Question: Gaia is a U.S. citizen who lives and works in Israel. She meets the bona fide resident test. Under §911, she elects to exclude her foreign earned income of $96,000 from U.S. taxation on Form 2555, Foreign Earned Income Exclusion. Can she also claim the foreign tax credit on Form 1116, Foreign Tax Credit, for income taxes she paid to Israel?
Answer: No. Because Gaia is using Form 2555 to exclude her foreign earned income, she cannot use Form 1116 to claim the foreign tax credit on that same income. Once Gaia elects to exclude her foreign earned income, she cannot take a foreign tax credit for taxes on income she excluded or could have excluded. If she does, one or both choices may be considered revoked [§911(d)(6)]. However, she can choose to take a foreign tax credit on any amount of foreign earned income that exceeds the amounts she excluded under the foreign earned income exclusion.
To use Form 1116, the taxpayer must have foreign tax liability that was either paid or accrued during the current tax year, the tax must be assessed on income, must be imposed on the taxpayer as an individual and must have originated legally in a foreign country.
There may be situations where it would be more beneficial to use Form 1116 to claim the credit instead of using Form 2555. For instance, people may prefer to use the credit if they live in a high-tax area, such as the United Kingdom.