Expatriate Tax Planning: FEIE vs. Foreign Tax Credit Explained

Introduction

For US citizens and residents working abroad, navigating the complex world of expatriate taxation is essential. The US is one of only two countries (along with Eritrea) that taxes its citizens on worldwide income regardless of where they live.

Fortunately, the US tax code provides two primary mechanisms to avoid double taxation: the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC). Understanding which strategy is optimal for your situation can save thousands in taxes.

Understanding US Expatriate Tax Obligations

As a US citizen or resident alien, you must:

• File US tax returns annually, reporting worldwide income
• Pay US taxes on income above exclusions/credits
• Report foreign bank accounts (FBAR) if aggregate balances exceed $10,000
• Consider state tax obligations (varies by state)

Important: Even if you live abroad permanently, you remain subject to US taxation unless you renounce citizenship (which has its own tax implications).

Foreign Earned Income Exclusion (FEIE)

What is FEIE?

The Foreign Earned Income Exclusion allows qualifying US expatriates to exclude up to $126,500 (2025) of foreign earned income from US taxation. This exclusion applies only to earned income (wages, salaries, self-employment income), not investment income.

Eligibility Requirements

To qualify for FEIE, you must meet one of two tests:

1. Physical Presence Test

• Present in a foreign country for 330 full days during any 12-month period
• Days don't need to be consecutive
• Partial days in the US count as US days
• Travel days count toward the 330 days

2. Bona Fide Residence Test

• Resident of a foreign country for an entire tax year
• Must demonstrate intent to establish permanent residence
• Factors considered: length of stay, nature of work, family ties, visa status

FEIE Limitations

• Income Cap: $126,500 (2025), adjusted annually for inflation
• Earned Income Only: Does not apply to investment income, dividends, interest, capital gains
• Housing Exclusion: Additional exclusion for housing costs (varies by location)
• Self-Employment: Can exclude income but still pay self-employment tax

FEIE Example

Scenario: US citizen working in Singapore, earning $150,000 in 2025

• Qualifies for FEIE via Physical Presence Test
• Excludes $126,500 from US taxation
• Remaining $23,500 subject to US tax
• Singapore tax: ~$20,000 (estimated)
• US tax on $23,500: ~$5,000 (estimated)
• Total tax burden: ~$25,000

Foreign Tax Credit (FTC)

What is FTC?

The Foreign Tax Credit allows you to offset US tax liability dollar-for-dollar for foreign taxes paid. Unlike FEIE, FTC applies to all types of income, including earned income, investment income, and capital gains.

How FTC Works

• Credit Calculation: Foreign taxes paid ÷ Total foreign income × US tax on total income
• Dollar-for-Dollar: Each dollar of foreign tax paid reduces US tax by one dollar
• Carry Forward/Back: Excess credits can be carried forward 10 years or back 1 year
• No Income Limit: No cap on the amount of income eligible

FTC Limitations

• Credit Limitation: Cannot exceed US tax on foreign income
• Basket System: Credits calculated separately for different income types (passive, general, etc.)
• High-Tax Countries: May generate excess credits that can't be used immediately

FTC Example

Scenario: US citizen working in UK, earning $200,000 in 2025

• UK tax: ~$75,000 (estimated 37.5% effective rate)
• US tax on $200,000: ~$50,000 (estimated)
• FTC: $50,000 (limited to US tax on foreign income)
• US tax after FTC: $0
• Unused FTC: $25,000 (carries forward)
• Total tax burden: $75,000 (UK tax only)

FEIE vs. FTC: Which Should You Choose?

Choose FEIE If:

• Your foreign earned income is below $126,500 (or close to it)
• You're in a low-tax country (tax rate below ~25-30%)
• You want to simplify tax filing (exclusion is straightforward)
• You have minimal investment income
• You're self-employed and want to exclude self-employment income

Choose FTC If:

• Your foreign earned income is significantly above $126,500
• You're in a high-tax country (tax rate above ~30-35%)
• You have significant investment income from foreign sources
• You want to carry forward credits for future use
• You have foreign tax paid that exceeds US tax liability

Hybrid Approach

You can use both strategies, but not on the same income:

• Use FEIE for earned income up to $126,500
• Use FTC for income above the exclusion and for investment income
• This maximizes benefits when you have both earned and investment income

Calculating Your Optimal Strategy

Step 1: Determine Your Foreign Tax Rate

Calculate your effective foreign tax rate:

• Foreign taxes paid ÷ Foreign income = Effective tax rate
• Compare to US marginal rate (typically 22-37% for high earners)

Step 2: Calculate Tax Under Each Scenario

Model your tax liability under both FEIE and FTC:

Scenario	Foreign Tax	US Tax	Total
FEIE	$X	$Y	$X + $Y
FTC	$X	$Z	$X + $Z

Step 3: Consider Future Years

• FTC carryforwards can benefit future years
• FEIE exclusion amount increases with inflation
• Consider your long-term expatriate plans

Additional Considerations

State Taxes

State tax treatment varies:

• Some states don't recognize FEIE (CA, VA, etc.)
• FTC may be more beneficial in these states
• Consider establishing residency in a no-income-tax state before moving abroad

Self-Employment Tax

If self-employed:

• FEIE excludes income from income tax but not self-employment tax
• You still pay 15.3% self-employment tax on excluded income
• FTC can offset both income and self-employment tax

Investment Income

FEIE doesn't apply to investment income:

• Dividends, interest, capital gains not eligible for FEIE
• FTC can offset US tax on foreign investment income
• Consider tax-efficient investment strategies

Filing Requirements

FEIE Filing

• File Form 2555 with your tax return
• Must meet physical presence or bona fide residence test
• Can file extension if abroad (automatic 2-month extension)

FTC Filing

• File Form 1116 with your tax return
• Calculate credit limitation by income basket
• Track carryforwards on Form 1116

Common Mistakes to Avoid

1. Not Qualifying for FEIE: Failing to meet 330-day test or bona fide residence requirements
2. Double-Dipping: Using both FEIE and FTC on same income (not allowed)
3. Missing FBAR Filing: Failing to report foreign bank accounts
4. State Tax Issues: Not considering state tax implications
5. Not Reviewing Annually: Optimal strategy may change as income or tax rates change

Working with Tax Professionals

Expatriate taxation is complex. Consider working with:

• International Tax Specialists: CPAs or EAs with expatriate expertise
• Tax Attorneys: For complex situations or tax disputes
• Expatriate Tax Services: Specialized firms focusing on expat taxation

Conclusion

Choosing between FEIE and FTC is one of the most important decisions for US expatriates. The optimal strategy depends on:

• Your income level
• Foreign tax rates
• Types of income (earned vs. investment)
• State tax obligations
• Long-term expatriate plans

Generally, if your foreign tax rate is lower than your US rate and income is below $126,500, FEIE is optimal. If foreign tax rates are high or income exceeds the exclusion, FTC is typically better.

For more expatriate tax strategies, see our Complete Guide to Global Tax Optimization and other tax optimization articles.