The foreign tax credit comes in two basic flavours or “baskets” – general and passive.
Tax paid in Australia on salary, self-employment income, and superannuation contributions are claimed as a credit against U.S. income tax on Form 1116.
Tax paid on dividends, interest and capital gains are claimed on a separate Form 1116.
Anything left over in either basket can be carried back one year or carried forward ten years – but only against other income in the same basket, i.e. excess credits generated on salary income cannot be set off against U.S. tax due on dividend income.
HOWEVER, there are two toppings to go with those flavours – the High Tax Kickout can move credits on passive income to the general basket.
A third Form 1116 is required if U.S. income is to be resourced under the treaty. This treats U.S. income as Australian, and allows the taxpayer to claim a credit for additional Australian tax paid on that income, subject to a calculation formula.
Does the Medicare levy count for foreign tax credit purposes?
Yes. The recent D.C. Appeals Court decision in Eshel bolsters this. Generally, a tax credit cannot be claimed for social security taxes paid to another country where there is a Totalization Agreement in place with that country and those taxes are subject to that agreement. Australian Medicare is not covered by the Totalization Agreement with the U.S.