International Tax Exemption

A friend of mine moved to Korea recently.  His company provided him with some tax support to help with the year that he would have income from two different countries.  I thought it might be beneficial (and educational) to tell you his story.

He worked from January to March in the United States and then from March 5th through the remainder of the year he worked in Korea.  Now, I am not a tax expert but I have heard that the double taxation for a U.S. citizen living and working in other countries is burdensome and complicated.  So I asked my friend what kind of advice he got from the tax support his company gave him.

The Foreign Tax Credit or Deduction

US citizens under certain circumstances have the ability to elect either the foreign tax credit or foreign tax deduction.  You can choose either one or the other and you can change each year if you would like.  The best way to proceed is to figure your taxes both ways and then decide which is more beneficial.  You cannot choose both, so that means that the taxes you pay to a foreign country must be either deducted or claimed as a credit.

The Credit

Claiming the credit is usually more beneficial.  Generally, if you pay more taxes to the foreign country than you would have if you were in the US then you would not need to pay any US taxes.  However, if the opposite is true and your taxes are lower in the foreign country than it would be in the US you would owe the difference to the US.  This is the case in Korea for the most part.  Also keep in mind that in my friend’s situation he could only claim this credit for the money he earned in Korea and not the money he got while working in the US.

The IRS gives us 3 good reasons to use the Credit rather than taking the deduction:

  1. The credit will reduce your US taxes on a 1 to 1 ratio (dollar for dollar).  But if you take the deduction then you will only be reducing your taxable income which is more like reducing your taxes by 20 to 30 percent or 20 to 30 cents on the dollar (depending on your tax rate)
  2. The deduction would require you to itemize.  Generally you only chose to itemize your deductions if you have lots of charitable deductions, student interest, mortgage interest, or business expenses. Most people choose the standard deduction because their itemized deductions are less than the standard.  But with the credit you can take the standard deduction and still see the benefits.
  3. The credit can be carried forward.  If you don’t end up using all the current tax credit then you can use the rest of it the next year.  This is not true with the deduction as that only reduces your taxable income.

My friend was advised to take the credit.  It was clearly the best option.