Will the U.S. double-tax income from a foreign country?

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Q. I have a question about income generated out of the country as a U.S. citizen. If I pay taxes on income in the other country as a permanent resident, will the income be taxed in the U.S. also?
— Worker

A. Of course Uncle Sam wants his due, but you have some options.

A U.S. citizen is subject to U.S. tax on income derived from worldwide sources, said Neil Becourtney, a certified public accountant and tax partner with CohnReznick in Eatontown.

There are three mechanisms available to mitigate the otherwise double taxation that would result from the income in question being taxed by both a foreign country and the U.S., he said

The first is the foreign earned income exclusion reportable on IRS Form 2555.

“A taxpayer that meets the tax home test and either the bona fide residence test or the physical presence test – the rules are explained in the Form 2555 instructions – can exclude up to $103,900 of foreign earned income from federal income tax for 2018,” Becourtney said. “This amount is indexed annually for inflation.”

Unearned income such as interest, dividends, and capital gains is not eligible for this exclusion, he said.

Next is the foreign tax credit reportable on IRS Form 1116.

He said a foreign tax credit cannot be claimed for foreign income taxes paid on any income for which a foreign earned income exclusion is claimed.

The last option is to claim a deduction for foreign income taxes paid on Schedule A as an itemized deduction, Becourtney said. This option is also unavailable on income for which a foreign earned income exclusion is claimed.

“Generally, a tax credit is preferable to a tax deduction since a credit provides a dollar-for-dollar tax savings, whereas a tax deduction at best provides a 37 percent federal tax savings,” he said. “Regardless of which strategy is used, the foreign earned income as well as the foreign taxes paid must be reported in U.S. dollars.”

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This story was originally published on June 17, 2019.

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