Cuts and Jobs Act (TCJA) is a significant piece of tax legislation enacted in December 2017 that overhauled the U.S. tax code, aiming to stimulate economic growth by reducing tax rates for individuals and businesses. This act brought about numerous changes, including adjustments to deductions, credits, and the overall structure of the tax system, impacting various sectors and types of taxpayers.
Tax Residency: Tax residency refers to the status of an individual or entity as a resident for tax purposes, determining which jurisdiction's tax laws apply to them. This status is critical for establishing tax obligations, as it influences the ability to claim foreign tax credits and income exclusions, allowing individuals to avoid double taxation on income earned in multiple countries.
Territorial Taxation: Territorial taxation is a tax system where a country taxes only the income earned within its borders, excluding foreign income from taxation. This system contrasts with worldwide taxation, which taxes citizens on all income, regardless of where it is earned. In the context of international business, this approach can influence decisions about foreign investments and operations, as businesses may seek to minimize their tax liabilities by choosing countries with favorable territorial taxation policies.
Transfer pricing: Transfer pricing refers to the pricing of goods, services, and intangibles between related entities within a multinational corporation. It plays a crucial role in determining taxable income and can significantly affect tax liabilities across different jurisdictions, impacting overall business strategy and compliance with various tax regulations.
Worldwide taxation: Worldwide taxation refers to a tax system where a country's residents are taxed on their global income, regardless of where that income is earned. This approach means that taxpayers must report all income earned both domestically and internationally, which can lead to the possibility of double taxation. To alleviate this burden, many countries offer mechanisms such as foreign tax credits or income exclusions to prevent taxpayers from being taxed twice on the same income.
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