Foreign Tax Credits and Non-Income Taxes

Foreign tax credits are a very important benefit if you are a US taxpayer with foreign income. These credits take what you pay as income tax to a foreign government, and reduce your US tax bill, dollar for dollar (and after exchange rates). But not every type of tax in the US can be reduced or eliminated by a foreign tax credit, only income taxes and only on foreign income. Self-employment taxes that you pay on business income aren’t actually income taxes, they are US Social Security and Medicare taxes. And this is confusing, because these so called ‘SE taxes’ are collected on your US income tax return, but foreign tax credits don’t do anything to ease them. The same is true of Net Investment Income Tax, or ‘NIIT’ as we call it, that is levied on investment income of high earners. This is because NIIT is not an income tax either, it is called a surtax, meaning it is taxing something already taxed – almost like a penalty. Accordingly, foreign tax credits don’t work on NIIT either. Our advice: When you are preparing for your US tax bill, don’t assume foreign tax credits will wipe everything out – there are just some US taxes you can’t reduce.

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Foreign Tax Credit Mismatch