Foreign tax credit limitation: how the limit works and how to calculate it in 2026

The foreign tax credit limitation caps the US tax credit you can claim for foreign taxes paid to the amount of US tax attributable to your foreign-source income. The limitation is calculated separately for each category of income under IRC Section 904, using Form 1116. The credit is nonrefundable – it can reduce your US tax liability to zero but cannot generate a refund.

What is the limit on the foreign tax credit?

The foreign tax credit limit prevents you from using taxes paid to a high-tax country to offset US tax on income earned in the US or in a low-tax country.

Three core rules define it:

• The credit cannot exceed your US tax liability on foreign-source income in each basket category
• You must file a separate Form 1116 for each income category unless you qualify for the de minimis exemption
• Excess credits that exceed the limitation carry back one year and forward ten years under IRC Section 904(c) – they are not lost permanently

The limitation formula, the basket system under IRC Section 904(d), and the nonrefundable nature of the credit work together to prevent double taxation while keeping the credit proportional to US tax on foreign income.

Limitation = foreign-source taxable income ÷ worldwide taxable income × US tax before credits

This formula appears on Form 1116, Part I through Part III. Part I captures foreign-source income and deductions. Part II reports foreign taxes paid or accrued. Part III applies the formula and determines the allowable credit for that category.

The limit on foreign tax credit is calculated separately for each income basket. A high credit in the general category cannot offset a shortfall in the passive category, and vice versa.

 

 

See our Form 1116 guide for a detailed walkthrough of each part of the form.

Foreign tax credit basket categories explained

The IRS requires you to calculate a separate foreign tax credit limitation for each income basket, preventing high-taxed income from offsetting low-taxed income. These separate foreign tax credit limitation categories are defined under IRC Section 904(d), and each requires its own Form 1116.

The five baskets most relevant to individual taxpayers:

 

Two additional categories – certain income re-sourced by treaty and lump-sum distributions – apply in narrower circumstances.

If you claim treaty benefits that re-source US income as foreign, you must file a separate Form 1116 for that income. You may also need to disclose the position on Form 8833, as described in the Form 1116 instructions.

Separate foreign tax credit limitations apply to each basket. Mixing income from different baskets on a single Form 1116 is one of the most common errors the IRS flags on expat returns.

Passive income basket vs. general income basket: key differences

Most US expats earning foreign wages file under the general income basket, while investment income abroad typically falls into the passive basket.

Understanding which basket applies to your income determines how the limitation formula is calculated.

• Passive category: dividends, interest, rents, royalties, and capital gains from foreign investments. If you hold foreign mutual funds or receive dividends from a foreign brokerage account, this is your basket.
• General category: wages, salaries, and active business income earned abroad. If you work for a foreign employer or run an active business, your earned income goes here.

Each basket has its own limitation ceiling. Excess credits in the passive basket cannot offset a general-basket shortfall, and unused general-basket credits cannot reduce passive-basket tax.

 

 

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GILTI foreign tax credit limitation: special rules for business owners

The GILTI basket has its own separate foreign tax credit limitation, and only 80% of foreign taxes allocated to GILTI income are creditable under IRC Section 960(d) for tax year 2025.

This 20% haircut means that even if your controlled foreign corporation paid substantial foreign taxes, one-fifth of those taxes cannot offset your US GILTI liability.

The high-tax exclusion election under Treasury Regulation Section 1.951A-2(c)(7) can remove CFC income from the GILTI base entirely if the effective foreign tax rate on that tested unit exceeds 18.9%. This is an annual election that applies per tested unit, not per country.

The Section 962 election allows individual CFC shareholders to be taxed on GILTI at corporate rates – 10.5% effective for tax year 2025 – and to access deemed-paid foreign tax credits otherwise unavailable to individuals.

For US expat business owners in countries with corporate tax rates above roughly 13.125%, the election can eliminate the residual US GILTI tax.

GILTI is reported on Form 8992, with the inclusion calculated under Section 951A. Without a Section 962 election, the deemed-paid credit for the CFC's foreign taxes generally isn't available at all – Form 1116, box a, only covers foreign tax the shareholder paid directly, such as withholding on a distribution of previously taxed earnings. With the election, that deemed-paid credit is instead claimed on Form 1118, using code "951A" on line a.

Excess credits in the GILTI basket cannot be carried back or forward – they expire in the year they arise.

 

 

Foreign tax credit limitation for corporations

Corporations that own at least 10% of a foreign corporation may claim deemed-paid foreign tax credits, subject to their own separate limitation calculation under IRC Section 960.

C-corporations apply the same IRC Section 904 limitation formula as individuals but also contend with indirect credits, the GILTI basket, and the foreign branch income basket. Corporate FTC claims use Form 1118 rather than Form 1116.

The Tax Cuts and Jobs Act of 2017 repealed the indirect credit for dividends from foreign subsidiaries and replaced it with a participation exemption under Section 245A.

Deemed-paid credits under Section 960 now apply only to Subpart F and GILTI inclusions, not to actual dividend distributions.

For tax year 2025, corporate shareholders receive a 50% deduction under Section 250 on GILTI income, bringing the effective rate on GILTI to 10.5% before credits. The OBBBA reduces this deduction to 40% – raising the effective rate to 12.6% – for tax years beginning after December 31, 2025.

The basket categories and limitation formula are structurally the same as for individuals, but the interaction with the Section 250 deduction for GILTI and FDII adds complexity that individual filers do not face.

Is the foreign tax credit refundable?

No – the foreign tax credit is a nonrefundable credit, meaning it can reduce your US tax liability to zero but cannot generate a refund. If your creditable foreign taxes exceed your total US tax liability for the year, the excess does not come back as a payment from the IRS.

The limitation formula under IRC Section 904 enforces this cap – the credit never exceeds the US tax attributable to your foreign-source income in each basket.

Any amount above that ceiling becomes an excess credit subject to the carryover rules – one year back, ten years forward.

This is an important distinction from refundable credits like the Additional Child Tax Credit, which can result in a payment even if you owe no US tax.

See our comparison of foreign tax credit vs. deduction for when deducting foreign taxes on Schedule A might be the better choice.

Foreign tax credit carryover: what happens when you hit the limit

Tracking your foreign tax credit carryover by basket is mandatory – passive basket carryovers cannot offset general basket limitations in future years. When your creditable foreign taxes exceed the limitation in a given year and category, the excess follows specific carryback and carryforward rules under IRC Section 904(c), detailed in IRS Publication 514.

Four rules govern the foreign tax credit carryover limit:

1. Excess foreign taxes carry back one year first. The carryback is mandatory – you cannot elect to skip it the way you can with a net operating loss.
2. Any remaining excess carries forward up to ten years.
3. Carryovers must be tracked separately by basket category. A passive carryover stays in the passive basket; a general carryover stays in the general basket.
4. Unused carryovers expire after the ten-year window. Credits not absorbed within that period are lost permanently.

Any foreign tax credit excess limitation carryforward is reconciled on Schedule B, Form 1116. This schedule tracks carryovers by category and year, and the total carryover amount enters Part III of Form 1116 at line 10.

The one exception: Section 951A category income – GILTI – does not allow carrybacks or carryforwards. Excess GILTI credits expire in the year they arise.

 

 

See our full guide on foreign tax credit carryover rules for worked examples of carryback and carryforward mechanics.

Exemption from the foreign tax credit limitation: the de minimis rule

Taxpayers whose total creditable foreign taxes do not exceed $300 for tax year 2025 – or $600 for married filing jointly – may be exempt from filing Form 1116 and calculating the limitation, but this exemption has strict eligibility conditions.

These thresholds are set by statute and are not adjusted for inflation.

All four of the following conditions must be met simultaneously:

• All foreign-source gross income is passive category income – dividends, interest, and similar items
• All foreign income and foreign taxes are reported on a qualified payee statement such as a 1099-DIV, 1099-INT, Schedule K-1, or Schedule K-3
• Total creditable foreign taxes do not exceed $300 for single filers or $600 for MFJ filers for tax year 2025
• You elect to claim the credit directly on Schedule 3, Form 1040 instead of filing Form 1116

This election is not available to estates or trusts. If you make this election, you cannot carry over or carry back any foreign taxes to or from that tax year.

Most US expats with a foreign salary will not qualify for this exemption because wages are general category income, not passive.

The de minimis rule is designed for taxpayers whose only foreign tax exposure comes from small amounts of foreign withholding on investment income reported on payee statements.

2025 foreign tax credit without Form 1116: limits for single and MFJ filers

Married filing jointly filers face a higher threshold to qualify for the simplified election to claim the foreign tax credit without filing Form 1116, but both thresholds apply only to passive income from payee statements.

 

The 2025 foreign tax credit without Form 1116 limit for single filers is $300. The 2025 foreign tax credit without Form 1116 limit for MFJ filers is $600.

Both thresholds are statutory under IRC Section 904 and do not change from year to year. The IRS outlines the full election conditions for claiming the credit without Form 1116.

If your creditable foreign taxes exceed these thresholds by even one dollar, or if any of your foreign income is not passive category income, you must file Form 1116 and calculate the full limitation.

Foreign tax credit limitation vs. foreign earned income exclusion: which is better?

Choosing the FEIE reduces your foreign-source income in the limitation formula, which can lower your allowable credit – making the choice between FEIE and FTC a critical planning decision.

The two mechanisms work differently, and the best option depends on your tax rate in the country where you live.

Key differences:

• The foreign earned income exclusion – Form 2555 – removes up to $130,000 of foreign earned income from US taxable income for tax year 2025. It applies only to earned income and requires a foreign tax home plus either the bona fide residence test or the physical presence test.
• The foreign income tax credit limit – Form 1116 – allows a dollar-for-dollar offset of creditable foreign income taxes against your US tax liability. It applies to both earned and passive income but is capped by the limitation formula.
• You cannot claim the FTC on income you excluded under the FEIE. The two do not stack on the same dollars.

 

 

See our detailed FTC vs. FEIE comparison.

How the foreign earned income exclusion affects your limitation calculation

Electing the FEIE can create a situation where you owe US tax on non-excluded income but have little or no foreign tax credit available to offset it. This happens because income excluded under the FEIE is removed from both the numerator and denominator of the limitation formula.

When you exclude $130,000 of foreign wages using Form 2555, that income disappears from the foreign-source taxable income figure on Form 1116, Part I. It also reduces worldwide taxable income on line 18.

The result: the limitation shrinks, and fewer foreign taxes are creditable against your remaining US tax.

A taxpayer who earns $180,000 abroad, excludes $130,000 under the FEIE, and pays foreign taxes on the full $180,000 may find that only a fraction of those foreign taxes are creditable against the US tax on the remaining $50,000. The rest becomes excess credit subject to carryover rules.

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The $6,886 excess can be carried back one year or forward up to ten years within the general category. It cannot offset tax in the passive basket or any other category.

See our guide on reporting foreign income on Form 1040 for how foreign wages and investment income are allocated on the return.

Foreign tax credit limitation and the alternative minimum tax

The foreign tax credit limitation is recalculated separately for AMT purposes, and the AMT limitation is based on your alternative minimum taxable income rather than your regular taxable income.

Taxpayers subject to AMT must refigure Form 1116 under AMT rules – using alternative minimum taxable income in place of regular taxable income – and enter the result on Form 6251, line 8, as described in the Form 6251 instructions.

The AMT limitation can differ from the regular tax limitation because the AMT uses a different income base – alternative minimum taxable income – and different rates. Deductions that reduce regular taxable income may not reduce AMTI by the same amount.

This changes the ratio of foreign-source income to worldwide income, which directly affects the limitation ceiling.

For expats with large foreign income, significant itemized deductions, or incentive stock option exercises, the AMT limitation may produce a smaller credit than the regular limitation. This means you could owe AMT even if your regular FTC fully offsets your regular tax.

 

 

Qualified foreign taxes: what counts toward the credit and what does not

A foreign levy only qualifies as a creditable tax if it is a compulsory payment imposed under the authority of a foreign government and is an income tax in the US sense.

The 2022 final regulations – T.D. 9959 – tightened the "net gain" requirement for creditability, requiring a foreign tax to satisfy specific conditions before it counts as a creditable income tax under Section 901.

Creditable foreign taxes include:

• Foreign national income taxes on wages, business profits, and investment income
• War profits taxes and excess profits taxes that meet the IRC Section 901 requirements
• Foreign withholding taxes on dividends, interest, and royalties – if the withholding tax is a creditable income tax
• Certain taxes paid in lieu of an income tax that meet the IRS regulatory tests

Non-creditable items include:

• Taxes on income excluded under the FEIE – you cannot credit taxes on income you already excluded from US tax
• Taxes that are refundable by the foreign government – if you can get the tax back, it is not a compulsory payment
• Social insurance taxes in most cases – unless the levy has been specifically held creditable, as with the French CSG/CRDS
• Taxes paid to sanctioned countries under Section 901(j)
• VAT, sales taxes, property taxes, and penalties – these are not income taxes

The IRS subsequently issued Notice 2023-55 and Notice 2023-80 providing temporary relief from certain of the stricter 2022 regulatory requirements. This relief remains in effect until further notice.

Foreign tax credit redetermination: when you must recalculate

A foreign tax redetermination can trigger an obligation to file an amended US return or notify the IRS, and failure to do so can result in penalties.

A redetermination occurs under IRC Section 905(c) when the amount of foreign tax you actually owe changes after the original US return is filed. The Form 1116 instructions detail the reporting requirements.

Common triggers include a foreign tax refund, a reassessment by the foreign tax authority, an amended foreign return, or accrued taxes that differ from the amount ultimately paid.

If the change increases your US tax liability, you must file an amended return – typically Form 1040-X – with a revised Form 1116. If the change does not affect your US tax, you report it on Schedule C, Form 1116, attached to your current-year return.

The redetermination affects the limitation calculation for the year the original credit was claimed, not the year the change occurred. Penalties apply if you fail to notify the IRS and cannot show reasonable cause.

Have a TFX CPA review your foreign tax credit before you file.

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US foreign tax credit limitation for expats: common mistakes to avoid

The IRS can disallow the entire foreign tax credit if Form 1116 is completed incorrectly – making accuracy in basket allocation and carryover tracking essential. The IRS foreign tax credit limit is enforced strictly, and these five errors appear repeatedly on expat returns.

Five common mistakes:

1. Mixing income from different baskets on a single Form 1116. Passive dividends and general-category wages each require their own form. Combining them distorts both limitations.
2. Failing to track carryovers by basket, year by year. A passive carryover from 2022 cannot offset a general-category limitation in 2025. Each carryover must be reconciled on Schedule B, Form 1116.
3. Claiming the credit on FEIE-excluded income. If you excluded $130,000 of foreign wages on Form 2555, the foreign taxes allocable to that excluded income are not creditable. You must reduce your foreign taxes accordingly.
4. Using the wrong exchange rate when converting foreign taxes paid. If you claim the credit on foreign taxes paid (the cash method), the IRS generally requires the exchange rate on the date each tax was paid or withheld. If you elected to claim the credit on an accrual basis, the opposite default applies: you generally must use the average exchange rate for the tax year the taxes relate to, unless you elect to use the exchange rate on the date paid. Using the wrong rate for your method is a common error. See the Form 1116 instructions for currency conversion rules and exceptions.
5. Overlooking the separate AMT limitation. The AMT uses a different income base and can produce a different limitation amount. Filing without the AMT calculation can result in underpayment.

See our FEIE denial case study for a real example of how errors on related forms can cascade into FTC problems.

Tax treaty benefits and the foreign tax credit limitation

Tax treaty benefits can reduce the foreign tax rate you pay, which in turn reduces the amount of creditable foreign taxes available – potentially lowering your foreign tax credit below your US tax liability on that income. This interaction means a treaty benefit in one direction can create a cost in the other.

Many US tax treaties contain withholding-rate reductions on dividends, interest, and royalties paid between treaty countries. If a treaty reduces your foreign withholding rate from 30% to 15%, you pay less foreign tax – which means you have fewer dollars to credit against your US tax on that income.

The "saving clause" in most US tax treaties preserves the US right to tax its citizens on worldwide income regardless of where they live. Treaty benefits may reduce your foreign tax, but they generally do not reduce the US tax you owe.

The limitation formula captures this – the credit is still capped at US tax on the foreign-source income.

If you elect to re-source US income as foreign under a treaty provision, you must compute a separate foreign tax credit limitation for that re-sourced income on its own Form 1116.

 

 

Foreign tax credit limitation for rental and passive investment income abroad

Passive basket foreign taxes are frequently limited because US taxpayers with foreign investment income often have a small passive income base relative to their worldwide income.

The US foreign tax credit limit in the passive basket is particularly sensitive to the ratio of foreign passive income to total income.

Key rules for passive foreign income:

• Rental income from foreign property generally falls into the passive basket unless the rents are derived in the active conduct of a trade or business under Treasury Regulation Section 1.904-4(b)(2)(iii) – a distinct test from the real estate professional election under Section 469, which affects passive-activity-loss deductibility, not FTC basket category.
• Foreign dividends and interest also fall into the passive basket, whether from a foreign brokerage account, foreign mutual fund, or foreign bank
• The passive basket limitation is calculated separately from the general basket – high-taxed wages cannot offset a passive-basket shortfall

If you own rental property abroad and pay foreign income tax on the rental income, the credit is limited to the US tax attributable to the net foreign rental income after deductions.

Foreign property taxes, VAT, and management fees are not creditable on Form 1116 – only foreign income taxes qualify.

For taxpayers with diversified foreign income across wages, rental property, and investment accounts, the limitation must be calculated separately for each basket. This often means filing two or more Forms 1116 in the same year.

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