If you're a US citizen or resident (including a green card holder or someone who meets the substantial presence test) with income sourced in India — NRE/NRO interest, dividends, capital gains, or rental income — that income is taxable in both countries. India taxes it at source (often via TDS), and the US taxes its citizens and residents on worldwide income regardless of where it's earned. The Foreign Tax Credit (FTC), claimed on Form 1116, is how the US side of that double taxation gets relieved: it lets you subtract the Indian tax you already paid from your US tax bill on that same income, dollar for dollar, up to a limit.
The FTC is not a deduction — it reduces US tax liability directly, not just taxable income. But it is not unlimited either, and understanding the mechanics (which income category the credit falls into, how the cap is computed, and what happens to credit you can't use this year) matters more than simply knowing the credit exists.
Income Categories: Why the Credit Is Split Into Baskets
Form 1116 doesn't let you lump all foreign income and all foreign tax into one pool. Foreign income is sorted into separate categories — commonly called "baskets" — the two most relevant for NRIs being passive category income (interest, dividends, capital gains, rental income, most annuities) and general category income (wages, self-employment income, and most active business profits). Other baskets exist for foreign branch income and GILTI (section 951A) income, which are less commonly relevant to individual NRI filers.
A separate Form 1116 (or a separate column) is required for each basket, and the credit limitation is computed independently within each one. If your Indian tax on passive income (say, NRE FD interest and mutual fund capital gains) exceeds the US tax attributable to that passive income, the excess cannot be used to offset US tax on general-category wage income, even in the same year — it can only carry over within the passive basket.
The Credit Is Capped at the US Tax on That Foreign Income
The core limitation formula is: FTC limit = US tax liability × (foreign-source taxable income in that basket ÷ total worldwide taxable income). In practice, this means the credit can never exceed what the US would have taxed on that foreign income anyway — you can eliminate US tax on Indian-sourced income up to that cap, but the FTC won't refund a rupee amount of Indian tax that exceeds the corresponding US tax liability on the same income in the same basket.
This is why the FTC works cleanly when Indian tax rates and US tax rates on the same category of income are roughly comparable, but leaves residual, unused credit when Indian tax on a basket (e.g., TDS on NRO interest) is higher than the US tax that basket would generate.
Unused Credit: Carryback One Year, Carryforward Ten
When Indian tax paid in a basket exceeds that basket's US limitation for the year, the excess isn't lost. It can first be carried back one year and applied against unused limitation in that basket for the prior year, and whatever remains after that can be carried forward up to ten years, tracked separately for each basket using Schedule B (Form 1116) to reconcile the prior-year carryover against the current year's usage. One notable exception: unused credit in the GILTI (section 951A) category cannot be carried back or forward at all — that basket is a use-it-or-lose-it calculation each year, though this rarely affects individual NRI filers without controlled foreign corporation interests.
Why FTC, Not the Foreign Earned Income Exclusion, for Indian-Sourced Income
The Foreign Earned Income Exclusion (FEIE, claimed on Form 2555) only applies to earned income — wages and self-employment income from services performed abroad. It does not apply at all to passive income like NRE/NRO interest, dividends, capital gains, or rental income, which is the bulk of what a US-taxpayer NRI typically has sourced in India. For that income, FTC is the only mechanism available, not merely the preferred one.
Even for the earned-income portion some NRIs may have (for example, consulting income paid into an Indian account), electing FEIE has a real cost: once income is excluded under FEIE, no foreign tax credit can be claimed for the foreign tax paid on that same excluded income. Filers with meaningful foreign tax paid often come out ahead using FTC instead of, or on top of, a partial FEIE election, since FTC preserves the ability to credit tax already paid rather than simply removing income from the US return.