Foreign Tax Deduction

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Definition: Foreign Tax Deduction

Foreign tax deduction may be categorized as the taxes paid to the foreign government and is classified as tax withholding. It is normally taken in lieu of foreign tax credit.


In most cases the foreign tax credit or itemized deduction is advantageous and the claimant does not need to live or work in that country to claim the tax credit. Those who itemize the deductions on Schedule-A Form 1040, taking foreign tax deduction are the most viable option. The claimant can have either the tax credit or deduction at one time and not both of them and can change choices for each year’s taxes.


Also foreign tax deductions do not come with any time requirements. If the claimant cannot claim foreign tax credit then claiming foreign tax deduction would be the only alternative. Foreign tax credits result in the reduction of US tax liability, and hence are generally more beneficial than tax deduction which merely reduces the taxable income. If the claimant takes foreign tax credit and the taxes paid exceed the credit limit for that year, then the excess tax can be carried over to another tax year.


For example, you are in the 30% income tax bracket and claim a $500 deduction. Hence your taxes paid will be reduced by $150 dollar whereas the foreign tax credit will provide you with $500 tax liability. Hence, although the tax credit option looks more advantageous on the paper, the tax credits usually come with credit limits. Moreover, the tax deduction option will be more advantageous if the claimant is on a higher income tax bracket.


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