If you’re a U.S. citizen earning income abroad, you face the challenge of double taxation – paying taxes to both the U.S. and your host country. To ease this burden, the U.S. offers two key tax tools:
- Foreign Earned Income Exclusion (FEIE): Lets you exclude up to $130,000 (for 2025) of foreign-earned income from U.S. taxes.
- Foreign Tax Credit (FTC): Gives a dollar-for-dollar credit for foreign taxes paid, reducing your U.S. tax bill.
Which is better? It depends on where you live, your income type, and tax rates. FEIE works well in low-tax countries, while FTC is ideal for high-tax countries. You can also combine both for maximum savings, but careful planning is required. Each option has unique rules, eligibility requirements, and benefits.
Quick Comparison
| Feature | FEIE | FTC |
|---|---|---|
| Purpose | Exclude foreign earned income | Offset U.S. tax with foreign taxes |
| Income Covered | Earned income only | Earned + passive income |
| Annual Limit | $130,000 (2025) | Capped by U.S. tax on foreign income |
| Residency Test | Required | Not required |
| Carryover | Not allowed | 1-year back, 10-years forward |
| Flexibility | Locked for 5 years if revoked | Can change yearly |
Choosing the right option can save you thousands, but the rules are complex. Professional tax advice can help you make the best decision.
What is the Foreign Earned Income Exclusion (FEIE)?
The Foreign Earned Income Exclusion (FEIE) allows U.S. citizens and resident aliens living abroad to exclude a portion of their foreign-earned income from U.S. taxes. This helps reduce the burden of being taxed twice on the same income by two countries. As Mel Whitney, EA, puts it:
"The foreign earned income exclusion (FEIE) is one of the most valuable tax benefits available to US citizens and resident aliens who live and work abroad. By excluding foreign-earned income from US taxation, the FEIE can help expats significantly reduce their US tax liability."
How FEIE Works
The FEIE works by excluding qualified foreign income from your taxable income in the U.S. Instead of offering a credit or deduction, it removes the income from taxation altogether, potentially resulting in substantial savings.
For 2025, the exclusion limit is set at $130,000, with annual adjustments for inflation. If you’re married and both you and your spouse meet the requirements while working abroad, you can each exclude up to $130,000, bringing the total potential exclusion to $260,000. To claim the FEIE, you’ll need to file Form 2555 along with your U.S. tax return.
Who Qualifies for FEIE
Qualifying for the FEIE requires having a foreign tax home and meeting one of two tests:
- Bona Fide Residence Test: You must be a bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year.
- Physical Presence Test: You must spend at least 330 full days in a foreign country during any 12-month period.
For example:
- Sarah qualifies under the Bona Fide Residence Test because she moved to London indefinitely and stayed abroad for the entire tax year.
- Karen meets the Physical Presence Test by spending 345 days in France between July 1, 2023, and June 30, 2024, with only two short trips back to the U.S..
- Harry, however, failed the Physical Presence Test. Despite working in the U.K. all year, he took four 20-day trips to the U.S., exceeding the 35-day limit.
| Bona Fide Residence Test | Physical Presence Test |
|---|---|
| Requires uninterrupted residence in a foreign country for an entire tax year | Requires at least 330 full days in a foreign country during any 12-month period |
Once you qualify, be aware of specific rules and restrictions tied to this exclusion.
FEIE Rules and Limits
The FEIE applies only to active, earned income. This means wages, salaries, commissions, bonuses, professional fees, and self-employment income from work performed abroad are eligible. However, passive income – such as dividends, interest, capital gains, rental income, pensions, annuities, and Social Security benefits – does not qualify.
If you meet the FEIE requirements for only part of the year, the exclusion is prorated. Additionally, revoking the FEIE triggers a five-year penalty, preventing you from claiming it again during that period.
Consider Robert’s situation: He moved to Tokyo on March 1, 2024, for a two-year assignment, but his project ended early, and he returned to the U.S. on January 25, 2025. Since his foreign residence didn’t cover an entire tax year, he doesn’t qualify under the Bona Fide Residence Test. However, based on the Physical Presence Test, he might still claim a prorated exclusion for his actual time abroad.
Another key limitation involves retirement contributions. Income excluded under the FEIE cannot be used to fund U.S. tax-advantaged retirement accounts, such as IRAs or 401(k)s. This restriction can affect your long-term savings plan.
To strengthen your FEIE claim, keep detailed records of your time abroad. Save boarding passes, track daily activities, and document your foreign stay.
What is the Foreign Tax Credit (FTC)?
The Foreign Tax Credit (FTC) allows U.S. taxpayers to offset their U.S. tax liability by claiming a credit for taxes paid to foreign governments. Its purpose is to prevent double taxation – where the same income is taxed both by the foreign country where it was earned and by the U.S.. This credit applies to both earned income (like wages) and unearned income (such as dividends, interest, and capital gains).
How FTC Works
The FTC works by directly reducing the amount of U.S. taxes you owe. For example, if you paid $5,000 in foreign income taxes, you could potentially claim a $5,000 credit against your U.S. taxes, provided you meet the necessary requirements and limitations.
That said, the credit has a cap. The maximum amount you can claim depends on your U.S. tax liability and the share of your income that comes from foreign sources. The IRS calculates this limit using a formula that compares your foreign income to your total worldwide income.
One helpful feature of the FTC is its carryover provisions. If you can’t use the full credit in the current year, you can carry it back one year or forward up to ten years. This flexibility lets you make the most of the credit over time.
Foreign taxes are categorized by income type, which can impact how the credit is calculated.
Who Can Use FTC
The FTC is available to a broader group of taxpayers compared to the Foreign Earned Income Exclusion (FEIE), as it doesn’t require meeting specific residency tests. U.S. citizens and resident aliens who pay income taxes to a foreign country or a U.S. possession can claim the credit.
Nonresident aliens may also qualify under certain conditions, such as being a bona fide resident of Puerto Rico for the entire tax year or paying foreign income taxes related to a U.S. trade or business. The credit is available to individuals, estates, and trusts to lower their income tax liability.
For married couples filing jointly, the credit can be based on the combined foreign income taxes paid by both spouses. If foreign taxes are imposed on income shared by multiple people, the credit is divided proportionally based on each person’s share of the income.
Additionally, shareholders in mutual funds might be eligible to claim the FTC for their portion of foreign income taxes paid by the fund, as long as the fund passes the credit through to its shareholders.
FTC Rules and Options
The FTC offers flexibility but comes with added complexity. You must choose between using the FTC or deducting foreign income taxes as an itemized deduction – you can’t do both for the same taxes. Generally, the FTC provides greater savings because it directly reduces your tax bill rather than just lowering your taxable income.
However, the FTC cannot be claimed on income excluded under the FEIE. This limitation means careful planning is necessary to optimize your overall tax strategy.
To qualify for the FTC, foreign taxes must meet four specific criteria: they must be imposed on you, you must have paid or accrued them, they must represent your legal and actual foreign tax liability, and they must be income taxes or taxes in lieu of income taxes.
Recent legislative updates have added more layers to the FTC. The One Big Beautiful Bill Act (OBBBA), signed into law on July 4, 2025, introduced several changes, including increasing the deemed paid FTC for certain types of income from 80% to 90%. These changes apply to tax years starting after December 31, 2025.
To make the most of the FTC, it’s essential to keep detailed records of all foreign income and tax payments. Given the complexities of FTC calculations and their interactions with other tax provisions – especially with recent legislative updates – seeking professional tax advice can be a wise move. This groundwork provides a basis for comparing the FTC with the FEIE in greater detail.
FEIE vs. FTC: Side-by-Side Comparison
To help you navigate the differences between the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC), here’s a detailed side-by-side comparison. This breakdown highlights how each option works, their requirements, and the benefits they offer, so you can make informed decisions about your tax strategy.
The FEIE allows you to exclude foreign earned income from U.S. taxation, while the FTC provides a dollar-for-dollar credit for foreign taxes paid. Let’s dive into the distinctions.
Comparison Chart: Key Features
Here’s a quick look at how FEIE and FTC stack up against each other:
| Feature | Foreign Earned Income Exclusion (FEIE) | Foreign Tax Credit (FTC) |
|---|---|---|
| Primary Purpose | Excludes foreign earned income from U.S. taxation | Reduces U.S. tax by the amount of foreign income tax paid |
| Income Types Covered | Earned income only (e.g., wages, self-employment) | Covers both earned and passive income (e.g., dividends, capital gains) |
| Annual Limits | $130,000 for 2025 tax year | Limited to U.S. tax on foreign-source income |
| Residency Requirements | Must meet Physical Presence or Bona Fide Residence Test | No residency requirement |
| Required Forms | Form 2555 | Form 1116 |
| Carryover Provisions | No carryover allowed | Unused credits can carry forward 10 years or back 1 year |
| Self-Employment Tax | Does not reduce SE tax | Does not reduce SE tax |
| IRA Contribution Eligibility | Excluded income does not count toward IRA eligibility | Income counts toward AGI; IRA contributions allowed |
| Tax Credit Benefits | Additional Child Tax Credit not available | Additional Child Tax Credit of $2,000 per child available |
| Flexibility | Revocation locks you out for 5 years without IRS approval | Can switch year to year without restriction |
| Best For | Low-tax or no-tax countries | High-tax countries |
| Complexity Level | Easier for most filers | More complex due to multiple income categories |
| Double Taxation Relief | Partially reduces double taxation | Fully reduces double taxation |
Key Considerations for Married Couples
For married couples, FEIE allows each spouse to exclude up to $130,000 of foreign earned income if both meet the qualifications. On the other hand, the FTC calculates a combined credit based on the total foreign taxes paid, making it a more holistic option for couples with diverse income sources.
Choosing Between FEIE and FTC
Your decision should factor in both your income type and the tax rate in your host country. If your income comes solely from employment or self-employment, FEIE might be the simpler and more effective choice, especially in low-tax jurisdictions. However, if you also earn passive income – such as dividends or rental income – FTC is more comprehensive since it applies to nearly all income types.
Tax rates matter, too. If you’re living in a high-tax country, the FTC often provides greater savings by allowing you to offset the full amount of foreign taxes paid. Conversely, in countries with little to no income tax, FEIE’s exclusion method is usually more advantageous.
Flexibility and Long-Term Planning
One major distinction is flexibility. The FTC allows you to change your approach annually, adapting to shifts in your income or tax circumstances. FEIE, however, requires a more cautious commitment – once revoked, you’ll need IRS approval to re-elect it within five years. This makes your initial choice critical to your overall tax strategy.
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How to Choose Between FEIE and FTC
Deciding between the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC) depends on several factors, including where you live, how much you earn, and the type of income you receive. There’s no universal answer – it’s all about weighing your host country’s tax system, your income structure, and your financial objectives.
Which Option Fits Your Situation
Your country of residence plays a key role in this decision. If you’re in a high-tax country, the FTC might be more advantageous because the foreign taxes you pay can offset your U.S. tax liability. On the other hand, if you’ve moved to a low- or no-tax country – like the UAE, Singapore, or certain Caribbean nations – the FEIE could offer greater relief since there are few or no foreign taxes to claim as credits.
Your income level and type also matter. For example, if your earned income is under the FEIE limit of $130,000 and you also have investment income, you might exclude your wages using FEIE while claiming the FTC for other income like dividends or capital gains. Remember, the FEIE only applies to earned income (like wages or self-employment income), while passive income from investments or rentals must be addressed with the FTC.
The length and consistency of your time abroad also influence your choice. If your stay overseas is short or irregular, the FTC might be a better fit since it doesn’t require strict residency tests like the FEIE.
Another consideration: FEIE-excluded income doesn’t count toward IRA eligibility, but FTC-covered income does. This distinction can impact your long-term financial planning.
"Expats in low‐tax countries typically save more with FEIE, while those in high‐tax countries often benefit more from FTC. Some situations allow you to use both strategies together for maximum savings."
– Mike Wallace, MBA, CEO at Greenback Expat Tax Services
Combining FEIE and FTC
It’s possible to use both FEIE and FTC to maximize your savings, but you can’t apply both to the same income. Start by using the FEIE to exclude foreign earned income up to the annual limit, and then apply the FTC to any additional foreign-sourced income that wasn’t excluded. This dual approach can be especially useful if you have both earned income and other income streams, like investments or rental income, or if your foreign income exceeds the FEIE limit.
For example, if you earn a high salary and also have foreign rental income, you could exclude part of your salary using the FEIE and then use the FTC to offset taxes on your rental income. Just keep in mind that once you exclude income with the FEIE, you can’t claim the FTC on the same income. Additionally, once you elect the FEIE, you’re locked into that choice for five years for the same income.
This combined strategy is particularly useful if you’re earning income from multiple countries with varying tax rates.
Getting Professional Tax Help
Navigating international tax rules can be tricky, especially if you have different income sources or are subject to foreign tax systems. A tax professional can run detailed comparisons of the FEIE and FTC based on your income mix, foreign tax rates, residency patterns, and financial goals. They can also guide you on multi-year strategies and help you understand the implications of switching between these options.
Tax advisors can assist with filing Form 2555 for the FEIE or Form 1116 for the FTC, ensuring compliance with complex rules like income sourcing and foreign tax credit limitations. For entrepreneurs and digital nomads, professional advice is particularly helpful in managing both personal and business tax strategies, including self-employment tax considerations.
Spending on professional tax advice often pays off by helping you optimize your tax savings while giving you peace of mind about your U.S. tax obligations.
BusinessAnywhere Support for International Entrepreneurs
For international entrepreneurs juggling U.S. tax requirements, having dependable support can make all the difference. Managing tax obligations from abroad often feels like a maze – especially for digital nomads, remote entrepreneurs, and international business owners. That’s where BusinessAnywhere steps in to simplify the process, offering tools to streamline business administration and tax compliance.
BusinessAnywhere provides a comprehensive platform tailored for entrepreneurs, expats, and digital nomads running U.S. operations from anywhere in the world. With services like company formation, registered agent assistance, virtual mailboxes, and compliance tools all in one place, managing a U.S.-based business remotely becomes far more manageable.
Tax Compliance Services
One of the toughest hurdles for international entrepreneurs is staying up to date with U.S. tax requirements. BusinessAnywhere tackles this challenge with services designed to simplify documentation and compliance.
The platform’s virtual mailbox service ensures you have immediate access to important IRS and state tax documents through digital scanning and global mail forwarding. This is especially useful for handling time-sensitive forms related to the Foreign Earned Income Exclusion (FEIE) or Foreign Tax Credit (FTC).
For business owners, BusinessAnywhere assists with EIN applications and S-Corp tax filings, making the reporting process smoother. This support integrates personal tax strategies like the FEIE or FTC with your business filings, ensuring everything aligns properly.
Another standout feature is the automated reminders for critical tax deadlines, including filing dates and quarterly estimated payments. Missing these deadlines can jeopardize your eligibility for benefits like the FEIE or FTC, so this feature helps you stay on schedule and avoid unnecessary penalties.
To further simplify tax planning, BusinessAnywhere connects users with tax professionals who specialize in international tax strategies. These experts can help you navigate complex choices – such as whether to prioritize the FEIE, FTC, or a mix of both – based on your business structure, income sources, and where you reside.
Additional Resources
BusinessAnywhere goes beyond basic compliance by offering specialized tools and resources for location-independent entrepreneurs. For example, the Digital Nomad Kit provides tailored advice on tax optimization and residency planning, catering to both U.S. citizens living abroad and non-U.S. individuals.
This kit helps you design a tax strategy that aligns with U.S. laws while taking full advantage of benefits like the FEIE. It also offers insights into structuring your business to match your personal and professional goals.
If you need to establish or maintain a U.S. business presence while living overseas, BusinessAnywhere’s U.S. business registration services make it easy. This service is particularly beneficial for entrepreneurs who need to demonstrate U.S. business operations – whether to claim tax benefits or to work with international clients who prefer dealing with U.S.-based entities.
To keep your financial records in order, the platform also offers bookkeeping and accounting services. Proper documentation is crucial when claiming the FEIE or FTC, as you’ll need to provide clear records of foreign income, tax payments, and residency status.
Serving entrepreneurs in over 100 countries, BusinessAnywhere provides the flexibility and expertise you need to manage U.S. business responsibilities while optimizing your international tax strategy. From compliance to tax planning, the platform equips you with the tools to implement effective strategies like the FEIE and FTC with confidence.
Conclusion
Your tax strategy as an expat boils down to understanding two key tools: the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC). The FEIE helps exclude a portion of your income from U.S. taxation, while the FTC reduces your tax bill by crediting taxes paid to a foreign country. Choosing the right approach depends on factors like your income level, the tax rates in your host country, whether you have passive income, and your long-term financial goals. Generally, expats in low-tax countries lean toward the FEIE, whereas those in high-tax countries often find the FTC more advantageous.
Both strategies have their limitations. For instance, neither reduces self-employment tax, and the FEIE comes with strict residency requirements. On the other hand, the FTC offers more flexibility, allowing you to switch between strategies each year without penalties. Additionally, unused FTC credits can be carried forward for up to 10 years, while revoking the FEIE comes with a five-year waiting period to re-elect it.
Because international tax law is complex and the stakes are high, working with a qualified tax professional is crucial. They can analyze your unique situation, calculate potential savings under both options, and help you design a flexible, long-term strategy tailored to your needs.
For entrepreneurs managing businesses across borders, platforms like BusinessAnywhere can make tax compliance and administrative tasks more manageable. With tools for tax planning, document management, and business upkeep, you can align your FEIE or FTC approach with your business structure and international lifestyle seamlessly.
Each year, hundreds of thousands of Americans file Form 2555 (FEIE) and Form 1116 (FTC), proving how vital these tools are for expat tax planning. By understanding the benefits and limitations of both, you can make informed choices that maximize your tax savings while staying compliant with U.S. tax laws.
FAQs
What’s the difference between the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC), and how do I choose the right one?
Deciding between the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC) comes down to your specific tax situation and income.
The FEIE is a good choice if your foreign income is within the annual exclusion limit and you want to avoid U.S. taxes on that income. This can be especially useful for those earning moderate foreign salaries, as it directly reduces your taxable income.
On the other hand, the FTC might be the better option if you’re paying high foreign taxes, have income that exceeds the FEIE limit, or earn from multiple sources like investments or self-employment. With the FTC, you get a dollar-for-dollar credit against your U.S. tax liability, which can be advantageous in countries with higher tax rates.
Deciding between these options depends on factors like your income level, the tax rates in your host country, and your overall tax planning approach. If you’re running a business while living abroad, services like BusinessAnywhere can streamline your administrative tasks. They offer tools for U.S. business registration, tax filings, and compliance – all accessible remotely.
Can I use both the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC) in the same year, and how should I divide my income between them?
Yes, you can take advantage of both the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC) in the same tax year, but they can’t be applied to the same income. Here’s how it works: the FEIE lets you exclude a portion of your earned income (like wages or self-employment income) from U.S. taxes, while the FTC is used to offset foreign taxes paid on unearned income (like dividends or interest) or on earned income that exceeds the FEIE limit.
To make this work, you’ll need to separate your income into two categories: earned income (like salaries or freelance earnings) and unearned income (like investment income). Then, use Form 2555 to claim the FEIE for your eligible earned income and Form 1116 to claim the FTC for the remaining qualifying income. Thoughtful planning is key here to maximize your tax benefits while staying compliant with IRS regulations.
How does choosing the Foreign Earned Income Exclusion (FEIE) instead of the Foreign Tax Credit (FTC) affect retirement contributions and long-term tax planning?
Choosing the Foreign Earned Income Exclusion (FEIE) can limit your ability to contribute to retirement accounts like IRAs or 401(k)s. Why? Because the income you exclude under FEIE usually doesn’t count as earned income for retirement savings purposes. Over time, this could shrink the opportunities to build up your retirement nest egg.
On the other hand, the Foreign Tax Credit (FTC) often provides more flexibility for tax planning. With the FTC, you can claim a dollar-for-dollar credit for foreign taxes you’ve paid. Plus, any unused credits can frequently be carried forward to future years. This makes the FTC a solid choice if your foreign income surpasses FEIE limits or if you’re looking to maximize tax credits and deductions over the long haul.
