Key Takeaways
- Foreign Tax Credit (FTC) prevents double taxation and is claimed using Form 1116 when foreign taxes exceed $300 ($600 MFJ).
- FTC is computed separately for passive and general income baskets; cross-offsetting is not allowed.
- FTC is limited to US tax attributable to foreign-source income using the statutory limitation formula.
- Unused FTC can be carried back 1 year and carried forward 10 years, category-wise.
- FTC vs FEIE decisions for Indian salary cases depend on Indian effective tax rate, income level, and long-term planning.
- Incorrect expense allocation and exchange rates are among the most common Form 1116 audit triggers.
Introduction
As more Indian CA firms expand into US tax compliance, Form 1116 becomes unavoidable. Almost every US citizen or resident with Indian income—salary, business profits, or investments—will trigger Foreign Tax Credit calculations at some point.
This article is written from one practitioner to another. The objective is not to explain FTC conceptually, but to show how to handle it correctly for your clients, especially Indian salary and business income cases where Form 1116 errors are common.
You will learn when Form 1116 is mandatory, how income categorization affects credit limits, and how to choose between FTC and FEIE in Indian tax scenarios. We also walk through Form 1116 line by line with an Indian salary example and explain how to manage FTC carryforwards at scale.
If you are building or scaling a US tax practice within your CA firm, this guide will help you reduce rework, avoid IRS notices, and advise clients more strategically.
What Is the Foreign Tax Credit (FTC)?
Purpose of the Foreign Tax Credit
The Foreign Tax Credit allows US taxpayers to offset US federal income tax with income taxes paid to a foreign country. The core objective is to prevent double taxation on the same income.
For Indian-source income—where effective tax rates often exceed US rates—FTC is usually the primary relief mechanism rather than exclusions.
Who Can Claim the Foreign Tax Credit
FTC is available to US citizens, green card holders, and resident aliens who have foreign-source income and have paid or accrued foreign income taxes.
From a practitioner perspective, this includes Indian-resident US citizens, returning assignees, and dual-status taxpayers (see dual status tax return preparation).
Types of Foreign Taxes That Qualify
Only income taxes or taxes in lieu of income taxes qualify. Indian income tax, surcharge, and cess generally qualify.
For official definitions, refer to IRS guidance on the Foreign Tax Credit.
Practitioner Tip: Exclude GST, wealth tax, interest, and penalties—these are non-creditable and frequently misclassified.
When Do You Need Form 1116?
Situations Where Form 1116 Is Required
Form 1116 is required when total foreign taxes paid or accrued exceed $300 ($600 for MFJ). This threshold applies to all foreign taxes combined.
Once crossed, the simplified FTC election is lost, and full limitation calculations apply.
FTC Without Form 1116 (De Minimis Exception)
If foreign taxes are below the threshold and all income is passive, taxpayers may claim FTC directly on Schedule 3.
Most Indian salary cases do not qualify due to general category income.
Common Triggers for Form 1116 Filing
Indian payroll TDS, advance tax payments, or self-assessment tax almost always breach the threshold.
Practitioner Tip: Expect multiple Forms 1116 when clients have both Indian salary and investment income.
Passive vs General Category Income Explained
Passive Category Income
Passive income includes interest, dividends, annuities, and most capital gains.
Indian bank interest and listed equity dividends fall here.
General Category Income
General category income includes salary, wages, professional fees, and active business income.
Most Indian employment and Schedule C income (see Schedule C self-employment tax scenarios) fall into this basket.
Why Income Categorization Matters
FTC limitation is computed separately for each basket. Excess credits in one basket cannot offset another.
Practitioner Tip: Incorrect basket classification is a high-frequency IRS adjustment issue.
FTC vs FEIE: Decision Matrix for Practitioners
Overview of FEIE and Form 2555
The Foreign Earned Income Exclusion (FEIE) under Form 2555 allows exclusion of up to $126,500 (2024) of earned income.
It applies only to earned income and requires physical presence or bona fide residence tests.
Side-by-Side Comparison: FTC vs FEIE
| Criteria | FTC | FEIE |
|---|---|---|
| Mechanism | Tax credit | Income exclusion |
| Income Covered | All categories | Earned income only |
| Impact on AGI | No reduction | Reduces AGI |
| Carryforward | Yes (10 years) | No |
When FTC Is Better Than FEIE (And Vice Versa)
For Indian salary cases with effective tax rates above US rates, FTC generally yields better long-term results.
FEIE may work for short-term assignments or low Indian tax exposure.
Practitioner Tip: FTC preserves eligibility for child tax credit and education credits tied to AGI.
How to Fill Form 1116: Line-by-Line Walkthrough
This section summarizes practitioner-relevant lines. Always cross-check with IRS Instructions for Form 1116.
Part I: Taxable Income From Sources Outside the US
Report gross foreign income by category. Convert INR to USD using average annual rates.
Allocate deductions (standard or itemized) proportionately.
Part II: Foreign Taxes Paid or Accrued
Report Indian income tax paid or accrued. Choose one method consistently.
Exclude interest and penalties.
Part III: Figuring the Credit
This computes the FTC limitation: (Foreign-source taxable income / Worldwide taxable income) × US tax.
Part IV & V: Carryback and Carryforward
Track unused credits by year and category.
Practitioner Tip: Maintain separate FTC schedules outside tax software for multi-year visibility.
Form 1116 Example: Indian Salary Income Case Study
Facts and Assumptions (INR to USD conversion)
US citizen resident in India earns INR 30,00,000 salary. Indian tax paid: INR 7,50,000.
Average exchange rate: INR 83/USD.
Completed Form 1116 Highlights
Foreign income: USD 36,145. Foreign tax: USD 9,036.
Category: General.
FTC Limitation Calculation Explained
If US tax on worldwide income is USD 8,000, FTC is limited to USD 8,000.
Excess USD 1,036 becomes carryforward.
Foreign Tax Credit Limitations You Must Know
FTC Limitation Formula
FTC cannot exceed US tax attributable to foreign-source income.
Impact of AMT and Other Credits
AMT can reduce usable FTC in certain cases.
Expenses Allocation and Apportionment
Improper allocation is a common audit risk.
How to Carry Forward or Carry Back Unused FTC
FTC Carryback Rules
Unused FTC can be carried back 1 year.
FTC Carryforward Rules
Credits can be carried forward 10 years.
Tracking FTC Across Tax Years
Carryovers are basket-specific.
Practitioner Tip: Build standardized FTC tracking templates for recurring clients.
Common Form 1116 Mistakes and Practitioner Tips
Frequent Errors Seen in US Expat Returns
Mixing income baskets and incorrect exchange rates.
Documentation Best Practices
Maintain Form 16, Indian returns, and tax payment challans.
How Automation Can Reduce Rework
Standardized data capture reduces review cycles.
Conclusion
Form 1116 is not just a compliance form—it is a planning tool. For Indian-source income, correct FTC computation often determines whether a return is optimal or merely acceptable.
Indian CAs entering US tax must master income categorization, limitation mechanics, and multi-year FTC tracking. With structured workflows and strong technical grounding, FTC becomes manageable even at scale.
As your US tax practice grows, consistent Form 1116 handling will significantly reduce notices, amendments, and client dissatisfaction.
FAQ
Do Indian surcharge and cess qualify for FTC?
Yes, surcharge and health & education cess are generally creditable as part of Indian income tax.
They should be included in Form 1116 Part II.
Always exclude interest and penalties.
Document components clearly.
Can FTC and FEIE be used together?
Yes, but not on the same income.
FTC can apply to income above FEIE limits.
This adds complexity.
Use only when beneficial.
Is Form 1116 required every year?
Yes, if foreign taxes exceed thresholds.
Even if no credit is usable.
Carryforwards still require reporting.
Consistency is critical.
Should I use paid or accrued method?
Both are allowed.
Paid is simpler.
Accrued may smooth cash flows.
Be consistent year to year.
How do I handle multiple countries?
Country-level detail is required.
Same category can be combined.
Maintain documentation.
Watch treaty positions.
Does FTC apply to PFIC tax?
PFIC taxes are complex.
FTC availability depends on regime.
Review carefully.
Can standard deduction be allocated?
Yes.
Allocation affects limitation.
Use IRS methodology.
Document calculations.
What if Indian tax refund is received later?
FTC must be adjusted.
Amended returns may be needed.
Track refunds carefully.
Common post-filing issue.
Is FTC allowed against state taxes?
No.
FTC applies only to federal tax.
States have separate rules.
Plan accordingly.
How long should FTC records be kept?
At least 10 years.
Carryforwards depend on history.
Digital storage recommended.
Essential for audits.
