Form 1116 lets you subtract the Canadian income tax you owe on Canadian income from the US tax on that same income. Because Canadian tax is usually higher, it often brings US tax to zero, and unused credit carries forward for up to 10 years.
Use your actual Canadian tax for the year from your T1 or Notice of Assessment, not the amount withheld on your slips. CPP, QPP and EI don't count.
How the credit works
You report your worldwide income on Form 1040, then claim a credit for foreign income tax on Form 1116. The credit is limited to the US tax on your foreign income, figured separately for each category of income:
Unused Canadian tax in a category carries back one year, then forward up to 10 years, for use against future US tax in the same category.
Which Canadian tax counts
- Your actual liability for the year. Federal and provincial income tax from your T1 (or Notice of Assessment if CRA changed it). Withholding on slips (T4 box 22 and similar) is just a prepayment; a refund means you owed less.
- Not CPP, QPP or EI. These are social security levies, not income tax. See CPP, QPP and OAS.
- Not tax on income the US doesn't tax. If you exclude wages with Form 2555 or leave treaty-exempt benefits off your return, the Canadian tax on that income can't be credited.
Canadian tax is split between categories in proportion to the income Canada taxed. Lou does this with Canada's own taxable amounts, including the dividend gross-up.
Where you can still owe US tax
- Income Canada doesn't tax but the US does: TFSA and FHSA earnings, Home Buyers' Plan and Lifelong Learning Plan withdrawals, sometimes the gain on selling a home.
- Passive income with little Canadian tax on it, such as Canadian dividends taxed lightly thanks to the dividend tax credit.
- PFIC tax and interest on Canadian funds, which the credit can't reduce in the usual way.
Foreign tax credit or foreign earned income exclusion?
Form 2555 lets you exclude foreign wages up to a yearly limit ($130,000 for 2025, $126,500 for 2024, $120,000 for 2023) instead of crediting the tax on them. In Canada, the credit is often the better choice:
- Canadian tax on wages is usually high enough to wipe out the US tax anyway, and the leftover credit carries forward.
- If you file Form 2555, you can't claim the refundable part of the child tax credit. With the credit, families can sometimes receive it.
- The exclusion only covers earned income, and if you claim it and later revoke it, you generally can't claim it again for five years without IRS approval.
It depends on your numbers, which is why Lou runs both.