18 May 2023 · Bureaucracy Without Pain · USA
Foreign Earned Income Exclusion vs. Foreign Tax Credit
Bureaucracy Without Pain—A Tax-Geek-Friendly Playbook
“Taxes are what we pay for civilized society—
but let’s not tip while we’re at it.”
—A CPA who has seen too many Form 2555 errors
Living abroad used to mean smuggling back exotic snacks and a few blurry postcard selfies. Now it means exporting your entire income stream across borders—and the IRS still wants a proper hello.
Two tools let U.S. taxpayers avoid getting taxed twice on salary, consulting fees, or that blockchain start-up equity you’re still praying will vest:
- The Foreign Earned Income Exclusion (FEIE)—Form 2555’s starring role.
- The Foreign Tax Credit (FTC)—Form 1116’s humble but generous cousin.
Both reduce your U.S. tax bill, but they work differently and rarely get equal screen time. As a practicing U.S. CPA who files these forms for everyone from gap-year English teachers to globe-trotting CTOs, I’m laying out the no-pain path: when FEIE rules, when FTC wins, and how power users combine the two without sending smoke signals to the audit department.
FEIE basics
What exactly is being excluded?
The FEIE knocks up to $120,000 of foreign earned income off your U.S. taxable base for 2023 (indexed annually—thank you, inflation). “Earned” means wages, freelance invoices, and active partnership draws—not dividends, capital gains, or crypto staking rewards. Those need different magic; see our guide on avoiding double taxation on investment income.
Qualifying tests—bonafide vs. physical presence
To exclude income you must pass one of two smell tests:
| Test | Time requirement | Good for… |
|---|---|---|
| Bona Fide Residence | Full calendar year as a tax resident of another country | Teachers, local hires, Green-card holders abroad |
| Physical Presence | 330 full days outside the U.S. in any 12-month period | Digital nomads, perpetual travelers, yacht crew |
Fail the day counts and the FEIE disappears faster than your hostel Wi-Fi. BorderPilot’s residency tracker inside every relocation plan pings you before the clock strikes 330.
The housing exclusion—often skipped, rarely useless
If your rent and utilities abroad exceed roughly 16% of FEIE (about $19,200 for 2023), claim the foreign housing exclusion/deduction. High-rent cities—Singapore, Zurich, basically anywhere with an Apple store—often unlock an extra ~$15–50k of tax-free income.
Common myths (and mild reality checks)
• “I can exclude my entire six-figure salary.”
– Only up to the annual cap; earnings above it go to regular U.S. tax rules.
• “Once I qualify, I’m done forever.”
– You elect FEIE annually and can revoke it. Miss the election and welcome back, tax bill.
• “The exclusion covers dividends.”
– Nope. Only earned income. The IRS dictionary is cruelly literal.
When the Foreign Tax Credit is better
FEIE is Instagram-photo friendly, but sometimes the FTC is the adult in the room.
High-tax countries = high-value credits
If you’re earning $200k in Denmark, your Danish tax could exceed what the U.S. would have charged on that same income. By taking a dollar-for-dollar credit, you wipe your U.S. liability clean and preserve U.S. tax attributes like future retirement contribution limits.
Example:
• Danish tax on $200k salary: $80k
• Hypothetical U.S. tax on same: $45k
• FTC eliminates the smaller of the two—your entire U.S. bill—without wasting $35k of Danish tax paid.
FEIE in this scenario would exclude only $120k of salary, leaving $80k still taxable in the U.S.—ouch.
Retirement and child-tax benefits
FEIE reduces your adjusted gross income (AGI), which sounds great until you faze out of:
• Roth IRA eligibility
• Child Tax Credit refunds
• Premium tax credits for ACA health plans (for those maintaining U.S. coverage)
FTC keeps AGI high enough for those calculations, sometimes yielding a bigger cash benefit than FEIE’s lower tax line.
State tax cliffhangers
Moving abroad doesn’t always break your bond with, say, California. FEIE is a federal concept; the Golden State yawns and taxes your worldwide income anyway. In that case, an FTC for foreign taxes won’t help either, but claiming FEIE could reduce federal tax while you still owe state tax on the excluded amount. Result: two taxes, no credit. For expats who can’t shake state residency, FTC may sync better with federal liability and leave fewer untaxed gaps for the state to exploit.
Combining both legally (yes, really)
The IRS lets you use FEIE on the first $120k and FTC on the rest of your foreign earned income—or on categories like investment income that FEIE ignores. Think of it as a tax parfait: exclusion layer first, credit sprinkles on top.
The ordering rules—Form 1116 gets jealous
- Complete Form 2555 and slide the exclusion onto Schedule 1, line 8.
- Calculate U.S. tax on remaining foreign income and any U.S.-source income.
- Claim FTC on Form 1116 for foreign taxes associated with the taxable slice.
The math can be serpentine because the FTC limitation ratio uses foreign taxable income / worldwide taxable income. When FEIE lowers the numerator, you might hostage some credit for future years. BorderPilot’s tax engine crunches up to 10 carryover scenarios so you don’t have to LBO your brain.
Trap alert: the Re-sourcing rule (Code §904(h))
If you FEIE part of your income, the U.S. re-sources a proportionate chunk of taxes you paid abroad to U.S.-source for FTC purposes. Translation: you could lose credit on exactly the slice you hoped to apply. Proper allocation of wages and employer withholding is critical; otherwise, IRS computer love letters follow.
Case studies for remote workers
Names changed, caffeine intact.
1. Sofia—UX designer in Portugal
• Income: $90,000 remote salary from a Delaware C-Corp
• Portuguese tax: ~20% after NHR regime incentives
• Days in U.S.: 21 (wedding + Thanksgiving)
Sofia’s Portuguese tax ($18k) roughly equals her hypothetical U.S. tax. She passes the physical-presence test. By excluding her entire salary with FEIE, she eliminates U.S. tax and still has enough Portuguese tax paid to offset her U.S. tax on dividends using FTC carryovers. Result: $0 federal, $0 double taxation, Roth IRA still possible because AGI under limit.
2. Brandon—DevOps engineer in Germany
• Income: $220,000 plus €10k bonus
• German tax withheld: €90k
• Married, filing jointly; spouse has no income
If Brandon used only FEIE, $100k of salary would be fully taxable in the U.S. at ~24% effective rate—call it $24k. Instead, he elects no FEIE, claims full FTC: $90k credit offsets his $55k U.S. tax completely. Extra €35k of unused credit carries forward ten years. Their AGI stays high enough for $4,000 of refundable child tax credit. Verdict: FTC wins.
3. Maya—independent consultant hopping Asia
• 2023 calendar: 4 months Thailand, 4 months Japan, 4 months U.S. touring clients
• Income: $160,000 1099
• Foreign tax paid: ¥1.5m in Japan (~$11k), $0 in Thailand
Maya doesn’t hit 330 full days abroad because of U.S. trips. She fails FEIE physical-presence and lacks bona-fide residence. FTC helps on the $11k Japanese tax but leaves much of her income exposed. She could elect FEIE next year by scheduling around the 330-day rule—BorderPilot’s date simulator shows she needs to trim her 2024 U.S. visit to 30 days max.
4. The Al-Sayed family—engineer in Dubai
• Salary: $180,000 tax-free in UAE
• U.S. presence: 15 vacation days
• Three children
Zero foreign tax means FTC is useless. FEIE nixes $120k; the remaining $60k is taxed in the U.S. at ~12% after standard deduction. Housing exclusion adds another $35k shield due to Dubai rent. Net U.S. tax: roughly $2,000 after child credit. For them, FEIE is the only game in town, and living in a no-tax country doesn’t mean zero IRS liability—but it gets close.
Common filing mistakes (and how to dodge them)
-
Starting FEIE mid-year but forgetting to prorate
– The exclusion cap scales with qualifying days. Miss this and IRS CP2000 notices will fill your inbox. -
Overlooking self-employment tax
– FEIE waives income tax, not Social Security/Medicare. Consider forming a foreign corporation or electing the Totalization Agreement route where available. -
Ignoring Form 1116 category splits (General vs. Passive)
– Mixing wages with dividend income hobbles credit usage. -
Not filing because “I owe nothing”
– If you skip Form 2555/1116 entirely, the statute never starts. The IRS gets an infinite window to audit—and they keep receipts. -
Missing foreign asset reports
– FEIE/FTC doesn’t exempt FBAR or Form 8938. Revisit our crash course on understanding foreign asset reporting requirements to keep penalties at bay.
The BorderPilot edge—zero-cringe bureaucracy
I’m good with spreadsheets, but I’d still rather watch them auto-populate. BorderPilot ingests your pay stubs, visa dates, and housing invoices, then:
• Projects your FEIE limit and calculates the optimal FTC mix.
• Tracks 330-day thresholds with iCal sync (“Don’t fly to Miami tomorrow, you’ll lose $10,450 in exclusion—cheers!”).
• Simulates state-residency break tests so California doesn’t crash your party.
• Spits out a relocation checklist linking local accountants, visa runners, and—they swear—real-life coffee shops with Wi-Fi strong enough for your next Zoom deposition.
All inside a free relocation plan that takes less time than ordering airport coffee.
Final thoughts & next steps
FEIE and FTC are not rival superheroes—they’re a dynamic duo. The trick is pairing them to your income mix, tax rates, and travel calendar, then documenting everything so the IRS sees tidy compliance instead of cryptic nomadism.
Ready to stop guessing and start optimizing? Build your free relocation plan with BorderPilot today and let the platform sweat the forms while you scout your next timezone. The only thing we can’t exclude is your sense of adventure.
Disclaimer: This article is for educational purposes, penned by a CPA, but does not create a client-advisor relationship. Tax situations are as unique as hotel Wi-Fi passwords—consult a professional before acting.