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You may claim a tax credit or an itemized deduction for taxes paid to foreign countries. You do not need to live or to work in that foreign country in order to claim this benefit. For example, you can claim the credit or deduction if foreign taxes were paid on your behalf from a mutual fund. There are no time requirements like there are for the income exclusions. You can claim either the deduction or the tax credit, but not both, for all foreign taxes paid.
As a US citizen you DO have to pay tax (report, in this case) on all worldwide income, but, again, the Foreign Tax Credit (FTC) and the deduction is what keeps you have having to pay tax on this yeice
Here's what IRS says:
The foreign tax credit is intended to reduce the double tax burden that would otherwise arise when foreign source income is taxed by both the United States and the foreign country from which the income is derived.
Four tests must be met for the tax to qualify for the credit:
Here's an excellent article on the subject: http://taxes.about.com/od/taxhelp/a/ForeignTaxCred.htm
and here's the IRS guidance: http://www.irs.gov/taxtopics/tc856.html
and finallym here's the information regarding the need to report the foreign source income: http://www.irs.gov/Individuals/International-Taxpayers/U.S.-Citizens-and-Resident-Aliens-Abroad
Fro the most recent link I provided: "Your worldwide income is subject to U.S. income tax, regardless of where you reside."
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