Hello everyone! Many people living in the United States may be concerned about their income in Japan. Did you know that when US residents file their US income taxes, there is a foreign tax credit for income earned in Japan?
What is foreign tax credit?
Under U.S. tax law, if you are a U.S. resident (Whether you are a U.S. resident under U.S. tax law, it depends on your U.S. visa type and length of stay in the U.S.), you must file a U.S. income tax return reporting your worldwide income. Therefore, you must report not only your income in the United States, but also your worldwide income during your residence period including income in Japan (foreign country).
U.S. permanent residents and U.S. citizens are considered U.S. residents for tax purposes even if they live outside the U.S., such as in Japan, and must report their worldwide income including foreign source income.
Therefore, if you are a U.S. resident and have income in Japan (foreign country), you can report income that has already been taxed in Japan (foreign country) on your U.S. income tax return and be taxed again in the U.S., resulting in double taxation.
The foreign tax credit is a system that allows U.S. residents to deduct foreign income taxes paid on income earned in Japan (foreign country) from federal taxes within limits. This allows you to avoid part or all of double taxation.
Foreign tax credit procedures
In order for foreign tax credit to be granted, the following three conditions must be met.
- Income tax must be paid to a foreign government.
- Have foreign source income.
- Attach Form 1116, the Foreign Tax Credit Limit Calculation Statement, to your U.S. income tax return, Form 1040.
Foreign tax credit limit
The foreign tax credit limit is calculated based on the proportion of foreign source income in worldwide income. When calculating this, it is necessary to allocate various deductions such as income adjustment deductions and itemized deductions to foreign source income on a pro rata basis.
The deduction limit is calculated for each income, categorized into passive category income, general category income, etc.
Foreign tax credit carrybacks and carryforwards
If the effective foreign income tax rate is lower than the effective federal income tax rate, the full tax credit is allowed because it falls within the limits. On the other hand, if the effective foreign income tax rate is higher than the effective federal income tax rate, the foreign tax in excess of the limit will be disallowed. Unused foreign income taxes that are denied due to exceeding the limit are allowed to use as tax credits to other years. You can carry back for one year and then carry forward for 10 years unused foreign tax.
However, no carrybacks or carryforwards of foreign tax credits is allowed for Section 951A category income.
Summary
It is quite possible for US residents to receive a foreign tax credit on their income in Japan, but it is essential to follow the correct procedures and submit the necessary documents. It is important to consult with a tax professional and conduct sufficient research before filing your income tax return.
The above is basic information about foreign tax credits for income earned in Japan by US residents. As different factors influence each specific case, we recommend that you seek advice tailored to your individual case from a professional.
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