Avoiding double taxation: Foreign tax credit & MAP process for U.S. expats

For many U.S. citizens living abroad, international tax compliance can be a complex and often confusing landscape. A recent case we handled at American Tax Filings highlighted a crucial issue faced by expatriates: double taxation and the potential solutions available, including the Mutual Agreement Procedure (MAP) process.

In this post, we’ll explore:

• Foreign tax credit rules and limitations
• Why choosing “accrual” vs. “paid” on Form 1116 matters
• How the MAP process can help resolve double taxation disputes

Case study: A U.S. citizen living in the U.K.

A client, a U.S. citizen residing in the U.K., had a U.S.-based brokerage account that she had never reported to U.K. tax authorities. When we became involved in her case last year, we informed her of her obligation to report worldwide income in the U.K. (as U.K. residents are taxed on their global earnings).

Recently, she reached out to us with a pressing question:
“How can I recover the U.K. taxes I will now owe on my U.S. brokerage income from my past U.S. tax filings?”

Unfortunately, the bad news was that she couldn’t—at least, not through the traditional foreign tax credit process.

Understanding Foreign Tax Credits (FTC) and Timing Issues

The U.S. Foreign Tax Credit (FTC), claimed on Form 1116, is designed to prevent double taxation by allowing taxpayers to credit foreign income taxes against their U.S. tax liability. However, timing plays a crucial role.

Key FTC Rules:

• Paid vs. Accrual Method on Form 1116
  • If the taxpayer selects “paid” (which is the default), they can only claim the credit in the year the tax was actually paid.
  • If they select “accrual,” they can claim the credit for the year the income was earned, even if the foreign tax is paid later.

• Carryback and Carryforward Rules
  • Foreign taxes can be carried back one year and carried forward ten years.
  • If taxes are paid late (e.g., in 2025 for income earned in 2015-2018), but the taxpayer uses the “paid” method, they can only carry them back one year, meaning most of the older U.S. tax returns cannot be amended.

The client’s dilemma

Since our client had not previously reported her U.S. brokerage income to the U.K., she now had to catch up on years of U.K. tax filings and pay taxes retroactively. However, because she used the “paid” method on Form 1116, she could only carry the credit back one year—meaning most of her prior U.S. taxes paid on this income were now non-recoverable.

Had she used the “accrual” method, she could have amended her past U.S. returns for up to 10 years, claiming foreign tax credits to offset the double taxation.

The MAP Process: A potential solution

For taxpayers facing double taxation issues due to foreign-initiated adjustments, the Mutual Agreement Procedure (MAP) process, under U.S. tax treaties, offers a potential remedy.

What is the MAP Process?

The Mutual Agreement Procedure (MAP) is a formal tax treaty dispute resolution mechanism that allows taxpayers to:

• Resolve cases of double taxation due to inconsistent tax assessments between countries.
• Request assistance from the U.S. and foreign tax authorities (Competent Authorities) to negotiate a fair resolution.
• Reduce or eliminate additional taxes imposed by foreign tax authorities when a taxpayer believes they have been unfairly taxed.

How Does MAP Work?

1. Taxpayer Submits a MAP Request
   • If a taxpayer believes that a foreign-initiated tax adjustment will lead to double taxation, they can request relief under the MAP process.
2. Competent Authorities Engage in Negotiation
   • U.S. and foreign tax authorities communicate and work toward an agreement to eliminate or reduce double taxation.
3. Resolution and Adjustment
   • If successful, the taxpayer receives an adjustment, either through an amended U.S. tax return or relief from foreign tax authorities.

When to Consider MAP?

• If a foreign tax audit results in additional tax liability, creating double taxation.
• If a U.S. taxpayer is taxed on the same income in two jurisdictions.
• If a foreign tax authority imposes new tax liabilities retroactively.

For our client in the U.K., MAP may offer a path to relief, though it is a complex and time-consuming process that requires careful consideration.

Key takeaways for U.S. expats

1. Be Proactive About Foreign Reporting
   • If you reside abroad, ensure that you report all U.S. income to your local tax authorities.
   • Many countries, like the U.K., tax worldwide income—delayed reporting can lead to significant tax burdens.
     
2. Choose “Accrual” Over “Paid” on Form 1116 When Possible
   • If you may face foreign tax obligations later, selecting “accrual” on Form 1116 allows you to amend past U.S. returns for up to 10 years.
     
3. Seek Professional Guidance Early
   • International tax compliance is complex—work with experts who understand both U.S. and foreign tax systems.
     
4. Consider the MAP Process if Facing Double Taxation
   • If a foreign tax authority is retroactively assessing tax liabilities, MAP can help prevent unfair double taxation.

Final thoughts

As tax authorities worldwide become more sophisticated in tracking international income, U.S. expats must take a proactive approach to tax compliance. Whether you are a U.S. citizen in the U.K., Spain, or anywhere else, understanding your obligations and planning ahead can save you from unexpected tax liabilities.

If you need assistance navigating international tax issues or the MAP process, reach out to contact@americantaxfilings.com for expert guidance.