Have you heard of the U.S. foreign tax credit?
As a U.S. citizen living full-time in the Dominican Republic (DR), you are still required to file a U.S. tax return and report your worldwide income due to the U.S. citizenship-based taxation system. However, you may be able to significantly reduce or eliminate your U.S. tax liability using the Foreign Tax Credit (FTC), along with other provisions like the Foreign Earned Income Exclusion (FEIE). Below, I’ll explain how the FTC works in this context and key considerations for your situation.
1. Foreign Tax Credit (FTC) Overview
The FTC allows U.S. citizens and residents to offset their U.S. tax liability by claiming a credit for income taxes paid to a foreign government, such as the DR, on foreign-sourced income. This helps prevent double taxation—paying taxes on the same income to both the U.S. and the DR.
- How it works: For every dollar of income tax paid to the DR, you can claim a dollar-for-dollar credit against your U.S. tax liability on that same income, up to the amount of U.S. tax owed. If the DR tax rate is higher than the U.S. rate on that income, you may offset your entire U.S. tax liability for that income. Excess credits can be carried back one year or forward up to ten years.
- Eligibility: You must pay income taxes to the DR on foreign-sourced income (e.g., income earned in the DR or from foreign investments). The taxes must be legal and actually paid or accrued.
- Form: You claim the FTC by filing IRS Form 1116 with your U.S. tax return (Form 1040).
- No U.S.-DR Tax Treaty: The U.S. does not have a tax treaty with the DR, which means there’s no formal agreement to streamline double taxation relief. However, you can still use the FTC and FEIE to avoid double taxation.
- DR Tax System: The DR follows a territorial tax system, meaning residents are generally taxed only on DR-sourced income. However, after three years of residency, foreign-sourced financial income (e.g., stocks, bonds, mutual funds) becomes taxable in the DR. DR income tax rates are progressive, up to 25% for individuals, which may be lower or higher than U.S. rates depending on your income level.
- Residency Definition: You’re considered a DR tax resident if you spend more than 182 days in the country in a year. This aligns with qualifying for U.S. tax benefits like the FEIE.
The FEIE can complement the FTC to further reduce your U.S. tax liability:
- FEIE Overview: The FEIE allows you to exclude up to $130,000 (for 2025) of foreign-earned income (e.g., wages, self-employment income) from U.S. taxation if you meet either the Physical Presence Test (330 full days in a foreign country in a 12-month period) or the Bona Fide Residence Test (establishing residency in the DR).
- Interaction with FTC: If you claim the FEIE, you cannot claim the FTC on the same income that’s excluded. However, you can use the FEIE for earned income (e.g., salary) and the FTC for other income (e.g., investment income or income exceeding the FEIE limit). For example:
- If you earn $100,000 in DR salary and qualify for the FEIE, you exclude all $100,000 from U.S. tax, and no FTC is needed for that income.
- If you also have $20,000 in DR-sourced investment income taxed in the DR, you can claim the FTC for DR taxes paid on that $20,000 to offset U.S. taxes.
- Strategic Choice: If DR taxes on your income are higher than U.S. taxes, the FTC may be more beneficial than the FEIE, as it allows you to carry over excess credits. If DR taxes are low or you don’t pay DR taxes (e.g., only employment income with taxes withheld at source), the FEIE might be better.
Whether you can avoid paying U.S. taxes depends on your income sources, DR tax liability, and how you use the FTC and FEIE:
- Employment Income: If your only income is from a DR employer and taxes are withheld at source, you may not need to file a DR tax return, but you still file a U.S. return. The FEIE can exclude up to $130,000 (2025), and if your income is below this, you may owe no U.S. tax. If DR taxes are withheld, you can claim the FTC for those taxes if you don’t use the FEIE.
- Self-Employment or Other Income: If you’re self-employed or have investment income, you’ll likely file a DR tax return (Form 606, due March 31) and pay DR taxes. You can use the FTC to offset U.S. taxes on this income. Without a totalization agreement, self-employed expats pay social security taxes to both the U.S. (15.3% on net earnings) and DR (e.g., 3.04% for health insurance, 2.87% for pensions), which can increase your tax burden but may qualify for FTC if considered income taxes.
- Foreign Financial Assets: You must report foreign bank accounts (FBAR, FinCEN Form 114) if the aggregate balance exceeds $10,000 at any point, and foreign assets exceeding certain thresholds (Form 8938). DR banks share account info with the IRS under FATCA, so compliance is critical.
- Capital Gains and Other Taxes: DR taxes capital gains at 27%, which may be creditable against U.S. taxes via the FTC. Non-cash compensation (e.g., housing stipends) is taxable in the DR and may also qualify for FTC.
- Scenario 1: Low Income, Employment Only
You earn $80,000 from a DR employer, with DR taxes withheld. You qualify for the FEIE, excluding all $80,000 from U.S. tax. You owe no U.S. tax and don’t need the FTC unless you have other taxable income. - Scenario 2: High Income, Mixed Sources
You earn $150,000 salary and $30,000 in investment income, paying 25% DR tax on both. You use the FEIE to exclude $130,000 of salary, leaving $20,000 salary + $30,000 investment income taxable in the U.S. You claim the FTC for DR taxes paid on the $50,000, potentially offsetting all U.S. tax if DR taxes exceed U.S. liability. - Scenario 3: No DR Taxes Paid
If you’re a digital nomad not paying DR taxes (e.g., no DR tax residency), you can’t claim the FTC but may use the FEIE to exclude earned income, assuming you meet the Physical Presence Test.
- U.S. Filing: You must file a U.S. tax return (Form 1040) if your income exceeds $10,000 (or $400 if self-employed). Expats get an automatic extension to June 15, 2025, for 2024 returns, with further extensions to October 15 or December 15 if requested.
- DR Filing: If you have non-employment income (e.g., self-employment, investments), file Form 606 by March 31. Employment income with taxes withheld typically doesn’t require a DR return.
- Streamlined Procedure: If you haven’t filed U.S. returns, the IRS Streamlined Filing Compliance Procedures allow you to catch up without penalties by filing the last three years’ returns and six years’ FBARs.
- Social Security Taxes: Without a totalization agreement, self-employed expats face double social security taxes (U.S. and DR). U.S. self-employment taxes aren’t offset by DR social security contributions, as they’re not considered income taxes for FTC purposes.
- DR Tax Residency: After three years, DR taxes foreign financial income, increasing your FTC potential but also your DR tax burden. Plan for this transition.
- Professional Help: Expat taxes are complex. A tax professional specializing in U.S. expat taxes (e.g., Bright!Tax, Taxes for Expats) can optimize your FTC and FEIE claims.
Record-Keeping: Maintain records of DR taxes paid, income sources, and days spent in the DR to support FEIE and FTC claims.
- FATCA Compliance: DR banks report U.S. account holders’ info to the IRS, so undisclosed accounts risk penalties (e.g., $10,000 per violation for unreported assets).
You cannot entirely “avoid” filing U.S. taxes as a U.S. citizen living in the DR, but you can potentially eliminate your U.S. tax liability using the FTC and FEIE. The FTC is effective if you pay significant DR income taxes, especially on investment or high earned income, while the FEIE is ideal for earned income up to $130,000. Your ability to avoid U.S. taxes depends on:
- The amount and type of income (earned vs. unearned).
- DR taxes paid (higher DR taxes increase FTC benefits).
- Proper use of FEIE and FTC, which cannot overlap on the same income.
Last edited:
