Foreign Tax Credit (Form 1116) 2026 Guide

The Foreign Tax Credit (FTC) allows US taxpayers to offset their US tax liability dollar-for-dollar with income taxes paid to foreign governments. For most US expats living in the UK — where income tax rates are comparable to or higher than US rates — the Foreign Tax Credit is often more beneficial than the Foreign Earned Income Exclusion (FEIE), and in many cases eliminates US tax liability entirely.

How the Foreign Tax Credit Works

The FTC is claimed on IRS Form 1116 and is a dollar-for-dollar reduction of US tax — not merely a deduction. For every pound of UK income tax you pay, you can reduce your US tax liability by the equivalent amount in US dollars (subject to the FTC limitation discussed below).

Example: You earn £100,000 working in London and pay £28,000 in UK income tax. The US would assess approximately $20,000 in tax on this income. Your Foreign Tax Credit of ~$35,000 (converted at current rates) would completely eliminate the $20,000 US tax bill — with $15,000 in excess credits available to carry forward.

The FTC Limitation: Preventing Double Benefits

The FTC is subject to a per-category limitation — you cannot credit more foreign tax than the US tax attributable to foreign-source income. The limitation is calculated on Form 1116 and is expressed as:

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FTC Limit = (Foreign-source income / Total worldwide income) × Total US tax liability

If your foreign taxes exceed the FTC limit for a given year, the excess can be carried back 1 year and carried forward 10 years to offset future or past US tax liabilities.

FTC Income Categories (Baskets)

Foreign income is divided into separate “baskets” and the FTC limitation is calculated separately for each basket. The main categories are:

General category income: Wages, salaries, self-employment income, business income
Passive category income: Dividends, interest, capital gains, rents, royalties
Section 951A category income (GILTI): Relevant for US shareholders of controlled foreign corporations
Foreign branch category income

You cannot “blend” baskets — excess general category credits cannot offset passive category limitation shortfalls. This is a common planning issue for UK expats who also have passive income from UK investments.

What Taxes Qualify for the FTC?

Not every foreign levy qualifies as a creditable foreign tax. A foreign tax qualifies if it is:

A tax imposed on income
A compulsory levy (not voluntary)
Not refundable to the taxpayer
Actually paid or accrued

UK taxes that generally qualify:

UK Income Tax (PAYE and self-assessment)
UK Corporation Tax (for US shareholders in UK companies)
UK capital gains tax

UK levies that generally do NOT qualify:

National Insurance Contributions (NICs) — not an income tax
UK Value Added Tax (VAT) — consumption tax
Council Tax — property-based levy

FTC vs. FEIE: Choosing the Right Strategy

For UK-based US expats, the choice between the FTC and FEIE is one of the most important annual tax decisions. Key considerations:

UK tax rates ≥ US rates: The FTC typically eliminates US tax entirely on earned income, while generating excess credits that can carry forward to offset tax on passive income or investment gains. The FEIE cannot create credits.
IRA contributions: The FEIE reduces “compensation” available to support IRA contributions. Using the FTC instead of the FEIE preserves IRA contribution eligibility — a significant long-term wealth consideration.
Self-employment tax: Neither the FTC nor FEIE eliminates US self-employment tax (15.3% on net SE income). However, the US-UK Totalization Agreement may exempt self-employed persons from US SE tax if UK NI contributions are paid.
The stacking rule: The FEIE creates a “stacking” effect whereby remaining income is taxed at higher rates. The FTC avoids this problem.
Passive income: The FTC can shelter UK-taxed investment income; the FEIE cannot.

Many UK-based expats find the FTC-only strategy to be optimal. However, the best approach depends on your total income profile, investment holdings, retirement savings strategy, and future plans. Our specialists can model both strategies for your specific situation.

FTC and UK Dividends: The “Ordering” Problem

A commonly overlooked FTC issue for UK expats relates to UK dividends. UK dividends carry a 7.5%–39.35% UK tax. These taxes fall in the passive FTC basket, while your employment taxes fall in the general basket. If your passive FTC limit is low (e.g., because you have little passive US income), you may not be able to fully credit UK dividend taxes — resulting in double taxation on UK investment income. Planning strategies include optimising asset location and timing of realISAtion.

Frequently Asked Questions About the Foreign Tax Credit

Can I claim the FTC on UK tax paid on my ISA?

UK ISAs grow tax-free from a UK perspective — meaning no UK tax is paid on ISA income. With no UK tax to credit, the FTC cannot shelter the income. ISA income (dividends, interest, capital gains within the wrapper) is fully subject to US tax without any FTC offset. This makes ISAs generally disadvantageous for US persons compared to UK-only taxpayers.

Can I use the FTC to offset US tax on UK pension distributions?

Yes — to the extent UK tax is withheld on pension distributions. The interaction of the FTC with UK pension distributions is complex and depends on the type of pension, the amount of any tax-free lump sum, the US-UK treaty provisions, and the applicable FTC basket. Specialist advice is strongly recommended.

How do I claim the FTC if I use the accrual method?

Most individuals use the cash method — crediting taxes in the year paid. The accrual method allows crediting taxes in the year they accrue (when the liability becomes fixed and determinable). For UK taxpayers who pay January 31 self-assessment tax bills, the accrual method may allow a 6-month acceleration of the credit.