U.S. Taxes for Americans Working Abroad: FEIE vs. FTC

Summary

U.S. taxpayers earning income abroad can reduce their tax burden through the Foreign Earned Income Exclusion (FEIE) or the Foreign Tax Credit (FTC). The FEIE allows taxpayers to exclude a certain amount of foreign-earned income from U.S. taxation, requiring them to meet either the Bona Fide Residence Test, or the Physical Presence Test. The FTC, conversely, provides a dollar-for-dollar reduction of U.S. tax liability based on foreign taxes already paid. Choosing between the FEIE and FTC depends on individual circumstances, such as income level and foreign tax rates, with the FEIE being simpler and more beneficial for lower earners, and the FTC offering more advantages for high-income earners or those in high-tax countries. The IRS provides detailed guidance on both options, including eligibility requirements and calculation methods.

Foreign Earned Income Exclusion (FEIE):

The Foreign Earned Income Exclusion (FEIE) is a U.S. tax provision that allows qualifying American taxpayers who work and reside outside the United States to exclude a specified amount of their foreign-earned income from U.S. taxable income. This exclusion aims to reduce the tax burden on U.S. citizens and residents who must also pay taxes in the country where they earn their income. The specific income amount that can be excluded under FEIE adjusts annually for inflation. To qualify, individuals must meet certain requirements, such as passing the Physical Presence Test or the Bona Fide Residence Test, demonstrating their residency or physical presence in a foreign country. See details on the IRS website. 

Foreign Tax Credit (FTC):

The Foreign Tax Credit (FTC) is a tax relief mechanism available to U.S. taxpayers to prevent double taxation on income earned abroad. When a U.S. taxpayer pays or accrues income tax to a foreign government, the FTC allows them to credit those amounts against their U.S. income tax liability on the same income. To qualify for the FTC, the tax must be imposed on the taxpayer by a foreign country or U.S. possession, and the taxpayer must have paid or accrued the tax. The income taxed must also originate from sources outside the U.S.  

The amount of credit claimed cannot exceed the portion of U.S. tax liability attributable to the taxpayer's foreign-earned income. Taxpayers may carry back unused foreign taxes to the previous tax year and forward to the next ten tax years, allowing them to utilize the credit in the most beneficial years. Taxpayers claim the FTC on their U.S. tax return, using IRS Form 1116 to calculate and report the credit.

Comparing the FEIE to the FTC

As a U.S. citizen or resident earning income abroad, you need to be aware of the Foreign Tax Credit (FTC) and the Foreign Earned Income Exclusion (FEIE) because they offer distinct advantages for mitigating double taxation, but each has its own specific benefits and limitations.

Foreign Tax Credit (FTC):

  • Direct Reduction of U.S. Tax Liability: The FTC allows you to directly offset your U.S. tax liability by the amount of foreign taxes paid on your foreign-earned income. This is a dollar-for-dollar credit, potentially resulting in substantial tax savings.

  • No Income Limit: There is no cap on the amount of foreign income you can claim for the FTC. This makes it particularly beneficial for those with high foreign earnings or who live in countries with tax rates higher than those in the U.S., like the U.K. and most other European countries.

  • Carryover Provision: If your FTC exceeds your U.S. tax liability in a given year, you can carry over the excess credit for up to 10 years, providing additional tax benefits in the future.

Foreign Earned Income Exclusion (FEIE):

  • Excludes Foreign Earned Income: The FEIE allows you to exclude a certain amount of your foreign-earned income from your U.S. taxable income. For 2025, the limit is the lesser of the foreign income earned or $130,000.

  • Simplicity: The FEIE is generally easier to claim than the FTC, as it doesn't require the detailed record-keeping and calculations associated with foreign tax credits, but has residency requirements.

  • Beneficial for Lower Earners: If your foreign earned income is below the exclusion limit, the FEIE can be a straightforward way to avoid double taxation.

Which One is Right for You?

The best option for you depends on your specific circumstances, including:

  • Amount of Foreign Earned Income: If your income is high and exceeds the FEIE limit, the FTC might be more advantageous.

  • Foreign Tax Rates: If you live in a country with tax rates higher than the U.S., the FTC could offer a larger tax benefit. 

Important Notes:  

  • IRA: You may not contribute to your IRA if you claim the FEIE and your income is below the income limit for the year.

  • Qualification: To qualify for the FEIE you must meet the bona fide residence test or the physical presence test.

  • You must file Form 2555 with your tax return to claim the FEIE, regardless of which test you meet.

  • There are exceptions to the time requirements for both tests in cases of war, civil unrest, or other adverse conditions in the foreign country.

  • The FEIE amount is adjusted annually for inflation.

    For 2025, the maximum exclusion amount is the lesser of the foreign income earned or $130,000.

Bona Fide Residence Test

This test focuses on the nature of your stay abroad and your ties to a foreign country. To meet this test, you must:  

  •  Establish a home overseas: You must have a permanent residence in a foreign country. This could be a house, apartment, or other dwelling where you live and have your belongings.  

  • Live there for more than one full calendar year: You must reside in the foreign country for an uninterrupted period that includes an entire tax year (January 1st to December 31st). You can take trips back to the U.S. or other countries for vacation or business, but your primary residence must be in the foreign country.  

  • Have no immediate intention of returning to live in the U.S. permanently: You must demonstrate that you intend to remain in the foreign country for an indefinite period. Factors that can help prove this include having a long-term lease, owning property, having family living with you, and being involved in the local community.  

Physical Presence Test

This test is more straightforward and focuses on the number of days you spend in a foreign country. To meet this test, you must:  

  • Be physically present in a foreign country or countries for at least 330 full days during any 12-month period. The 330 days do not have to be consecutive, and the 12-month period can begin on any day of the year. A "full day" is defined as 24 consecutive hours.  

Key Differences and Considerations

  • Flexibility: The Bona Fide Residence Test offers more flexibility in terms of time spent in the U.S. You can return to the U.S. for vacations or business trips without jeopardizing your eligibility, as long as you maintain your residence abroad and intend to return. The Physical Presence Test, on the other hand, is stricter and limits the amount of time you can spend in the U.S. 

  • Subjectivity: The Bona Fide Residence Test is more subjective, as it requires you to prove your intent to remain abroad indefinitely. The IRS will consider various factors, such as your ties to the foreign country and your reasons for being there. The Physical Presence Test is more objective, as it simply requires you to count the number of days you were physically present in a foreign country.  

  • Ease of Qualification: The Physical Presence Test is generally considered easier to meet, as it has clear and specific requirements. The Bona Fide Residence Test can be more challenging due to its subjective nature.  

  • Initial Year: It's often easier to qualify for the FEIE using the Physical Presence Test in the year you move abroad, as you may not yet meet the one full calendar year requirement of the Bona Fide Residence Test.

Which Test Should You Choose?

The best test for you depends on your individual circumstances and how much time you plan to spend in the U.S. If you plan to spend significant time in the U.S. but still maintain a residence abroad, the Bona Fide Residence Test may be more suitable. If you plan to spend most of your time in a foreign country and want a more straightforward test, the Physical Presence Test may be the better option.

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Last Updated: 3/16/2025