Which is more advantageous: the Foreign Earned Income Exclusion or the Foreign Tax Credit?
The U.S. taxes its citizens and permanent residents on their worldwide income. However, taxpayers with foreign source income have two major options to help avoid double taxation: the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit.
Both can produce major tax savings, but they cannot be applied to the same dollar of income leaving taxpayers to choose. Should you use the FEIE or the Foreign Tax Credit? As you would guess, each has its own benefits and drawbacks—so which one is better? Well, it depends on the details of the taxpayer’s unique situation!
What is the Foreign Tax Credit?
The Foreign Tax Credit is a dollar-for-dollar reduction in a taxpayer’s U.S. income tax liability for qualifying foreign income taxes paid. Not all foreign taxes qualify. They must be taxes paid on income or profit (with some exclusions, see below). This means that foreign real estate, social security, and property taxes do not qualify for the credit, because they are not a tax that is imposed on income. Additionally, to be deductible the tax must meet four tests:
From the IRS: Generally, the following four tests must be met for any foreign tax to qualify for the credit:
- The tax must be imposed on you.
- You must have paid or accrued the tax.
- The tax must be the legal and actual foreign tax liability.
- The tax must be an income tax (or a tax in lieu of an income tax).
What is the Foreign Earned Income Exclusion (FEIE)?
The FEIE allows a taxpayer to exclude up to $120,000 (2023 figure) of foreign earned income from U.S. taxation. To qualify they must meet one of two tests: the Physical Presence Test or the Bona Fide Residence Test.
The Physical Presence Test requires the taxpayer to be physically located outside the U.S. for 330 days during a 12-month period and establish their tax home in a foreign country. The Bona Fide Residence Test requires a taxpayer to become a resident of a foreign country for an uninterrupted period that covers an entire tax year and establish their tax home in a foreign country.
What is the difference between the Foreign Tax Credit and the Foreign Earned Income Exclusion?
The Foreign Tax Credit and the FEIE are both designed to provide relief from double taxation, but they achieve this objective very differently:
Foreign Tax Credit: When using the Foreign Tax Credit, your tax return is completed more or less as normal, ignoring the fact that a portion (or all) of your income was earned outside of the country. At the very end, once your income tax has already been calculated, the Foreign Tax Credit is applied for the taxes already paid to a foreign government, which reduces your U.S. liability.
It’s like Uncle Sam saying “You owe me $10,000 for taxes on that income” and you respond “I already paid King Charles $10,000 for taxes on that income, take your complaint up with her!”
Foreign Earned Income Exclusion: The FEIE operates completely differently. It allows you to take the portion of your income (up to $120,000 in 2023) that was foreign earned and subtract it from your reported income. By the time you’re calculating your tax, it’s almost as if you had not earned that income at all.
This is more like telling Uncle Sam “Income? What income? I was in England that whole time.”
Along with being applied differently, they also have substantially different bars for qualification.
Foreign Tax Credit: This has a very low bar.
“Do you have foreign income on which you paid foreign taxes? Yes? Ok here’s a Foreign Tax Credit.”
Foreign Earned Income Exclusion: This, on the other hand, has a very high bar. Not only you, but potentially your family, dog, cat, ferret, and possessions must physically leave the U.S. for a certain period of time.
When is the Foreign Earned Income Exclusion more beneficial than the Foreign Tax Credit?
The FEIE is generally best for taxpayers whose income is earned in a low- or no-income tax country. It will allow them to shield up to $120,000 (2023 figure) from U.S. taxation, while the Foreign Tax Credit would have little or no benefit since they are in a low- or no-income tax country.
Example 1: You take a 3-year assignment in the Cayman Islands. The Cayman Islands doesn’t tax income, therefore you are paying no local income tax on your salary. The income is still reportable on your U.S. income tax return, but by using the FEIE you can exclude the first $120,000 from U.S. taxation. Pretty great right?
In the example above you’ll receive no benefit from the Foreign Tax Credit, because you aren’t paying any foreign income taxes in the Cayman Islands. You may be paying property taxes, sales taxes, and numerous other taxes in the Cayman Islands, but none of them would qualify for the Foreign Tax Credit and allow you to reduce your U.S. tax.
Example 2: Instead of the Cayman Islands, let’s say that your 3-year assignment placed you in Bulgaria, a low income tax country with flat 10% rate. This time you would be eligible for a Foreign Tax Credit because you are paying income taxes in Bulgaria. However, the Foreign Tax Credit is likely to be less beneficial than the FEIE because you are only being taxed at a 10% rate (much lower than the rate you are likely to pay in the U.S.).
When is the Foreign Tax Credit more beneficial than the Foreign Earned Income Exclusion?
Because the Foreign Tax Credit is applied dollar-for-dollar against your U.S. tax liability, it is more advantageous when a taxpayer’s income is earned in a high tax rate country. The top tax rate in the U.S. is currently 37% (2023 figure). If your income is earned in France (45%), Spain (47%), Austria (55%), or any other high tax country, the credit is likely to be more beneficial.
Example 3: You’re living in Barcelona, paying taxes at the highest marginal personal income tax rate of 47%. You’ll receive a Foreign Tax Credit for the amount paid in Spain and because the tax rate is higher than in your U.S., it will reduce your U.S. taxes on your foreign earned income to zero.
Which is right for me, the Foreign Tax Credit or the Foreign Earned Income Exclusion?
Although the examples above were simple and straight forward, that’s not the case in the real world. France may have a higher top tax rate than the U.S., but both systems are progressive (meaning the rates increase as you earn more money) and tax different amounts of income at different rates. If you are eligible, you should prepare your tax return under both the FEIE and the Foreign Tax Credit to see which one is more beneficial.
Can I take both the Foreign Earned Income Exclusion and the Foreign Tax Credit?
While you cannot take the FEIE and Foreign Tax Credit on the same dollar of income, you can take both in the same year. This is especially likely when you are earning a relatively high income, in a country with a lower tax rate than the U.S. You would apply the FEIE to the first $120,000 (2023 figure) of your income and would use the Foreign Tax Credit to reduce your liability on your income above $120,000.
Example 4: Let’s take our Bulgarian example again. Ignoring any deductions and exclusions (needless to say, the intricacies of Bulgarian tax policy are beyond the scope of this blog post), you are earning $180,000 which is taxed at a flat rate of 10%, so $18,000 in taxes. You could use the FEIE to shield the first $120,000 (2023 figure) from U.S. taxation. The next $60,000 would be fully taxable, but you could reduce your liability by taking a partial Foreign Tax Credit.
I said partial, because you’re not allowed to use the FEIE and Foreign Tax Credit on the same dollar of income. Since you have already used the FEIE on $120,000 (or 66.7%) of your $180,000 income, you are only entitled to a credit for 33.3% of the foreign taxes you paid.
Do you have questions about the Foreign Earned Income Exclusion or Foreign Tax Credit? Leave them in the comments below!
Resources and Tax Forms:
IRS Summary: Foreign Earned Income Exclusion
IRS Form 2555: Foreign Earned Income
IRS Form 2555: Instructions
IRS Summary: Foreign Tax Credit
IRS Form 1116: Foreign Tax Credit
IRS Form 1116: Instructions
IRS Publication 514: Foreign Tax Credit for Individuals
This is extremely helpful info! My daughter lives and works in Ireland (she got her masters and then stayed and got a full time job in 2019). Her income is below $40,000; she rents an apartment and is not married. Is it better for her to complete the Income Tax Credit. She is being taxed at between 20-25% of her income. She has lived in Ireland full time for 2019.
Anita – I’m glad you like the post! Without reviewing all of the facts of her circumstances I can’t be certain. However, based on what you’ve said the FTC may easily reduce her US tax liability to zero.
Does the Foreign earned income exclusion reduces income on which the marginal tax rate would apply (top end of income) or on which the lower bands’ rates would apply (bottom end)? Thank you.
It reduces income on the bottom bands.
Thanks David, we may fill out both and see which one is better for her, but we were thinking the FTC may be best.
Can I use the FEIE on my salary and then apply the FTC to foreign unemployment benefits from Finland?
Hi,
I’m currently living in Florida and run my own translation + graphic design business from home. I’ve been paying into the American system for 20 years and would like to continue doing so in order to collect social security when I turn 60. I also hold a French passport and plan to move to Tahiti for a few years which is a French territory. I would retain my American customers and ALL my income would come from my US clients and would be deposited into my US bank account. Do I need to maintain a residency in the US in order to do this? How will I be taxed? Thanks
Hi David,
I’m a US citizen living and working in Germany for a while. I’ve always claimed the FEIE, since my income is lower than the max exclusion amount, and I’m rooted in Germany (wouldn’t be able to use carry over taxes with the FTC). However, this year I took the CARES act withdrawal from an old 401K (of 30K), and a week later my company offered buy-out packages. Therefore especially if I take a buyout, I would for sure exceed the FEIE.
Does a buyout package from a company count as income that be excluded in the FEIE? And if I go over the FEIE, can I use FTC on the amount I’m over, and also apply the foreign tax I paid to the 20% Federal Withholding my 401K charged me for a foreign resident CARES act withdrawal? Or does the FTC not apply toward a 401K withdrawal? Thanks in advance for any advice.
Rose,
Thank you for your questions! If you pay taxes in Germany on the 401(k) withdrawal, you’ll be able to claim the FTC to ensure you’re not taxed twice. Withdrawals from retirement accounts do not qualify for the FEIE, so the FTC is your only option for that income. If the buyout package is wages or a bonus it will be excludable under the FEIE. You can use the FTC for amounts above the FEIE. You could also look at the Foreign Housing Exclusion. Be careful if you decide not to take the FEIE. You may not be able to switch back to using it for 5 years if you stop!
Thank you David! I’ll definitely need to carefully consider my options come tax time, but I’m thinking it makes sense to then max out the FEIE and then use the FTC for portion of the buyout on top, since German taxes are much higher than US ones at the level. I’ve never used the foreign housing exclusion before, but it might actually help me this year, so I’ll also look into it.
Hi David, my questions is in regards to carry over foreign tax credit that I was not able to apply to far to us taxes owed. I have a rental property in Germany, pay income there and report the income on my us tax return and thus get a foreign tax credit. I am planning on selling the property. Because I had it more than 10 years there will be NO German tax on the proceeds. However, according the US tax law when selling a property that was depreciated, the depreciation sum is being deducted from the initial cost basis and this will create a huge income in US. Is this regarded foreign income? And can I use my carry over foreign tax credit to pay this US tax? Also, the carry over tax credit only goes back 10 years, however the depreciation recapture goes back 37 years to the purchase of the property. This does not seem right… am I missing something?
Anna,
You are correct. You are likely to have a US taxable gain on the sale of your German rental property that is composed of depreciation recapture and a capital gain from the appreciation of the property. You may also have a gain or loss to report because of currency conversions. You should be able to apply any foreign tax credit carryforward from passive sources and reduce the US taxes that you owe on the sale. You correctly point out that there is a mismatch though. You’ve likely fully depreciated the property if you have held it for 37 years, but you’ll only have foreign tax credits from the last 10 years to offset the recapture. It doesn’t seem right, but it is. I don’t think you’re missing anything.
Hello David,
How does FTC apply with regards to income from a rental property? In Germany it’s taxed as regular income (net of expenses). Is the rental income also considered taxable income in the US and can it be excluded using the FTC?
Alex,
Rental income on your German property is taxable in the US. It can be offset by the taxes you pay in Germany using the FTC on your US return.
Hi David,
My salary is within the FEIE threshold but I want to start paying into a roth IRA. Is it possible to declare a portion of my salary under FEIE and the remaining that would go towards the roth IRA under FTC?
Thanks vm,
Steph
Steph,
Unfortunately, no. If you want to make a Roth contribution you either need earnings in excess of the FEIE or you need to take the FTC.
Thank you — I had the exact issue. I thought about forgoing the FEIE and use the FTC to start the ROTH. It would have meant only a couple hundred dollars in Federal taxes. But then realized given I still have a Virginia residency, the state taxes would be several thousand dollars! Seems like at this point (I’m only 25), I can put that money in a regular mutual fund for the time being – and it would be better despite the clear benefits of Roth.
Beware! Just yesterday I realized that with the Roth you have to add back the FEIE to change AGI to MAGI. Then for a single person it puts you darn close to exceeding the income if you have any passive or rental income on top of the FEI.
Hi, David,
I claimed the foreign income tax exclusion for the 2019 tax return already.
Now reading about the information here, realized I should have taken the foreign tax credit, can I still amend my 2019 tax return to change back to claim foreign tax credit?
Sum,
You are able to amend your return, revoke the FEIE, and switch to the foreign tax credit. However, there are some extra steps and you should be aware that you won’t be able to claim the FEIE again for 5 years, unless you obtain IRS pre-approval. I recommend reviewing their website for more details: https://www.irs.gov/individuals/international-taxpayers/revoking-your-choice-to-exclude-foreign-earned-income
I’m a US citizen who moved to Germany on September 1st and who will have to pay taxes to the German government for all income earned after September 1st (2020). Does this mean I simply 1) Pay German taxes, 2) fill out IRS form 1040, and then 3) opt for the Foreign Tax Credit? Technically I wouldn’t yet qualify for the FEITE for 2020 I believe.
Brandon,
That’s correct. You’ll pay your German taxes and then use the FTC or FEIE on your US return to reduce your US taxes.
Applying the FTC on top of the FEIE, does it have to be apportioned by income, or can it be apportioned by income tax?
Under Example 4, it assumes the income tax is flat. If it is not flat, can the effective tax rate of the income above the FEIE threshold be used instead of taking the % as you did?
Hey David,
This is super helpful, thank you! I’ve been in the UK for the last 2 years, and work for the UK branch of my company, so I’m paying income tax there on a “Pay as you Earn” basis.
To confirm, if I claim the Foreign Tax credit, I can come back and visit the US for as long as I want (no 30 day limit like for the Exclusion)?
Thanks,
Garima
Garima,
That’s correct. If you claim the FTC there is no limit on the time you can spend in the US.
Hi David,
Thanks for your post. On an expat forum it was suggested that by claiming FTC rather than FEIE, I could have received Child Tax Credit for each of my children. My income is low enough that no tax is owed and this means I would have received this money (I think?-I’m no tax expert.) I’m wondering if it is worth amending my past tax returns (up to 3 years, I believe?) to claim this credit or just leave it! I have lived in the UK for many years, have no intention of returning to the USA to reside anytime soon (if that matters.)
Any help would be gratefully appreciated.
Thank you!
Katherine
Katherine,
Its possible that switching to the FTC could result in a refund of $1,400 per child versus using the FEIE. To obtain the refundable portion of the CTC you need to have a positive AGI. If the FEIE is offsetting all of your income, your AGI may be zero or too low to obtain the refundable portion. Using the FTC could fix that. One thing to note is that if you amend your old returns and switch to the FTC you won’t be able to claim the FEIE again for 5 years.
Thank you very much for your reply-really appreciate you taking the time to help me!
Hi David,
Thank you for your informative post. My wife and I are both working abroad and qualify for the FEIE and/or FTC. However, the tax brackets here are very progressive and I make much more money than she does. Can she take the FEIE on her (low-foreign tax) income while I take the FTC on my (high-foreign tax) income if we are married filing jointly, or do we have to make the same election?
This seems like a workaround for our IRA problem, but I am not sure. Any guidance would be appreciated!
Best,
Nicholas
Nicholas,
There is no requirement to make the same choice. She can take the FEIE and you can take the FTC. Depending on your income you may even want to take the FEIE and the FTC.
Hi David,
I am living and working in Austria and am trying to determine my filing status while at the same time trying to open up a Roth IRA in US. I have been living in Austria full time since 2018, would be eligible for the FEIE or FTC I believe, but my income is very low. Also, just to clarify if you know if the income in Austria IS taxed, I believe it comes out automatically month to month, instead of having to pay it at the end of the year.
Am I correct in that I would be able to contribute to Roth IRA if my AGI is 0-10,000 $ as “Married Filing Separately” (My husband is Austrian citizen and at this time I don’t think it would be beneficial to file “MFJ”) I am struggling to understand the AGI, but if all my foreign income is excluded, wouldn’t my AGI be 0? You previously mentioned in another persons question that in order to contribute to Roth IRA income would have to exceed FEIE so I’m just wondering if this is at all applicable to my situation.
IRS Website says this “Your filing status is married filing separately, you lived with your spouse at any time during the year, and your modified AGI is more than zero. You can’t make a Roth IRA contribution if your modified AGI is $10,000 or more.”
I appreciate you taking the time to read my question! Any guidance is MUCH appreciated.
Best regards,
Bekah
Bekah,
You’re correct. If you’re modified AGI is more than $10,000 you won’t be able to make a Roth contribution under the married filing separately status. The FEIE reduces your AGI, but excluded income is added back in for your modified AGI. Additionally any income excluded by the FEIE is ineligible for Roth contributions. That’s why some people choose to use the FTC instead.
The standard deduction for 2020 is $12,400. If you income was less than the standard deduction, you won’t need to apply the FEIE or FTC. You wouldn’t owe any taxes anyway and could make a Roth contribution as long as your modified AGI is less than $10,000. That being said, don’t take this as advice that you should make a Roth contribution. That depends on your long-term residence plans and how Australia would tax (or not) the growth and distributions from a Roth account.
Thank you so much David ! This has been very helpful and I understand it a bit better. A couple follow up questions..
Let’s say my gross income is approximately 34,000 $… so not as low as the standard deduction, but still low. The 34,000 $ would be before any deductions, and before either the FEIE or the FTC is taken into account. I’m just trying to determine which is the best path to take CONSIDERING possibly opening a Roth IRA. Is it possible for you to explain why the amount is so much different for a “Married Filing Separately” Person than it is for someone who is “Single” or “Married Filing Jointly”? (120,000 vs 10,000 $) to open up Roth IRA? Just seems like the options are very limited, for someone in my particular circumstances.
Thanks again!
Bekah,
You’re right, US taxed advantaged retirement savings is very limited for American expats! The low threshold is to stop high earning couples from filing separately just to qualify for benefits. Unfortunately, expats trying to prevent their non-resident alien spouses from getting tangled in the US tax system are unfairly caught as well. Someone earning $34,000 would have all of their income excluded by the FEIE and would need to use the FTC if they wanted to make IRA contributions. However, if they file “married filing separate” they would be above the $10,000 threshold for Roth contributions. Traditional IRA contribution may or may not (probably not) make sense in that scenario based on Australian taxation and long-term residency plans.
Just to throw another consideration out there: an expat with dependents can file under the “head of household” status without having to include their spouse’s income.
Hi David,
I hope you are well and will be kind enough to assist with my inquiry!
I am considering purchasing an investment rental property overseas. I have realized that I will not need to pay taxes on the rental income (as the income from it would not exceed my $12,400 standard deduction, and my regular foreign earned income is already totally exempt under the FEIE since it’s under 100K). I confirmed this on the phone with the IRS today but please correct me if I’ve misunderstood!
Where I am more confused, however, is on the question of the capital gains I would pay with the eventual sale of the property. I thought it would be 15% for my income bracket based on my research, but now I’m unsure! I see that the FTC does not apply to foreign property. When I decide to sell, is there any exemption or other mechanism I can use to avoid paying capital gains taxes twice (as I will need to pay foreign capital gains taxes in the country of sale)? Will I have to pay both foreign and US capital gains taxes? How can I figure out how much US capital gains tax I will need to pay? The country of purchase is Japan, by the way.
I look forward to your feedback and thank you for your response.
Emily
Emily,
Yes, I agree with you and the IRS on the first part. If someone’s earned income is excluded under the FEIE and the rest is under the standard deduction they won’t owe any taxes. One thing to note is that the standard deduction is set to be cut in half when the Tax Cuts and Jobs Act expires in 2025 unless Congress extends it or makes other changes.
Your main question has a lot of variables and assumptions that make a straight answer difficult. You can apply the FTC to a foreign capital gain, so that may provide some relief. If someone sells a property for a gain in Japan and paid taxes on the gain in Japan, they can claim the Japanese taxes paid as a FTC to offset the gain in the US. The difficulty comes from the fact that those two amounts likely won’t match because of exchange rates and the requirement to take depreciation of the property on your US return. For example, it is possible to have a gain in yen on the sale because the property increased in value in Japan, but because the yen depreciated against the US dollar during that time the transaction is a loss in US dollar terms, or vice versa. Additionally if a property is sold at a gain in USD terms a portion of the gain would be taxed as depreciation recapture at ordinary rates.
David,
Thanks again! I think I may I have to look at doing something different other than an IRA. Sounds like my options are very limited. We have no kids so I don’t think I would qualify as “Head of Household” either…
Thank you again for the advice and information! Have a nice day!
Hi David,
My question refers to self employment income which was not covered in your post. I have income
from self Employment in Ireland and was advised to pay my estimated SE taxes on this to US which I did in 2020. I am also registered as a tax resident in Ireland and will pay tax on all my income here. My question is does the FTC offset SE taxes in the US or are they always due? I’m unsure which return to file first. I believe I will be taxed more in Ireland than the US and could use that as FTC rather than FEIE. Income is well below the threshold.
I have two children too, so read about that credit only being possible if you use FTC option.
Thank you in advance
David – I’m an expat living in Canada, I have been using tax credit which removes any U.S. tax liability for my foreign income. In 2020 however, I took a 401K distribution under the CARES act. Do I include that U.S. income on Form 1116, and if so, can I allocate the U,S. standard deduction amount of $12.4K uniquely to my U.S. income? As we pay more taxes in Canada, paid taxes more than offset any U.S. tax due on said income, and therefore I would prefer to use the standard deduction uniquely against my U.S. income? Thanks.
Larry,
Distributions from US retirement accounts are likely US source income and should not be included on Form 1116. The US / Canada tax treaty should be reviewed. The US tax rate on the distribution may be limited or a credit may be allowed on the Canadian return for taxes paid in the US.
Hi David, if I take the FEIE, can I take the child tax credit just until there is no tax liability? I thought that the FEIE means that you can’t take the child tax credit at all, but Intuit is allowing the child tax credit and the FEIE (but is not making any excess child tax credit refundable). Also can I take the FTC for unearned income (like interest income) while using the FEIE on earned income?
I am very curious about this since the new stimulus package increases the child tax credit and provides for the entire amount to be refundable. I don’t want to get locked onto the FEIE if next year it makes more sense to just take the FTC to get a refund for the child tax credit.
Jen,
If someone uses the FEIE they can claim the child tax credit, but not the “additional” (refundable) portion.
The FTC can be applied to unearned income while using the FEIE on earned income. This is very common with foreign dividends.
Someone won’t be locked into the FEIE, but they could get themselves locked out. A taxpayer can always switch from the FEIE to the FTC, but they may not be able to switch back without requesting IRS approval or waiting 5 years.
Hi David, I live in Denmark. I pay a reduced tax bracket due to special expat tax status of 27.5%. I’ve always used the FEIE since I can remember living in Brazil, UK and Switzerland, but am considering using the FTC this year, because of a Roth IRA contribution that is now being classified as over contribution. My income with the FEIE is zero, as its about half the limit of FEIE. When/if moving over to FTC only for the ~72K USD salary, should I only be including my income (wages/salary) on the 1116 form?
Garrett,
You’re correct. If all of your income is excluded by the FEIE you’re ineligible for IRA contributions. You should also be aware that switching from the FEIE to the FTC could stop you from being allowed to claim the FEIE for the next 5 years. It is a decision that shouldn’t be taken lightly and you should work to review the long-term positives and negatives of such a decision.
Income reported on Form 1116 should be separated by country and type of income. Wages/salary is general category income and shouldn’t be mixed with passive category income like interest and dividends that may be subject to foreign taxes and also reported on Form 1116.
Hi David, follow-up question. I stuck with the FEIE for 2020 tax returns and removed the over contribution to the Roth. In 2021 (next month), I will consolidate my US retirement accounts and convert my Traditional IRA to a Roth IRA (appx 3500 USD). Question is; with my 2021 foreign salary continuing to fully exempt (since it will be below the threshold). Will the ~3500 conversion be considered a contribution/over-contribution, which would result in the 6% excise penalty due to my income being zero (fully exempt)?
Garrett,
A conversion and a contribution are different. A conversion will not generate excise penalties.
Hi David! I’m a US citizen currently living in Canada. I invoked the foreign income exclusion in previous years but I’ve recently stopped working. Do I need to still file the 2555 with 0 income to keep it invoked for future years? Or can I just not file it for the years that I’m unemployed and then file it again in future years when I’m employed?
Anita,
There is no requirement to file a tax return with zero income to keep the FEIE. Someone can simply pick it up again when they start working. However, it may be prudent to file a “zero” tax return if it impacts eligibly for a stimulus check.
This is great and very clear. But what about those of us who live in Europe (or another place that is NOT a tax haven) and have US income that is taxed by our country of residence. For example, although I work and have income that can be excluded since it doesn’t exceed $107K I also have US capital gains income that is taxed here in Europe. Can I claim the foreign tax credit on that income? Thanks.
Erik,
Absolutely. If someone’s capital gains income is taxed in their country of residence they can determine the amount of tax attributable to that income and claim a foreign tax credit on their US return.
Beautiful information that was clearly and concisely explained. Thank you for that. I do have one question, is my non-resident alien wife with no ITIN (we’ll be applying for one with the return) eligible to exclude her 2020 income from her country under FEIE?
Context:
I am an H1B work authorization holder here in the US. From what I understand, I am considered a resident alien for tax purposes. I got married in September 2020, my spouse is of a foreign country that has a tax treaty with the US. While she visited me in 2020 on a B1/B2 visa, she visits me now on the recently obtained H4 Dependent visa as she transitions to the US. Now, I would like to file 2020 taxes as married, filing jointly and I’m trying to ascertain if her income is eligible for the FEIE, even though she is a non-resident alien and does not have an ITIN. I do believe she would pass the bona-fide test and I have filled out the w7 form for the ITIN and will attach this to our 2020 paper file. What do you think? Many thanks for your help!
Ramon,
I recommend reviewing the “Nonresident Alien Spouse Treated as a Resident” section of IRS Pub. 54 . It is my understanding that she would need to have the ITIN before you could file, so you may wish to request an extension.
My daughter resides in Germany and is finishing University this year. I reside in the US and, as her parent and provider of funds, plan to claim her as a dependent on my tax return one final time for 2020. She worked in Germany this year and has some earned income, but it is well within the FEIE and Roth IRA limits (Approx $15000). She would like to open a Roth IRA but that means taking a FTC rather than the FEIE. It also means having to apply for the FEIE if she wishes to use that in the next 5 years, as she plans to remain in Germany for some time and has a full time job there lined up after graduation. Since her earned income was all earned and taxed in Germany, can she contribute to a Roth IRA? Is this generally advisable? She does not know whether she’ll be back in the US permanently and I guess that is important with regard to withdrawal as any IRA withdrawal income (Roth or traditional) will be a taxable event with regard to Germany. I expect that her income in the near future will be within the FEIE limits, and with Germany as a high tax state, the FTC may be a better option for her for now as she has some US sourced unearned income as well ($10000 or so). Does the Roth IRA plan make sense? Am I missing something?
Reb,
You’re correct. In general if someone lives in country with a higher tax rate than the US, they may be better off using the FTC. The decision to make Roth IRA contributions is impossible to advise on without being in a financial planning relationship because it is a long-term decision. If she decided to do it, she would have to claim the FTC because it wouldn’t be allowed if all of her earned income is excluded by the FEIE.
David,
My wife and I married last summer. She has lived and worked her entire Adult life in Canada although she is a dual citizen of the US. We lived separate all of 2020 and maintained separate residences, me in the US and her in Canada. She is self employed and sold her condo in 2020. I am attempting to do our taxes for the US and filing jointly. Is claiming the FTC the way forward for us?
Michael,
Since she is a dual citizen she would have filed a 2019 US tax return as well. I would expect that she should continue to in the same manor as previous years even though you’re now married. That being said, there are a lot of financial advisors and CPAs that specialize in the US / Canadian relationship. I highly recommend that you reach out to a country specific expert to review your situation before making any decisions.
https://www.transitionfinancial.com/
Hi, I have been filing annual Foreign Income Tax Exclusion (living in Australia, earning under the converted rate of $105k USD) so I do not owe any US taxes. However, I have had children in the last few years, and wasn’t aware I could/should be claiming Child Tax Credits. Should I change from filing a Foreign Income Tax Exclusion to filing a Foreign Tax Credit (and therefore be eligible for Child Tax Credits for my 3 dependents with SSNs)? Thanks!
Jenna,
This is a common question that expats are asking these days! The answer is yes, an expat with kids may want to consider using the FTC over the FEIE so that they can obtain the refundable child tax credit. It isn’t a simple decision though. The FEIE reduces your AGI, while the FTC does not. A return should be prepared both ways to determine which option is in the taxpayer’s best interest given their specific facts. Someone deciding whether to switch should also weight the fact that they won’t be able to return to the FEIE again for 5 years without requesting an IRS exception.
Hi there, thanks so much for writing this post. I earn less than the FEIE limit, but would like to use the FTC for a portion of the income in order to contribute to my existing Roth IRA. Is this possible or can I only use both if I make more than the FEIE limit (and use the FTC on the remainder?) I’m asking because I always use TurboTax to file, and it seems to not allow this option – I’m not sure if it’s a limitation with the software or simply not allowed. Thanks1
Al,
No you can only use both if your income exceeds the FEIE and you’re using the FTC on the remainder.
Hi David,
Hi David,
I hope you are doing well. Thank you for writing this post and taking your time to reply to everyone. I hope you can answer mine…
I would like to move to South America for 1-2 years and work remotely for my US based employer. My employer has no physical presence outside the US and there are no issues regarding my ability to perform the job remotely (web dev), but I would like to know if there could be any tax implications for my employer. I would still be on payroll (with all the taxes deducted in my W2) and would also be paying taxes in South America.
1. Would I need to change my address or can I keep my US address for work, banks, and such, so that I can claim FEIE or FTC?
2. Is there anything my employer needs to do? Any tax implications?
Thanks again,
chieri
My husband has worked in Iraq and take the FEIE. Because of the time frame in Iraq only a portion of his income can be excluded (not the entire 106,000 as he did not make that much) say he made 69,000 and he is allowed to take the FEIE on only 40,000 can he claim the foreign tax credit on the other 29,000? He paid in 12,000 in Iraq taxes.
Thanks
Yvonne
Great article. Thanks! Question – on the year when you switch from using Foreign Earned Income Exclusion, to filing only the Foreign Tax Credit – do we still need to file form 2555, or eliminate it all together? Do we need to send the IRS some sort of additional note that we want to switch methods, and want to revoke the exclusion for for 5 years? Thank you!
Hi David, I’ve been trawling the internet for help as I fill in my tax return and your site has been by far the most helpful! Thank you!
I am wondering one thing – I am a dual UK/US citizen, living in the UK. I operate a home baking business as a sole trader and earn well under the limit to pay income tax in the UK. Similarly, when I apply the Married Filing Separately deduction I have 0 taxable income in the US as well. Given that I have a “zero” tax return, is there any point in my filing a FEIE? As for the FTC – well, I don’t pay income tax in the UK, so that wouldn’t apply either!?
Hopefully that is a simple question to answer! I’m also wondering if I were to file a FEIE, and that asks me to put the FEI onto my Schedule 1 line 8 – how does that work with filling out a Schedule C, showing my business net profit – which Schedule 1 asks for on line 3? Clearly I’m not meant to put the same income down twice ! Any clarification would be greatly appreciated!
Many thanks for your time!
Liz
Liz,
As a dual citizen you likely should file a US tax return even if it results in zero tax being due. You may not need the FEIE if your income is below standard deduction for MFS. Self-employed individuals have an extra step in that they need to submit evidence that they are subject to another country’s social security system so they won’t be subject to self-employment taxes on their US return. You’ll need to request the evidence from the UK Government. https://www.irs.gov/individuals/international-taxpayers/self-employment-tax-for-businesses-abroad
The number of schedule 1, line 8 will be negative and the number on schedule 1, line 3 will be positive. That is how you’ll report the income, but then take an exclusion for the income.
I have question. Taxpayers who claimed 911 in prior years until 2012 and back to US in 2013. Can they take foreign tax credit on 2020 US tax return on fresh new assignment?
Chena,
Yes, that shouldn’t be a problem. A multi-year gap in claiming the FTC does not impact your ability to qualify for it.
Hello David,
I have a very specific question you might be able to help me with.
The FEIE is usually reported as a negative number in parentheses on line 8 of schedule 1. I have other amounts to report on this line that are foreign unearned income. Do I sum the numbers? This doesn’t seem right to me since I thought I should use the FTC to cover those unearned amounts. BUT, I need a negative number on line 8 to reduce my foreign business income on line 3 sched 1 which should be covered by the FEIE. It’s a little confusing, unless I’m reporting amounts on the wrong lines. Any comments are greatly appreciated. Thank you!
Melissa,
It sounds like you’re doing your return by hand, which is not recommended. You should use preparation software that would handle this question for you.
David,
Echoing what others have written: thanks for the clear, concise information.
One bit of ambiguity around changing the FEIE election.
Can one amend the prior three years of returns to “un-elect” the FEIC? In other words, un-elect for years tax years 2018, 2019 and 2020? I suspect yes based on what I read.
Assuming one can amend, when does the 5-year period start and one can re-elect the FEIC? Does the time start from the amended 2018 tax year (so could elect again starting for tax year 2023) or from the year of the amendment (so one could elect again starting for the tax year 2026)? I suspect in 2023, but I’m uncertain.
Thanks again.
Hi David – great site! saw your earlier answer on no FEIE on roth contribution. What about roth conversion from current trad IRA? Thanks!
Hi David!
I have question about the Foreign Earned Income Exclusion (FEIC). As i read that mentioned if I “revoke” the FEIC , i cannot use it again for 5 years. However, I was wondering, what exactly counts as a “revoked FEIC”?
My situation is as follows:
Year 1, worked and lived fully in South Korea, utilized the FEIC.
Year 2, worked and lived in US , did not utilize the FEIC.
**Year 3, working and living fully in South Korea again – can I still utilize the FEIC?**
Thank you so much for your help!
James,
Revocation and not qualifying are different. If you didn’t qualify for the FEIE in year 2, but then do again in year 3 there is no issue.
My 18 year old daugher is a U.S./German dual citizen. She has lived in Germany her entire life and hasn’t visited the U.S. in 14 years! She began working as an apprentice. Her tax home is Germany but Germany says her income is low enough that she does not need to pay any tax. But her income is higher than the U.S. Standard deduction.
1. She wanted to take the FTC but how can that work if the German government didn’t take any tax from her?
2. We wanted to avoid the FEIE because she hoped to visit her relative in the U.S. for a few months (with intention to return to her home in Germany).
– What happens if she does go the U.S for 3 months and then returns to another apprenticeship where the German gov’t again doesn’t take any tax?
Would she be stuck then not being able to take either the FEIE or the FTC?
Jo,
If no non-US income taxes are paid, there is no opportunity to use the Foreign Tax Credit. Someone that has extensive ties to a non-US country would be a good candidate for the FEIE using the bona fide residence test. Under the bona fide residence test there is no set limit on the amount of time someone can spend inside the US so long as they continue to be resident in the non-US country.
Hi if you made contributions to your Roth IRA in a brokerage account like Vanguard, while living abroad for over 10 years, and have been taking the FEIE when filing your income taxes (without knowing that you were not allowed to contribute to your Roth IRA), can the IRS penalize you the 6% tax penalty on every year your money has been sitting in your Roth IRA account after 6 years? In other words, would the statutes of limitations protect you once 6 years has passed if you were never notified by the IRS about your contributions?
Ben,
Unfortunately there is no statute of limitations for excess Roth contributions.
Thank you so much David for getting back to me-I really appreciate it! I know it doesn’t matter at this point, but I had no idea this was not allowed and was not notified by either the IRS or Vanguard. I just stumbled on it on the internet. If the IRS is unaware of it for now, and I move my contributions to a non-retirement account, would that solve the problem? Although it would be extremely expensive, is it better to go back and amend all the tax returns since the year I first made a contribution to my Roth? It seems that Vanguard should have let me know that I wasn’t allowed to make contributions while living abroad.
Hi David, thanks a lot for your help. I have two questions. I have a non-US person spouse who does not work. Can I claim close to 220K USD (Approx 110K for each of us ) with FEIE from my income although she does not work? Do I have to be tax resident in a country in order to take advantage of FEIE? We could simply change countries every 2-3 months without being tax resident in any country and we could still take advantage of FEIE right? Thanks
Andy,
The FEIE requires a person to have earned income to claim it, so if someone’s spouse does not work they would not be eligible. A one income family would be limited to ~110K. To pass the physical presence test in order to claim the FEIE there is no requirement that someone be a tax resident in another country. Simply that they spend sufficient time outside the US.
Hello David,
I have been looking online for quite awhile and have never found a straight answer.
I currently work in Japan and pay Japanese taxes, using the FEIE to exclude it so I don’t pay U.S. Taxes on it.
If I switch to the FTC, no matter the potential tax repercussions, is it possible to contribute to my old Roth IRA? My understanding is if i don’t exclude my income then this would be possible…
Kris,
So long as your income is below the Roth IRA maximum AGI threshold you could contribute based on Japanese income that is offset by the FTC. Income excluded by the FEIE can not be contributed to an IRA.
My daughter is working for the next two year at a university in Scotland. She only makes $55,000/year. Is it better for her to use the exclusion or use the tax credit. I know she can’t contribute to her IRA if she uses the exclusion but we don’t really see all the advantages of using the credit approach. can you help clarify ?
Lisa,
If the tax rate in Scotland is higher than the tax rate in the US, then you may be best off using the Foreign Tax Credit. That way you don’t need to worry about passing the bona fide residence test or limiting your time in the US so that you can pass the physical presence test. As you mentioned it also has the added benefit of still having the option to make IRA contributions. Someone in this situation likely wouldn’t want to make Traditional IRA contributions, because they would be deductible at a 0% tax rate, however Roth could be advantageous.
Hi David,
Many thanks for your help. I am US citizen by birth but I havent actually lived in the US and I dont even have a SSN, I recently realised that I must start filing taxes for US moving forwards and also for the past 3 years and I am in a discovery process to figure out how that works. I am also a UK citizen and currently live and work in the UK. My income is about $205,000 annually and I am a UK tax resident paying taxes here.
I am also planning to move to Dubai in 1 year with roughly the same income and there are no income taxes there.
My question is if I choose the FTC option now (to also cover the last 3 years), would it be possible to switch to FEIE next year when I move to Duabi? and if not what would be the best way to do this given my circumstances?
Many thanks.
Adam,
Yes, if someone uses the FTC they can easily switch to the FEIE. That would likely make sense if they are moving from the UK to the UAE.
Browsed the many comments and a few things came up that you should probably highlight in the article for the benefits of taking the FTC vs the exemption. IRA contributions are one (allowed for FTC, may or may not be allowed with the exemption depending on over the exemption limit or not), and the child credit. Not sure if there are others but these are definitely worth mention as they are not well known and may impact taking one vs the other.
Hi David,
One question, am I able to file FEIE for my salary earned income and separately, file for foreign tax credits for rental income on a foreign rental property? (living in New Zealand with rental property in New Zealand) – many thanks.
Charlie,
Absolutely! Someone can apply the FEIE towards their earned income and then use the FTC to offset taxes on their passive income.
Hi, this site is very helpful. I’m a US/UK dual citizen, permanently living in the UK. I still file taxes in the US to maintain my citizenship however, all of my earnings are from self employment work in the UK. I pay tax every year in the UK, but don’t ever earn that much. I earn below the US Standard Deduction and claim that on my taxes, therefore – do I need to file the FEIE or FTC? I believe that if I claim the US Standard Deduction, I DON’T need to file either the FEIE or the FTC, correct? However, I do need to file form 1040 Schedule C, Form 8833 AND include evidence that my tax is paid here in the UK (which I need to request from the UK government). Is this correct as well? Thanks so much for any help you can provide!
Sarah,
If someone’s income is below the standard deduction, they may not need to use the FEIE to reduce their US liability. If the US liability is zero, the FTC can’t be applied because there is nothing to offset. A self-employed person (or sole trader) would need to file a Schedule C regardless of their liability. You’re correct to point out Form 8833 and a statement from the UK indicating that you’re paying into their Social Security equivalent program, that way the income won’t be subject to self-employment tax (Social Security and Medicare tax) in the US. Form 114 (FBAR) and Form 8938 are other common forms that may be required.
Hi David
I am an expat working in China. I was unable to travel back to the US at all from Jan 2020 until Dec 2021. I earn about 95000 a year with 2 dependents. I file as Head of Household since my spouse is not a US citizen. I normally use the FEIE however, this year I am wondering if it wouldn’t be better to use the FTC since I haven’t been able to claim the Child Tax Credit because of the FEIE. I did not qualify for the expanded Child Tax credit this year due to the fact that I was not in the US for 6 months of the year but if I don’t use the FEIE i can still qualify for the additional Child tax credit of $1400 for each kid. I paid taxes on my income in China of around 13000. I’m not sure but I think my tax liability in the US if I use the FTC would be around $10000. Would it make sense to file the FTC instead. What if I leave China and go to a different country, will I still be bound to the 5 year rule to switch back to the FEIE?
Hi David, I invoked the foreign income exclusion last year, but this year I have negative self employment income (self-employment loss). Do I need to still file Form 2555 to keep the election invoked for future years? Will I be accidently revoking the election? Thank you!
Dolly,
There is no need to file a blank Form 2555 if you do not have income. Having negative income will not revoke the election.
Do you have to prove you paid foreign income tax to claim the foreign earned income exclusion?
Jim,
There is no requirement that foreign income tax be paid to claim the FEIE. Many people work in countries with no income tax and can still claim the exclusion.
Hello – I lived as an expat in the UK for a number of years (accumulating a foreign tax credit). My job transferred to the Cayman Islands. Can I first apply the FEIE in order to reduce my tax balance before claiming the foreign tax credit? Thank You!
John,
Yes, the rules allow for the FEIE to be applied first and a FTC may be taken for any income above the FEIE.
Hi David, I am a dual citizen living in Canada. My income was $32,000 last year. I always submit the FEII, but this year have taxable capital gains of $1000. I will include this on my 1040, but do I have to use form 1116 also?
Phoebe,
A taxpayer in your situation may not need to claim a Foreign Tax Credit on Form 1116 to reduce their US liability to zero. If the earned income is fully offset by the FEIE, the standard deduction may be sufficient to offset a $1,000 capital gain.
Hi
I m new to USA and will appreciate your help.
Recently got a greencard for me, my wife and my son (19 yrs). Because of my son’s education we are still residing in England but have visited USA on our green card.
I m in full time employment and pay my taxes in full – in England. My wife does’t work and son is in full time education. None of us work or own any asset as yet in USA.
I have learned that as greencard holders we need to file tax return in USA regardless of my employment in England.
I’ve been checking the information and want to be compliant but like to know which option is best for me – so I don’t end up paying double taxes. i.e. foreign-earned-income-exclusion-OR-foreign-tax-credit?
Many thanks in advance
H.Hasan,
Depending on your income level you could use either or a combination of the two. The tax rates in the UK are generally higher than in the US, so the Foreign Tax Credit is likely to fully offset any US liability. Be sure to look into any required FBAR and Form 8938 filing obligations as well.
Thanks David
Total household income is under 60K USD – Would you kindly advise about the State Tax implications – Can the FTC be used for state tax filing too? Currently in Michigan.
Hi David,
This is a very useful post, thanks.
As a dual citizen EU / US, planning to move to Andorra (10% tax), working as a web dev for a US company with no presence outside the US and making over 6 figures. What do you recommend ? My main concern is the fact that the company (my employer) has only US presence (at least by now). I will be spending all my time in Europe, getting paid in my bank in the US
Thanks a lot,
Roger
Hi David,
Thanks for all your articles!
I was wondering if you could quickly go through my situation to check if all makes sense. I will be permanently moving to the US in 2023. You can assume that I will become a tax payer in 2023 (substantial presence test). Therefore, I will need to file taxes in 2024 for the 2023 fiscal year. I will do this jointly with my wife. As, I come from a high-tax country, I would like to use the Foreign Tax Credit (Form 1116) to offset high taxes I paid for fiscal year 2023. I am from a country that the US has a tax treaty with (including social security tax treaty). Three question from my end. Question 1: Are the following calculations correct?
Foreign Gross Income of $55000 and Total US Income (including partner’s) of $130000. Total Worldwide Income is then $185000.
Total US Tax Liability (Excluding Social Security) is around $33000. I will have paid $17000 in taxes (excluding social security) in my home country.
Foreign Tax Credit Limit would be = ($55000/$185000)*$33000 = $9810. The foreign income was 30% of the worldwide income, and thus total tax credit limit is 30% of US Taxes (excluding Social Security).
Since, I have already paid $17000 in foreign taxes, I will only be able to reduce taxes by $9810.
Question 2: I know that you can either carry over or carry back this unused foreign tax credit. Carrying it over will not be very beneficial as I don’t expect to have any foreign income in the next 10 years. So I looked at carrying it back, however, that seems a bit strange in my opinion. My wife and I will only have filed jointly in 2024. It seems strange that I can look back – including her income – to fiscal year 2022 and reduce taxes there as well. Especially that I have only become a US tax resident in 2023. Without giving the numbers, the credit limit for fiscal year 2022 would be more than the outstanding credit. Could I get this potentially too?
Question 3: Even though, I am from a high-tax country. If I do the calculation with the FEI method, I come to a lower total (jointly filed) US tax liability of $17K instead of $22K with the FTC method. Is this driven by a rather high total income in the US and a low proportion of of foreign income (30%). Just seems a bit off to me but I’m pretty sure I did the calculations right.
Thanks a lot for your input. I really appreciate it and again you have been super helpful for me already!!
If you are a resident of Spain, but are taxed under Beckham Law at 24% as a Non-Resident, can you still claim the Foreign tax credit in the US on the taxes you paid in Spain?