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Dividends or interest from foreign sources: Should you take the foreign tax credit?

Avoiding double taxation of your foreign income requires careful tax planning. There are many factors involved, from the source of the income to your overall tax compliance strategy.

Given these factors, when does it make sense to take the foreign tax credit? In this post, we will discuss that question as it applies to interest or dividend income.

When discussing foreign income, it is important to be clear about the source of the income. If the income is earned income, you will want to make proper use of the foreign earned income exclusion. For taxpayers working abroad, there are also certain exclusions available for housing and meals.

But what if the source of the income is interest, dividends or capital gains that may have already been taxed by another country? The U.S. tax code recognizes that U.S. taxpayers should not be taxed twice on the same income. But taxpayers must carefully evaluate whether to take a tax deduction or a tax credit in order to offset the foreign taxes.

For some taxpayers, taking a deduction may be preferable because it can be done on Schedule A of Form 1040. But for other taxpayers, a greater tax benefit may be gained by using the foreign tax credit. The applicable IRS Form is Form 1116.

There are, however, numerous complex compliance issues that can arise concerning foreign tax credits. For example, specialized tax considerations apply to certain types of income, such as long-term capital gains.

It is therefore important to discuss your specific situation with an attorney who is knowledgeable about international taxation.

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