What is Foreign Tax Credit (FTC)?

How it works

Per PwC US individual foreign-tax-relief, US persons (and foreign persons with US-effectively-connected business income) may claim a credit against US federal income tax for "foreign income, war profits, and excess profits taxes" paid to foreign countries and US possessions. Alternatively, they may deduct the foreign tax with no limitation. Most taxpayers credit because dollar-for-dollar offset beats deduction at marginal rate.

Only specific taxes qualify: foreign income taxes (or in lieu of). VAT, sales tax, property tax, social security contributions, payroll taxes — generally not creditable. Inheritance / wealth taxes — usually no.

The FTC is basket-limited: foreign tax paid in one income category can only offset US tax on the same category. The current US baskets:

• Passive category — interest, dividends, capital gains.
• General category — operating business income, salary, royalties.
• GILTI / NCTI category — separate basket for CFC inclusions.
• Foreign branch income — separate basket.
• Treaty-resourced income — separate basket for income reclassified by treaty.

Per-basket limitation formula:

FTC limit (per basket) = US tax × (foreign-source taxable income in basket / total taxable income)

Excess FTC carries back 1 year and forward 10 years, but only within the same basket. A high-tax-foreign-country year might generate excess passive-basket FTC that can't offset general-basket US tax.

Forms

• Form 1116: individuals (US persons + foreign persons with ECI).
• Form 1118: domestic corporations.
• Form 8833: required when claiming a treaty-based FTC modification.

The OBBBA reform (July 2025)

Per PwC US Significant Developments, the One Big Beautiful Bill Act modified FTC mechanics:

• Income sourcing rules adjusted for certain payments.
• CFC tax years and pro-rata-share rules modified, affecting the GILTI / NCTI basket.
• BEAT calculation (which doesn't allow general business credits in the same way as regular tax) modified.

These changes are recent enough that current tax planning around FTC should be done with 2025-aware advisors — older guidance often misstates the current basket rules.

Examples

• US citizen consulting from France. Earns €100,000, pays approximately €30,000 of French income tax. Files Form 1040 reporting the €100,000 (converted to USD) as worldwide income. Claims FTC of approximately $30,000 (USD-converted) on Form 1116 in the general basket. Net US tax on French income: zero, assuming the FTC limitation doesn't bite.
• US founder owns 100% of a French SAS, treated as CFC. SAS pays 25% French CIT on €1M profit = €250k. Profits flow through as GILTI / NCTI to the founder. FTC at 80% × €250k = €200k creditable in the GILTI / NCTI basket. Residual US tax depends on basket math + Section 250 deduction (C-corp shareholders only).

Common mistakes

• Assuming any foreign payment is creditable. Only foreign income taxes (or in-lieu-of taxes) qualify. VAT, sales tax, property tax, social security generally don't.
• Mixing baskets. High-tax passive income basket excess FTC cannot offset US tax on general-basket income. Carry-forwards are basket-locked.
• Skipping the deduction comparison. In low-marginal-rate years (or with itemised deductions), the FTC isn't always optimal. Run the math both ways.
• Forgetting the GILTI / NCTI 80% haircut. Individual US shareholders of CFCs without §962 election face significantly worse FTC mechanics than C-corp shareholders.