Jessica I. Marschall, CPA, ISA AM
March 19th, 2025
U.S. citizens and resident aliens who earn income abroad may be able to exclude foreign income or claim foreign tax credits to reduce double taxation. The Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC) serve different purposes and can sometimes be strategically used together, depending on the taxpayer’s situation.
1. Foreign Earned Income Exclusion (FEIE) – Form 2555
What It Does:
Excludes up to $126,500 (for 2024, indexed annually) of earned income (wages, salaries, self-employment) from U.S. taxation.
Does NOT eliminate tax on unearned income (dividends, capital gains, pensions, rental income).
Eligibility Requirements:
Bona Fide Residence Test: Must be a bona fide resident of a foreign country for an entire tax year.
Physical Presence Test: Must be physically present in a foreign country for 330 full days in any 12-month period.
Limitations:
Cannot be used for passive income (dividends, rental income, pensions).
Excludes income but does not provide a tax credit, meaning you may still owe U.S. tax on amounts exceeding the exclusion cap.
Self-employment tax is still due even if earned income is excluded.
2. Foreign Tax Credit (FTC) – Form 1116
What It Does:
Provides a dollar-for-dollar credit for income taxes paid to a foreign country, reducing U.S. tax liability.
Applies to both earned and unearned income, including wages, dividends, rental income, and capital gains.
Eligibility Requirements:
Must have paid or accrued foreign income tax.
Cannot claim FTC for taxes paid on income excluded under FEIE (no double-dipping).
Limitations:
The credit is limited to U.S. tax liability on the same income (cannot exceed what would have been owed in the U.S.).
Unused credits can be carried forward (10 years) or carried back (1 year).
The foreign tax must be an income tax (not VAT, property tax, or social security tax).
3. Mixed Use: When to Use FEIE vs. FTC
| Situation | Best Option |
| Earns less than $126,500 in salary/wages and lives abroad full-time | FEIE (Form 2555) to exclude all foreign-earned income |
| Earns above the FEIE limit | Use both: FEIE to exclude up to $126,500 + FTC for foreign taxes on remaining income |
| Has dividends, rental income, capital gains, or pensions | FTC (Form 1116) (FEIE does not apply to these types of income) |
| Pays high foreign taxes on all income | FTC (better than FEIE since U.S. tax can be fully offset by foreign tax paid) |
| Self-employed in a foreign country | Combination: FEIE to exclude earned income + FTC for foreign taxes paid on remaining income |
Key Considerations for U.S. Expats Choosing Between FEIE and FTC in Western Europe
- High-Tax Countries Favor FTC Over FEIE:
- Many Western European countries, such as France, Germany, Italy, and Spain, have higher income tax rates than the U.S.
- Since U.S. tax rates are lower, using the Foreign Tax Credit (FTC) often eliminates any U.S. tax liability because the foreign tax paid exceeds what would have been due in the U.S.
- Example: If a U.S. expat earns $150,000 in Germany, where the tax rate may be 45%, they would pay $67,500 in German taxes. Since U.S. taxes would be lower, they could claim an FTC to offset all U.S. tax liability.
- Lower-Tax Countries May Allow FEIE to Reduce U.S. Taxes:
- In countries where income taxes are lower or income is exempt under special regimes (e.g., Portugal’s NHR program or Italy’s flat tax for new residents), the Foreign Earned Income Exclusion (FEIE) may be a better option.
- Example: If a U.S. expat earns $100,000 in Portugal under NHR, and it is not taxed in Portugal, using the FEIE would allow them to exclude the income from U.S. taxes entirely.
- Self-Employed Expats Still Owe U.S. Self-Employment Tax:
- Even if income is excluded under FEIE, self-employed U.S. expats must still pay 15.3% self-employment tax on earnings, unless covered under a totalization agreement with the host country.
- Example: A U.S. freelancer living in Spain may exclude $126,500 of income under FEIE, but still owe self-employment tax unless they pay into Spain’s social security system under a totalization agreement.
- Tax Treaties and Social Security Agreements Vary by Country:
- Some countries have tax treaties with the U.S. that prevent double taxation, affecting whether FEIE or FTC is more beneficial.
- Countries like France, the UK, and Germany have strong totalization agreements, meaning U.S. expats paying into those systems can avoid U.S. self-employment taxes.
- Portugal and Italy have more complex rules, requiring strategic planning.
Optimizing Tax Benefits as a U.S. Expat
Choosing between the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC) depends on:
- The tax rates in your host country.
- Whether your foreign income is subject to taxation locally.
- Whether you have significant unearned income (FTC applies, FEIE does not).
- Your self-employment status and social security obligations.
In high-tax Western European countries, the Foreign Tax Credit (FTC) is usually the best option. In lower-tax or special tax regime countries like Portugal and Italy, the FEIE may be preferable for reducing U.S. tax liability. Consulting with a tax professional experienced in expatriate taxation is essential to maximize savings and avoid unexpected tax obligations.
Would you like a country-specific tax comparison or guidance on filing Forms 2555 (FEIE) or 1116 (FTC)?
Top Tax-Friendly Countries for U.S. Expatriates
- Panama
- Tax System: Operates on a territorial tax system, meaning only income earned within Panama is taxed. Foreign-sourced income is not subject to Panamanian taxes.
- Benefits: This system allows U.S. expats to potentially exclude foreign-earned income from Panamanian taxation, making it easier to manage U.S. tax obligations.
- Considerations: Utilizing the FEIE can be advantageous for income earned within Panama, while the FTC may apply to any Panamanian taxes paid.
- Portugal
- Tax System: Offers the Non-Habitual Resident (NHR) program, providing tax exemptions or reduced tax rates on certain foreign income for the first 10 years of residence.
- Benefits: Under NHR, qualifying foreign income, such as pensions and dividends, may be exempt from Portuguese taxation.
- Considerations: The FEIE can exclude up to $126,500 (for 2024) of foreign-earned income from U.S. taxation. However, since Portugal’s NHR program may exempt certain foreign income from Portuguese tax, the FTC might not be applicable for that income.
- Malaysia
- Tax System: Employs a territorial tax system, taxing only income sourced within Malaysia. Foreign-sourced income is generally not taxed, though recent policies may affect this exemption.
- Benefits: U.S. expats can potentially exclude foreign-earned income from Malaysian taxation, simplifying U.S. tax obligations.
- Considerations: The FEIE can be beneficial for income earned within Malaysia, while the FTC may apply to any Malaysian taxes paid.
- United Arab Emirates (UAE)
- Tax System: The UAE has no personal income tax, making it highly attractive for expatriates.
- Benefits: Earnings are not taxed locally, allowing U.S. expats to utilize the FEIE to exclude foreign-earned income from U.S. taxation.
- Considerations: Since there’s no local income tax, the FTC is generally not applicable.
- Costa Rica
- Tax System: Operates on a territorial tax system, taxing only income earned within Costa Rica. Foreign-sourced income is not subject to local taxes.
- Benefits: U.S. expats can exclude foreign-earned income from Costa Rican taxation, facilitating U.S. tax planning.
- Considerations: The FEIE can be advantageous for income earned within Costa Rica, while the FTC may apply to any Costa Rican taxes paid.
- Italy
- Tax System: Italy taxes residents on their worldwide income but offers special tax regimes for new residents, such as the Flat Tax Regime, allowing qualifying individuals to pay a flat tax on foreign income.
- Benefits: The flat tax can simplify tax obligations and potentially reduce overall tax liability.
- Considerations: The FEIE can exclude up to $126,500 (for 2024) of foreign-earned income from U.S. taxation. For income exceeding this limit, the FTC can be used to offset U.S. taxes with Italian taxes paid, avoiding double taxation.
- Greece
- Tax System: Greece offers the Non-Domicile (Non-Dom) regime, providing a flat tax on foreign income for qualifying individuals.
- Benefits: The Non-Dom regime can reduce tax liability on foreign income, making it attractive for retirees and high-net-worth individuals.
- Considerations: The FEIE can exclude foreign-earned income from U.S. taxation, and the FTC can offset U.S. taxes with Greek taxes paid on income exceeding the FEIE limit.
Western European Tax Basics
When considering the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC), the optimal choice for U.S. expatriates often depends on the tax policies of their host country. Here’s a country-specific comparison for select Western European nations:
1. United Kingdom (UK)
- Tax System: The UK imposes progressive income tax rates up to 45%.
- Recommendation: Given the UK’s higher tax rates compared to the U.S., utilizing the FTC is generally more beneficial. This allows U.S. expats to offset their U.S. tax liability with the taxes paid to the UK, often reducing the U.S. tax owed to zero.
- Note: The U.S.-UK tax treaty further helps prevent double taxation.
2. France
- Tax System: France has progressive tax rates reaching up to 45%.WSJ
- Recommendation: Similar to the UK, the FTC is typically more advantageous due to France’s higher tax rates. By claiming the FTC, U.S. expats can offset their U.S. taxes with French taxes paid.Bright!Tax Expat Tax Services
- Note: The U.S.-France tax treaty provides additional mechanisms to avoid double taxation.
3. Germany
- Tax System: Germany’s income tax rates are progressive, with top rates around 45%.
- Recommendation: The FTC is usually preferable for U.S. expats in Germany, as the higher German taxes can offset U.S. tax liabilities.
- Note: The U.S.-Germany tax treaty aids in mitigating double taxation.
4. Spain
- Tax System: Spain imposes progressive income tax rates up to 47%.
- Recommendation: Given Spain’s high tax rates, the FTC is generally more beneficial for U.S. expats, allowing them to credit Spanish taxes paid against their U.S. tax liability.
- Note: The U.S.-Spain tax treaty offers provisions to prevent double taxation.
5. Italy
- Tax System: Italy has progressive tax rates up to 43%.
- Recommendation: The FTC is typically more advantageous due to Italy’s higher tax rates. U.S. expats can offset their U.S. taxes with Italian taxes paid.
- Note: The U.S.-Italy tax treaty helps prevent double taxation.
6. Portugal
- Tax System: Portugal offers the Non-Habitual Resident (NHR) program, which provides tax exemptions or reduced rates on certain foreign income for the first 10 years of residence.
- Recommendation: Under the NHR program, if specific foreign income is exempt from Portuguese taxation, the FEIE may be beneficial to exclude up to $126,500 (for 2024) of foreign-earned income from U.S. taxation. For income exceeding this limit or not covered by the FEIE, the FTC can be applied to offset U.S. taxes with Portuguese taxes paid.
- Note: The U.S.-Portugal tax treaty provides mechanisms to avoid double taxation.
Key Considerations
- High-Tax Countries: In nations with higher income tax rates than the U.S., such as the UK, France, Germany, Spain, and Italy, the FTC is generally more beneficial. This is because the foreign taxes paid can fully offset U.S. tax liabilities, often resulting in no additional U.S. taxes owed.
- Special Tax Regimes: Countries like Portugal, with programs like the NHR, may offer tax exemptions on certain foreign income. In such cases, the FEIE can be advantageous for excluding foreign-earned income from U.S. taxation.
- Tax Treaties: Many Western European countries have tax treaties with the U.S. that provide additional mechanisms to prevent double taxation.
