The foreign tax credit offsets US tax with foreign income tax already paid, claimed on Form 1116. It is capped by the section 904 limitation — US tax multiplied by the share of your taxable income that is foreign-sourced in that category. Excess credit carries back one year (mandatory) then forward ten years, tracked per basket on Schedule B.
For an American living in a country with higher tax rates than the United States, the credit is the whole ballgame. It is what makes a UK salary bearable on a Form 1040, and the surplus it generates is a genuine asset with a ten-year life.
It is also the item most often lost. Carryovers are routinely reset to zero when a client changes preparer, because the incoming firm has no supporting schedule for the opening balance and takes the cautious route of starting again.
The credit cannot exceed US tax on foreign-source income in that category. Concretely: if your US tax before credit is $90,000 and three quarters of your taxable income is foreign-source in the basket, the limit is $67,500 — however much foreign tax you actually paid.
Whatever the limitation refuses becomes a carryover. In a country like the UK that is most years, permanently.
Credits are computed separately for each category of income, and a surplus in one is worthless against tax in another. This is the single most misunderstood feature of the regime.
| Basket | Typical UK income | Common outcome |
|---|---|---|
| General | Salary, self-employment, most trading profit | Large permanent surplus |
| Passive | Dividends, interest, most gains, rent | Surplus, and often unusable |
| Foreign branch | UK sole trade, LLP interest | Frequently mis-allocated |
| Section 951A | CFC inclusions from a UK company | Own rules, no carryover at all |
A six-figure general-basket carryover does nothing about US tax on a dividend. People discover this in the year they finally have US tax to pay.
Section 904(c) allows unused credits to be carried back one year and forward ten, in that order. The carryback is not elective. An excess arising this year must first be applied against last year to the extent that year had spare limitation, which usually means amending the prior return.
Skipping the carryback does not preserve the amount. The carryforward is computed as though the carryback had been claimed, so quietly rolling the full excess forward overstates the balance from that point on — and every later year inherits the error.
The UK tax year ends 5 April and the US year 31 December, so UK tax is almost never paid in the US year the income belongs to. Claiming credits when paid therefore reports income in one year and its tax in another, manufacturing surplus limitation in the first year and surplus credit in the second.
Electing to claim on the accrual basis lines them up. The election binds all future years, so it should be made deliberately and early rather than after a decade of mismatched years.
This is recoverable work and it is frequently worth more than the year's fee. Collect up to ten years of Forms 1116 by category, compute each year's excess and available limitation, apply the mandatory carryback, then run the remainder forward oldest-first and retire anything past its tenth year.
Where a return is missing, reconstruct from HMRC records of tax paid alongside the income reported to the IRS, and document the method rather than presenting the result as certain.
Credits are consumed oldest first, so the tenth-year layer is always the one at risk. If a large tranche is about to expire, that is the year to deliberately create US tax on foreign-source income in the same basket — a Roth conversion, a planned disposal, or exercising an option.
That only works if somebody knows the maturity profile. It is the clearest argument for keeping a running schedule rather than reconstructing one under pressure.
Ten years, after a mandatory one-year carryback. Credits are absorbed oldest first, so the tenth-year layer is always the one at risk of expiring. Anything unused after the tenth succeeding year is lost permanently — there is no extension and no deduction for the lost amount.
In a high-tax country such as the UK, usually yes. The credit offsets US tax with UK tax paid and banks the surplus for up to ten years, while the exclusion removes the income and wastes the foreign tax attached to it. In a no-tax country such as the UAE the exclusion is normally better, because there is no foreign tax to credit.
Because credits do not pool across baskets. A large general-basket surplus from UK employment cannot offset US tax on passive income such as dividends or gains. Income the US treats as US-sourced also generates no credit capacity at all, regardless of what any other basket holds.
Whenever you file Form 1116 for a category and there is a carryover in the prior year, the current year or both. It is filed per basket, so someone with general and passive carryovers files two. It reconciles the opening balance to the closing balance and is the only place the IRS sees the asset.
For someone settled in the UK, generally accrued. The mismatch between the 5 April UK year end and the 31 December US year end means a cash-basis claim splits income and its tax across different US years, creating artificial surplus in one and shortfall in the next. The accrual election binds all future years, so make it deliberately.
Often, yes. If prior Forms 1116 exist the balance can be rebuilt by category from the filed returns, and where a return is missing it can be reconstructed from HMRC records of tax paid against the income reported. Document the method — a reconstructed figure presented as certain is worse than one presented honestly.
If not, it is probably wrong — and possibly much larger than your return shows. We rebuild them from filed returns.
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