Can I deduct taxes paid to foreign governments?

Foreign taxes on investments can surprise many U.S. taxpayers. Over the last 30 years, as investment options have multiplied globally, more Americans encounter foreign tax on income from their holdings. These funds range from broad, like “American Large Caps,” to niche, such as “International Copper Mining.” Fortunately, the U.S. tax code allows you to reduce double taxation through the Foreign Tax Credit or a Foreign Tax Deduction. 

1. Foreign Tax Credit: This lets you offset U.S. tax on foreign income by claiming a dollar-for-dollar credit for taxes paid abroad. Use Form 1116 to calculate this credit, though some may qualify to skip this form if the tax is below a set threshold. 

2. Foreign Tax Deduction: If you itemize deductions on Schedule A, you can deduct foreign taxes from your income, thus lowering your adjusted gross income (AGI). However, itemizing only benefits those whose deductions exceed standard amounts, like $27,700 for Married Filing Jointly (2023). 

Example: Anne, a teacher, earned $2,000 in dividends from a South American mine, with $400 in foreign tax withheld. If she claims the Foreign Tax Credit, her U.S. tax on the dividends would drop to $40. With the Foreign Tax Deduction, her taxable income would reduce to $1,600, resulting in $352 of U.S. tax owed. In her case, the credit method minimizes her tax most effectively. 

If you are still unsure about your situation, and want expert advice, you can click this link to set an appointment to speak with a Tax Expert from Lisa Brugman, EA & Associates.