Americans living abroad face the same problem every filing season: US law taxes citizens on worldwide income, even when foreign tax has already been paid. Two provisions exist to prevent double taxation, the foreign tax credit (FTC) and the foreign earned income exclusion (FEIE), but they work differently and produce different results depending on where you live and what kind of income you earn.
How Does the Foreign Tax Credit Work?
The FTC lets you offset US taxes dollar-for-dollar with income taxes paid to a foreign government. If you paid $15,000 in UK income tax on your salary, you can apply that $15,000 directly against your US liability on the same income.
The credit is subject to a limitation formula: (foreign income / total worldwide income) x US tax owed. This prevents the FTC from reducing US tax on US-source income. Unused credits carry back one year or forward ten years.
The FTC covers all income types: earned wages, self-employment income, dividends, interest, capital gains, and rental income. That breadth is one of its main advantages over the FEIE.
How Does the FEIE Work?
The FEIE removes up to $132,900 per qualifying person from US taxable income for 2026 (inflation-indexed under IRC §911). Both spouses can each claim $132,900 independently, for a combined $265,800.
To qualify, you must meet either the bona fide residence test or the physical presence test (330 full days outside the US in any 12-month period) and have a tax home in a foreign country.
One critical limitation: the FEIE covers only earned income (wages, salaries, self-employment). Dividends, interest, capital gains, and rental income are not excludable. Foreign taxes allocated to excluded income also cannot be credited.
FTC vs FEIE: Side-by-Side
Which Saves More?
The answer depends mainly on your host country's effective tax rate relative to the US rate.
High-tax countries (UK, Germany, France): Foreign income taxes at 40-45% typically equal or exceed US liability on the same income. The FTC alone often eliminates the US tax bill. Using the FEIE here triggers a five-year lock with no added benefit.
Low or no-tax countries (UAE, Qatar, Cayman Islands): No foreign taxes to credit. The FEIE protects up to $132,900 from US tax without requiring any credits.
Middle-tax countries (Mexico, Portugal, Costa Rica): The math gets nuanced. If the effective foreign rate is below your US marginal rate, the FTC does not fully cover the US tax, and the FEIE may protect more of the first $132,900.
Can You Use Both in the Same Year?
Yes, but never on the same income. A common stacking strategy:
- Apply the FEIE to the first $132,900 of foreign earned income.
- Claim the FTC for foreign taxes paid on earned income above the exclusion limit.
- Claim the FTC separately for passive income (dividends, interest) using the passive income basket on a separate Form 1116.
This approach can eliminate most or all US tax for higher earners in moderate-tax countries.
The 5-Year Revocation Lock
Once you elect the FEIE, you are generally locked in. Revoking the election means you cannot re-elect FEIE for the next five tax years without IRS approval under IRC §911(e)(2). If you move from a low-tax country to a high-tax country and want to switch strategies, that lock-in has real consequences. Plan the initial election carefully.
What the FEIE Does Not Cover
The FEIE does not reduce self-employment tax. SE income excluded under FEIE still triggers 15.3% SE tax (Social Security and Medicare), because SE tax is calculated separately from income tax under IRC §1401.
The FEIE also triggers a stacking rule that effectively taxes non-excluded income at higher marginal rates than it would otherwise face. Your tax is computed as if all income were included, then reduced by the tax on the excluded portion at the lowest brackets. For high earners, this can partially offset the exclusion's benefit.
Bottom Line
If you live in a country with income taxes at or near US rates, the FTC typically eliminates double taxation without restriction or trade-offs. If you live somewhere with little or no income tax, the FEIE is almost always the better choice for the first $132,900 of earned income. Mixed situations, particularly those layering earned income, passive income, and housing exclusions, often call for both tools used in coordination.
Have questions about your expat tax situation? Contact TS CPA for a personalized review.