Part of the U.S. Expat Tax Series by Tax.Travel

This article is part of Antravia’s U.S. Expat Tax Series - a collection of practical guides for Americans living or working abroad. Whether you’re a long-term expat, digital nomad, or remote entrepreneur, these resources explain how to stay compliant with the IRS while reducing double taxation and managing your finances internationally.

Foreign Earned Income Exclusion vs Foreign Tax Credit

A 2025 Guide for U.S. Expats Trying To Avoid Double Taxation**
By Antravia

U.S. expats quickly discover that the American tax system works differently from almost every other country. While most countries tax you based on where you live, the United States taxes you based on who you are. If you are a U.S. citizen or Green Card holder, you must file a federal tax return no matter where in the world you live. That creates a problem for many Americans abroad. Your local country already taxes your salary, your business income and sometimes your savings. Without the right relief, you could find yourself taxed twice on the same income.

The two main tools that U.S. expats use to reduce or eliminate double taxation are the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC). They work in completely different ways and choosing the wrong one can have long term consequences for tax, pensions and business structures. Yet many expats are never told the real differences, and most online explanations simplify the topic so much that people end up making decisions that do not fit their situation.

This guide explains the FEIE and the Foreign Tax Credit in a way that reflects how expats actually live and work. Whether you are a salaried employee, a contractor, a business owner or a self employed travel professional, it is worth understanding how these two rules work before the next tax season.

This is an educational guide for U.S. expats. It is not a substitute for professional advice, especially if you run a foreign company, own foreign investments or have complex income.

Why U.S. Expats need either FEIE or the Foreign Tax Credit

The U.S. tax system does not automatically recognize taxes paid in your country of residence. You must claim relief on your return. Without doing so, your U.S. tax will be calculated as if your foreign income had no foreign tax applied at all. For most expats this would be a significant overpayment.

The FEIE and Foreign Tax Credit aim to solve the same problem, but they work in opposite ways.

• The FEIE excludes a portion of foreign earned income from U.S. taxation.

• The Foreign Tax Credit gives a dollar for dollar credit for certain foreign taxes you paid.

Many expats assume they can choose either in any year. In reality it depends on how you earn, where you live and how the U.S. treats certain types of income. There are situations where one method works well and situations where it creates more tax or reduces the benefit of the other method. Understanding the differences allows you to plan more effectively.

**Foreign Earned Income Exclusion (FEIE)**

The Foreign Earned Income Exclusion is the rule that most new expats hear about first. It was created as a simple way for Americans working abroad to avoid double taxation on salary earned outside the United States.

The FEIE allows you to exclude up to a specific amount of foreign earned income from your U.S. taxable income. The amount changes each year. For the 2025 tax year the exclusion is around 130,000 dollars. This amount is indexed for inflation each year.

To use the FEIE you must pass either the Physical Presence Test or the Bona Fide Residence Test. These rules determine whether you are genuinely living abroad or only temporarily working overseas.

The Physical Presence Test requires 330 full days outside the United States within a twelve month period. The Bona Fide Residence Test requires stronger evidence that you have made a foreign country your main home.

FEIE applies only to earned income. That means salary and self employment income. It does not apply to dividends, rental income or profits you receive from a foreign company. It does not apply to pensions or passive income. It also does not cover employer paid housing unless you separately claim the foreign housing exclusion.

For employees living in a low tax country FEIE often works well because the exclusion alone may eliminate most or all of your U.S. tax.

For people living in a high tax country FEIE can actually be less effective. This is because you might pay more tax locally than the amount excluded under the FEIE. In those situations you may be better off claiming a Foreign Tax Credit.

Where FEIE becomes complicated is when a U.S. expat is self employed or owns a foreign company. FEIE does not exempt you from U.S. self employment tax. It also interacts poorly with the rules that govern foreign corporations. Many U.S. expats are surprised to learn that using the FEIE can increase their tax when combined with ownership of a foreign company. This is explained in more detail later in this guide, as well as in this article - U.S. Citizens Living Abroad with a Company | GILTI, Form 5471, and U.S. Tax Reporting for Foreign Companies

FEIE must be elected on Form 2555. Once you take the exclusion you must continue using it unless you formally revoke it. If you revoke FEIE, you cannot claim it again for five years without IRS permission. This is another reason to choose carefully.

**Foreign Tax Credit (FTC)**

The Foreign Tax Credit works differently. Instead of excluding income, it gives you a credit for foreign income taxes you paid. It is claimed on Form 1116. The credit reduces your U.S. tax bill dollar for dollar.

The Foreign Tax Credit is available to both employees and the self employed. It is also used by people with investment income, business profits, dividends and rental income.

For many expats living in countries with tax rates similar to or higher than the United States, the Foreign Tax Credit usually provides better relief than FEIE. If your foreign tax rate is higher than your U.S. tax rate, the credit will often eliminate U.S. tax entirely.

The Foreign Tax Credit has categories of income called baskets. There is a general basket, a passive basket and others. Taxes paid on income in one basket cannot offset U.S. tax in another basket. For example, foreign tax paid on salary cannot be used to offset U.S. tax on dividends. This creates planning considerations for expats with multiple sources of income.

Unused credits can be carried back one year and carried forward ten years. This is useful for people who have inconsistent income, years with relocation costs or periods of part year residence.

The Foreign Tax Credit works best when:

• you live in a country with a comparable or higher tax rate
• you earn income through a foreign company
• you receive dividends from a foreign company
• you have investment income
• you pay foreign tax that is creditable under U.S. rules

Many expats do not realise that foreign employer social security taxes can sometimes be included in the Foreign Tax Credit. This varies by country and depends on totalization agreements.

**FEIE vs FTC which one is better for Expats**

There is no single answer. The best choice depends on your country of residence, how you earn your income, whether you own a business abroad and whether you have foreign investments.

Salary Earners in Low Tax Countries

If you live in a low tax country such as the UAE, Thailand or Singapore, the FEIE may provide the highest immediate benefit. It excludes income directly and often eliminates the U.S. tax completely. However this only works for salary from an employer. It does not protect you if you operate your own company.

Salary Earners in High Tax Countries

If you live in a country like the United Kingdom, France, Germany or Canada, the foreign tax rate is often higher than U.S. tax rates. In these countries the Foreign Tax Credit normally gives a better result because the credit eliminates the U.S. liability without limiting the amount of income you can earn.

Self Employed Expats

FEIE does not exempt you from U.S. self employment tax. For a self employed expat who must pay U.S. social security and Medicare taxes, FEIE may reduce your income tax but does nothing for your self employment tax. The Foreign Tax Credit combined with certain totalization agreements can be more effective.

Expats who own a Foreign Company

This is the area that most general expat guides overlook. Owning a foreign company changes everything because your income might be corporate income rather than individual earned income. FEIE does not apply to corporate income. FEIE also interacts poorly with foreign tax credit calculations when you take distributions.

The Foreign Tax Credit is usually more appropriate for business owners because it aligns with how foreign companies are taxed locally. It also prevents you from accidentally reducing your ability to use credits in future years.

The 2555 exclusion can also reduce the amount of foreign tax available for the FTC, creating mismatches that are time consuming to unwind.

Expats who receive Dividends or Investment Income

FEIE does not apply to investment income. The Foreign Tax Credit almost always produces a better result in these situations. This is particularly important for expats with foreign rental properties, dividends from foreign companies or interest on foreign bonds.

**Examples that show how the two methods work**

Example One

A U.S. citizen moves to Dubai and earns a salary of 100,000 dollars. The UAE has no income tax. FEIE excludes the entire salary from U.S. taxation. No foreign tax credit is available because no foreign tax was paid. In this situation FEIE is the most effective approach.

Example Two

A U.S. expat works in London and earns the equivalent of 140,000 dollars. They pay more tax to HMRC than the U.S. would require. FEIE would exclude only the first 130,000 dollars, leaving some income still taxable by the United States. The remaining income would be taxed unless a Foreign Tax Credit is claimed. In this situation the Foreign Tax Credit eliminates U.S. tax completely.

Example Three

A U.S. travel consultant moves to Italy and works as a sole proprietor. They pass the FEIE test and exclude their earned income. However they still owe U.S. self employment tax which FEIE does not reduce. The Italian tax is high, the U.S. tax is low and a Foreign Tax Credit would have eliminated the entire U.S. liability. FEIE in this case creates more tax than the Foreign Tax Credit.

Example Four

A U.S. expat owns a one person company in the United Kingdom. The business earns a profit, pays UK corporation tax and the owner receives dividends. FEIE does nothing for dividends and nothing for corporate income. Only the Foreign Tax Credit can apply here. The wrong FEIE election can also reduce the credit available for dividend income.

**Common mistakes Expats make**

Choosing FEIE because it sounds simple

Many expats choose FEIE because they think it avoids all U.S. tax. They later discover that it does not apply to company income, does not remove self employment tax and limits their planning ability in future years.

Claiming FEIE without understanding the Five Year Rule

Once you revoke FEIE you cannot use it again for five years. If you live in a high tax country this may lock you into a method that produces more tax.

Trying to use both FEIE and FTC on the same Income

You can use FEIE and Foreign Tax Credit on the same return, but not for the same income. Mixing the two without understanding the limitation rules can reduce the credit that would otherwise eliminate tax.

Forgetting that housing is separate

The foreign housing exclusion is not part of FEIE. Many expats assume it is automatic. It must be calculated separately.

Using FEIE when you own a Foreign Company

This is the most serious mistake. FEIE interacts poorly with rules for foreign corporations, including the earnings and profits calculations used on Form 5471. It can also reduce the foreign tax credit available in future years.

**How to choose the Right Method**

Choosing the right approach depends on three things. First, where you live. Second, how you earn income.
Third, whether you own a foreign business.

FEIE generally works best in low tax jurisdictions for salary earners. The Foreign Tax Credit generally works best in high tax jurisdictions, for business owners and for people with mixed types of income. If your income type changes during the year, you may need to split methods or work with a professional who understands the rules.

The most important point is that FEIE and FTC are not interchangeable. The right decision depends on your future plans as much as your current income. A method that produces a small saving today can create long term disadvantages, especially if you start a business, receive equity or relocate again.

**A Note for Expats with Foreign Companies**

This guide would be incomplete without addressing foreign companies directly. An American who owns a foreign company enters a different part of the tax system. In these cases the Foreign Tax Credit is almost always more practical because it aligns with how corporations pay tax abroad. FEIE rarely helps because most income is corporate rather than personal.

Foreign companies also come with additional reporting including Form 5471, Form 8858, Form 8865 and occasionally Form 926. They may also involve CFC rules, Subpart F and GILTI which FEIE does not address.

For expats who run their own business, choice of method is not only an individual tax decision but part of a wider structure. Getting it wrong can produce more U.S. tax or reduce the credit available to offset future dividends. It is worth planning this carefully.See - U.S. Citizens Living Abroad with a Company | GILTI, Form 5471, and U.S. Tax Reporting for Foreign Companies

**FEIE and the Foreign Tax Credit are both Valuable, but very Different**

Neither method is more correct than the other. The right choice depends on country of residence, type of income and structure. Understanding how they work gives you more control over your tax position as an expat and helps you avoid costly mistakes.

U.S. tax as an expat becomes simpler once you understand how these rules interact. If you live abroad or run a business overseas, Antravia can help you understand your choices clearly so you can file with confidence. Learn more through our U.S. expat guides or contact us for structured, practical guidance.

Looking for more expat tax guidance? Visit tax.travel/us-expats for detailed resources on filing from abroad, FBAR and FATCA rules, and other essentials for U.S. citizens overseas.

Need help with your U.S. taxes abroad?

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References

• Internal Revenue Service. Foreign Earned Income Exclusion (Form 2555). https://www.irs.gov/individuals/international-taxpayers/foreign-earned-income-exclusion

• Internal Revenue Service. Instructions for Form 2555. https://www.irs.gov/instructions/i2555

• Internal Revenue Service. Foreign Tax Credit (Form 1116). https://www.irs.gov/forms-pubs/about-form-1116

• Internal Revenue Service. Instructions for Form 1116. https://www.irs.gov/instructions/i1116

• Internal Revenue Service. Publication 54: Tax Guide for U.S. Citizens and Resident Aliens Abroad. https://www.irs.gov/publications/p54

• Internal Revenue Service. Tax Treaties. https://www.irs.gov/businesses/international-businesses/united-states-income-tax-treaties-a-to-z

• Internal Revenue Service. Totalization Agreements. https://www.ssa.gov/international/agreements_overview.html

• U.S. Department of the Treasury. Regulations under IRC Section 901 (Foreign Tax Credit). https://www.ecfr.gov/current/title-26/part-1/subpart-N

• OECD. Model Tax Convention on Income and on Capital. https://www.oecd.org/tax/treaties/model-tax-convention-on-income-and-on-capital.htm

• Department of the Treasury. Foreign Earned Income Guidance and Threshold Adjustments. https://home.treasury.gov

Disclaimer:
Content published by Antravia is provided for informational purposes only and reflects research, industry analysis, and our professional perspective. It does not constitute legal, tax, or accounting advice. Regulations vary by jurisdiction, and individual circumstances differ. Readers should seek advice from a qualified professional before making decisions that could affect their business.
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