Foreign Tax Credit
The Foreign Tax Credit (FTC) is the US tax mechanism that gives US holders of foreign-source income a credit against US tax for foreign tax already paid on the same income. It's claimed on Form 1116 with separate computation by 'basket' (passive vs. general category), per-country sourcing, and a 10-year carryforward for unused credits.
FTC exists because US citizens and resident aliens are taxed on worldwide income — without the credit, foreign-source income would be taxed twice (once by the source country, once by the US). FTC is the dominant double-tax-relief mechanism in the US system; the alternative (deduction of foreign taxes) is rarely better and is the path most filers don't take.
The FTC limitation calculation is per-basket. The two baskets that matter for most wealth-tech use cases are 'passive category' (dividends, interest, capital gains, royalties) and 'general category' (active business income, wages). FTCs computed in one basket cannot offset US tax on income in the other basket. Within a basket, the credit is limited to: US tax × (foreign-source taxable income in basket / total taxable income).
Excess foreign tax beyond the basket limit carries forward 10 years and back 1 year, separately by basket. The carryforward tracking is non-trivial: per-basket, per-source-country, per-year rolling balance. Tax software that silently aggregates carryforwards loses information that affects future-year computations.
The sourcing rules are where most platforms have bugs. A foreign mutual fund distribution is foreign-source if the fund provides per-country sourcing data; otherwise it may be treated as foreign-source-from-fund-domicile (a different rule that produces different limit calculations). ADR dividends are sourced based on the underlying issuer's country, not the depositary bank's location. Resourcing-by-treaty rules can move some US-source income to foreign-source for FTC purposes.
FTC_limit = US_tax × (foreign_basket_income / total_taxable_income)- US_tax
- = total US tax liability before FTC
- foreign_basket_income
- = foreign-source taxable income in the basket
- total_taxable_income
- = worldwide taxable income
US tax $42,000; foreign passive income $15,000; total taxable income $200,000. Passive-basket FTC limit = $42,000 × 0.075 = $3,150. Up to $3,150 of foreign tax credit usable in passive basket this year.FTC-aware synthetic data needs per-country sourcing on every foreign income item, separate basket categorization, and FTC carryforward state carried across the longitudinal window. A test corpus that aggregates foreign income to a single 'international' source can't exercise per-country logic. Households in a multi-year longitudinal need realistic carryforward consumption — credits earned in one year used in the next, with proper basket and source tracking.
Common pitfalls
- Aggregating across baskets — FTCs computed in the passive basket can't offset US tax on general-basket income; a platform that treats them as fungible produces wrong totals.
- Treating excess withholding as fully FTC-eligible — over-withholding beyond the treaty rate isn't always credit-eligible; the holder may need to pursue source-country reclaim instead.
- Forgetting the high-tax kick-out election — passive-basket foreign income with high effective foreign tax can sometimes be moved to the general basket where the credit is more usable.
- Losing per-country tracking on carryforwards — the 10-year carryforward is per-basket; some computations also benefit from per-country tracking.
Examples
US holder receives $5,000 in Canadian-source dividends with $750 (15%) Canadian withholding. US tax on the $5,000 (at marginal 24%) is $1,200. FTC limit (passive basket): US tax × ($5,000 / total taxable income $200,000) = $42,000 × 0.025 = $1,050. Foreign tax actually paid: $750. Full credit allowed: $750. Net US tax: $1,200 - $750 = $450. Total tax (US + Canadian): $1,200 — same as if all income were US-source.