FEIE vs Foreign Tax Credit: Which Works Best for US Expats?

If you’re a successful American living overseas or planning to become one, you already know that Uncle Sam doesn’t care how far you roam – as a US citizen, your global income is still on the IRS’s radar.

Fortunately, you’re not powerless. US expats have two powerful tools to legally reduce or even eliminate that tax bill: the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC). 

However, knowing how to use these options can be tricky: When do you use them? How do you use them? Can you use them both?

Making sense of FEIE and FCA is one of the most common pitfalls for Americans abroad, as structuring things isn’t always straightforward.

But, complex as they are, the two processes have one thing in common: building a tax-efficient life overseas.

Whether you’re earning tax-free income in Dubai or navigating the complexities of French law and bureaucracy in Paris, understanding how to leverage the FEIE or FTC can make a huge difference to your annual bottom line and your freedom.

To make understanding these two issues a little easier, the Nomad Capitalist team has put together a comprehensive guide on when and how to use them and demonstrates how building the right structure can dramatically improve your tax situation and your freedom.

Foreign Earned Income Exclusion vs Foreign Tax Credit

If you’re a US citizen living abroad, the Foreign Earned Income Exclusion and Foreign Tax Credit can help you avoid paying more tax than you need to. 

Both exist to stop the IRS from double-dipping on your income, but they work in very different ways.

The FEIE allows you to exclude a set amount of foreign-earned income from your US tax return (estimated to be US$130,000 for the 2025 tax year). If you qualify, that chunk of income is simply removed from your taxable income.

The FTC, on the other hand, gives you credit for taxes you’ve already paid to a foreign government. 

Think of it as a reimbursement. If you’ve paid tax abroad, Uncle Sam reduces your US bill accordingly. 

There’s no dollar cap, and it works for all types of income, including passive income like dividends, royalties and rental profits.

So, one excludes income from your return, while the other gives you a tax break after you’ve declared everything. 

Which is better? That depends on your income, where you live and how aggressive you want to be with your tax planning.

That’s the basic idea, but of course, each program includes plenty of details and technicalities. Let’s explore them in more detail.

What is the Foreign Tax Credit?

The Foreign Tax Credit is the IRS’s way of saying, ‘Fine, you paid tax to another country, so we’ll back off.’ 

It’s a dollar-for-dollar credit against your US tax bill for income taxes paid to a foreign country or government. No cap or exclusion, just credit for what you’ve already handed over.

You claim the Foreign Tax Credit on Form 1116; you need to track foreign tax payments, categorise your income correctly, deal with exchange rates and calculate your US tax liability before the credit kicks in.

This method is especially useful if you live in a country with high-income taxes, like Germany or France, where the taxes you pay abroad are likely to be higher than you’d owe in the US. In those cases, the credit could reduce your US tax bill down to zero.

When to Claim the Foreign Tax Credit

You use the FTC when you’re paying high taxes in your country of residence. 

If your effective tax rate abroad is the same or higher than your US tax rate, the FTC will usually cover your US liability completely. This is common if you’re earning a solid income in places like the UK, Australia and most of Western Europe.

The FTC is also the go-to strategy if your income exceeds the FEIE limit, if you earn passive income or if you’re aiming to claim the Additional Child Tax Credit (which FEIE disqualifies you from). 

It also lets you carry forward unused credits for up to ten years, which can help if your tax situation changes in future.

How to Calculate the Foreign Tax Credit

First, calculate how much tax you paid to a foreign government. You need proof of this, and you must convert it to US dollars using the proper exchange rate.

Next, calculate your US tax liability as if you didn’t have the FTC. Then, apply the credit to offset it.

You can’t use the credit on income that you already excluded under the FEIE. The IRS won’t let you double-dip.

You’ll also need to divide your income into categories (general, passive, etc.) and fill out Form 1116 for each. 

What is the Foreign Earned Income Exclusion?

The Foreign Earned Income Exclusion lets you remove a set amount of earned income from your US tax return. That’s income from work you perform abroad, including wages, salaries or self-employment income. 

It doesn’t apply to dividends or rental profits.

The cap is estimated to be US$130,000 in 2025. It rises slightly with inflation every year. 

You claim it by filing Form 2555 and choosing either the Bona Fide Residence Test or the Physical Presence Test. You can read our guide on how these tests work for details.

This is a good option if you live in a low-tax or no-tax country and you want to legally get your income out of the US tax system altogether.

Who Can Claim Foreign Earned Income Exclusion?

To claim the FEIE, you need to have earned income from working abroad. You also need to pass one of two tests:

• The Bona Fide Residence Test: This means you’ve established residency in another country for a full calendar year. That doesn’t mean being a tourist for 12 months. You need legal residency, ties to the country and a long-term plan.
• The Physical Presence Test: This test is simpler. Spend at least 330 full days outside the US in any rolling 12-month period, which is 330 full 24-hour days. Time spent in international waters or airports doesn’t count.

If you’re self-employed, the FEIE only covers federal income tax. You’ll still owe self-employment tax unless you’re covered by a totalisation agreement.

When to Use Foreign Earned Income Exclusion

Use the FEIE if you live in a low-tax or tax-free country, like the UAE or Singapore, or if you’re a digital nomad bouncing between jurisdictions. 

It’s also ideal if your income is below the exclusion threshold or you’re earning from active work, not passive investments.

This strategy keeps things simple. You exclude the income and move on. 

Just be aware that using the FEIE can disqualify you from claiming things like the refundable Additional Child Tax Credit or making IRA contributions.

Can You Use Both FEIE and Foreign Tax Credit?

Yes, but with a major caveat.

You can’t use both on the same income. That’s key. You either exclude the income using FEIE or you claim a credit on it using FTC. You don’t get to do both.

But if your income exceeds the FEIE cap, or if you have a mix of income types, you can use FEIE to exclude part of your earned income and then use FTC to offset US tax on the rest, including passive income.

How to Use FEIE and FTC Together

It’s not either-or. The best strategy often involves using both FEIE and FTC in the right proportions for the same return.

Start by using FEIE to exclude your earned income up to the maximum. This immediately removes that portion from your US tax return.

Then, apply the FTC to the rest, especially if you have foreign taxes paid on income not covered by FEIE, like rental income or investment gains, or on earned income above the FEIE limit.

Done right, you can end up with little or no US tax liability on six or even seven-figure sums of global income. But if you mess it up, the IRS will come knocking.

FTC vs FEIE: Which is Best for Expats?

There’s no one-size-fits-all answer. The best choice depends on where you live, how much you earn, what type of income you have and what your long-term strategy is.

If you’re in a high-tax country, the FTC is often better. You get full credit for taxes already paid, you don’t lose access to IRA contributions or child tax credits, and you’re not limited by a cap.

If you’re in a low-tax or no-tax country, FEIE is usually the way to go. You can exclude your income and walk away from the US tax system legally and cleanly, at least up to the annual limit.

Want to invest in an IRA or claim the refundable ACTC? You’ll need taxable income in the US, which FEIE removes. So, in that case, the FTC might serve you better, even if it means more paperwork.

The real strategy is knowing how to balance both – using FEIE where it makes sense and FTC where it gives you more long-term value. 

That’s what smart tax planning is all about.

Foreign Earned Income Exclusion vs Foreign Tax Credit: FAQs

Make the Most of Tax Tools as a US Expat

Choosing between the Foreign Earned Income Exclusion and the Foreign Tax Credit is about building a life where your wealth works for you, not against you. 

The right choice can mean the difference between keeping your hard-earned money and handing over more than necessary to the IRS. And in many cases, it’s not a matter of either/or – you can combine them strategically to maximise the benefits. 

But don’t underestimate the complexity. A misstep could cost you thousands or flag you for a tax audit. If you’re serious about living life on your own terms, you need more than just information – you need a strategy.

That’s where Nomad Capitalist comes in. 

We’ve helped 2,000+ high-net-worth individuals to ‘go where they’re treated best’, whether by moving their business offshore, relocating to a tax-friendly country or pursuing a second citizenship. 

Our clients are paired with experts in tax, investment strategy, asset protection and immigration to create and execute a holistic plan as unique as their goals. To learn more about how we can help you, get in touch today.