If you’re a U.S. expat earning income abroad, you have two key tax benefits to reduce your U.S. liability: the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC).
The FEIE lets you exclude up to $126,500 (2024) of foreign-earned income, while the FTC provides a dollar-for-dollar credit for foreign taxes paid. The best choice depends on your income, tax rate abroad, and eligibility.
This guide compares both options, their pros and cons, and how to decide which works best for you.
What is the difference between foreign income exclusion and foreign tax credit?
Both FEIE and FTC help U.S. expats reduce their tax liability on foreign earned income, but they work differently.
FEIE allows you to exclude up to $126,500 (2024 tax return) of foreign income from U.S. taxable income. However, it doesn’t eliminate taxes above that threshold or apply to passive income like rental or investment earnings.
FTC provides a dollar-for-dollar credit for foreign taxes paid to a foreign government. This reduces your U.S. tax bill based on the foreign tax rate and allows unused credits to be carried forward to future years. Unlike FEIE, FTC applies to both earned and passive income.
Related: Foreign Tax Credit Carryover & Carryback: Explained
What Is the Foreign Earned Income Exclusion?
The Foreign Earned Income Exclusion is a provision in the U.S. tax code that allows expats to exclude foreign wages from taxable income using IRS Form 2555.
To qualify for FEIE, you must meet the tax home requirement and pass one of the following tests:
- Bona Fide Residence Test: You must be a tax resident in a foreign country for an entire tax year and demonstrate long-term residency.
- Physical Presence Test: You must be physically present in a foreign country for at least 330 full days during a 12-month uninterrupted period.
Tax Home Requirement: Your tax home must be in a foreign country, meaning your primary place of work and economic ties are outside the U.S. If you maintain a significant presence in the U.S., you may not qualify.
Who Can Claim Foreign Earned Income Exclusion?
To qualify for the Foreign Earned Income Exclusion, you must have foreign earned income, such as wages, salaries, bonuses, commissions, or self-employment income. Passive income (e.g., dividends, interest, capital gains) does not qualify.
You may also qualify for a foreign housing exclusion or housing deduction (for self-employed expats) if your housing expenses exceed a certain limit.
FEIE only applies to federal income tax—you may still owe self-employment tax or state income tax, depending on your situation.
When to use FEIE:
✅ If you live in a low-tax or tax-free country (e.g., UAE, Singapore)
✅ If your income is below the maximum exclusion amount ($126,500 for 2024)
✅ If you have little to no foreign income taxes paid
✅ If your income is from wages/salary (not passive income)
What Is the Foreign Tax Credit?
The Foreign Tax Credit provides a dollar-for-dollar credit for foreign taxes paid to a foreign government. Instead of excluding income, it reduces your U.S. tax bill. You can claim it using IRS Form 1116.
When to use Foreign Tax Credit:
✅ If you live in a high-tax country (e.g., Germany, France, Canada)
✅ If your foreign tax rate is equal to or higher than U.S. tax rates
✅ If you earn above the FEIE threshold and still have foreign taxes paid
✅ If you have foreign passive income (e.g., rental, dividends, interest)
✅ If you want to carry forward unused credits to future years
✅ If you have children and want to claim the refundable ACTC
Can you use both FEIE and Foreign Tax Credit?
Yes, you can use both the Foreign Earned Income Exclusion and the Foreign Tax Credit, but not on the same income. FEIE allows you to exclude foreign earned income from U.S. taxable income, while FTC provides a dollar-for-dollar credit on foreign taxes paid to reduce your U.S. tax liability.
How to Use FEIE and FTC Together
- First, apply FEIE to exclude foreign earned income (up to the annual limit) from federal income tax on your tax return.
- Then, use FTC on any remaining foreign sourced income that was not excluded under FEIE to offset U.S. income tax on that amount.
FEIE vs. FTC: Which One Should You Choose?
Here’s what you need to consider:
- You cannot claim FTC on foreign taxes paid for income already excluded under FEIE.
- Passive income (e.g., dividends, interest, rental income) does not qualify for FEIE but can be covered by FTC.
- Self-employed U.S. citizens using FEIE still owe self-employment tax on their foreign earnings since FEIE only applies to federal income tax.
- IRA contributions require earned income that is taxable in the U.S. If all of your income is excluded under FEIE, you may not be eligible to contribute to a Traditional or Roth IRA.
- Expats living in high-tax countries may benefit more from FTC, while those in low-tax countries may find FEIE more advantageous.
- Those with children may prefer FTC, as FEIE disqualifies them from the refundable Additional Child Tax Credit (ACTC).
| Foreign Earned Income Exclusion | Foreign Tax Credit | |
|---|---|---|
| Best for | Low-tax or no-tax countries | High-tax countries |
| Applies to | Earned income (salary, self-employment) | Earned and passive income |
| Maximum benefit | $126,500 exclusion (2024), $130,000 exclusion(2025) | Dollar-for-dollar credit (no limit) |
| Can be carried forward? | ❌ No | ✅ Yes (for future tax years) |
| Reduces U.S. taxable income? | ✅ Yes | ❌ No (reduces tax liability instead) |
| Reduces double taxation? | ✅ Partially | ✅ Fully |
| Works well with | Expats with lower income levels | Expats in high-tax countries |
Choosing the Best Strategy
The best choice depends on tax rates in your country of residence, income level, and specific circumstances. Consulting a tax professional can help determine the best way to reduce your U.S. tax bill, maximize IRA contributions, and avoid double taxation under U.S. tax laws.
At 1040 Abroad, we understand the complexities of US tax obligations for expats and are committed to providing free tax advice to all US expats. Our team of expert accountants can guide you through the process and ensure that you stay compliant with all applicable tax laws. Don’t hesitate to reach out to us for help navigating your state tax obligations as a US expat living abroad.
