U.S. citizens and residents compute their U.S. taxes based on their worldwide income. This sometimes results in U.S. citizens having to pay tax twice on the same income: once to the U.S. government and once to the government of the foreign country where the income was earned.
The foreign tax credit was created to help taxpayers avoid this double taxation. It allows taxpayers to take a tax credit for taxes paid to a foreign government on foreign source income that is subject to U.S. tax. Like other nonrefundable credits, the foreign tax credit allows taxpayers to take a dollar-for-dollar reduction in the amount of U.S. tax owed. However, there are cases in which not all taxes paid to a foreign government on foreign-sourced income can be used in the computation of the credit. Four tests must be met to qualify for the credit: