Tax Tip Tuesday: State Foreign Tax Credit - Why Your Foreign Taxes May Not Count at the State Level
You worked abroad, paid tax to a foreign country, and claimed the federal foreign tax credit. Your federal tax on that income dropped to zero. Then your state return arrived with a bill.
That is not a mistake. The federal foreign tax credit is a federal rule. Most states do not offer anything like it, so the same income can be taxed by the foreign country and your state, with no offset.
The General Rule
Most states give residents a credit only for income tax paid to other U.S. states (and usually D.C. and U.S. territories). Taxes paid to a foreign country simply do not count. A handful of states are l exceptions, and many of those exceptions apply only to Canada.
How the States Break Down
No state income tax on wages: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington*, Wyoming. Foreign income generally faces no state income tax, so no credit is needed.
Credit for taxes paid to foreign countries: North Carolina, Montana, Hawaii. Some relief is available, with limits. Montana, for example, denies the credit to the extent you claimed the federal foreign tax credit.
Credit for Canadian provinces only: Massachusetts (Canada and its provinces), Minnesota, Michigan, Vermont, New York, Maine (provincial-level taxes). Helps if you worked in Canada; no help for taxes paid to any other country.
Narrow exception: Virginia. Credit only for foreign tax on a pension from past work in that country.
No credit for foreign taxes: Including California, Connecticut, Illinois, Maryland, New Jersey, North Dakota, Oregon, Pennsylvania. Foreign taxes do not reduce your state tax.
A Quick Example
Tom lives in Alhambra. His employer sent him to Japan for six months, where he earned $50,000 and paid about $10,000 in Japanese income tax.
Federal: The foreign tax credit wipes out most or all of his U.S. tax on that $50,000.
California: No credit for the Japanese tax. At a 9.3% marginal rate, he owes about $4,650 to California on the same income.
If Tom lived in North Carolina, he might be able to claim a state credit for part of the Japanese tax.
Watch Out for the Foreign Earned Income Exclusion, Too
The foreign tax credit is not the only federal benefit that may stop at the state line. Most states start from federal adjusted gross income, so the foreign earned income exclusion usually carries over. California does not follow the exclusion, and states that define income their own way, such as Pennsylvania, can also tax foreign wages in full.
Who This Affects Most
Employees on short-term overseas assignments who keep their state residency
Remote workers living abroad who never formally changed their state domicile
Investors receiving foreign dividends or interest with foreign tax withheld
Owners of foreign rental property paying tax in the country where the property sits
Do not assume your federal result carries to your state. Run the state calculation separately.
Check your state's specific rule before you take a foreign assignment or invest abroad.
Budget for state tax on foreign income if you live in a no-credit state like California.
Review your domicile if you are moving abroad long term. Breaking state residency properly can matter more than any credit.
Keep foreign tax records, including foreign returns and proof of payment. States that do allow a credit usually require them.
Earning income abroad while keeping a U.S. state residence? MKHS Tax Group helps clients coordinate federal and state treatment of foreign income so there are no surprises at filing time. Email info@mkhstaxgroup.com to schedule a review.
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