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Foreign Tax Credit vs FEIE: Which Saves You More Abroad

The Basics: US Tax Filing Obligations Abroad

As an Enrolled Agent working with US expats in Colombia and worldwide, the most common question I hear is: I live outside the US, do I still have to file US taxes? The answer is yes. US citizens and green card holders must file US tax returns no matter where they live. The United States taxes based on citizenship, not residency. This means that even if you have not set foot in the US for years, you still have a filing obligation if your income is above the filing threshold.

The good news is that the US tax code recognizes that you may also be taxed by the country where you live and work. To prevent double taxation, there are two primary tools available: the Foreign Earned Income Exclusion and the Foreign Tax Credit. Each works differently, each applies to different types of income, and choosing the right one can save you thousands of dollars per year.

The mistake I see most often is expats using the FEIE year after year without checking whether the Foreign Tax Credit would produce a better result. The choice depends on your country of residence, your income level, and the type of income you earn. As an Enrolled Agent, I run the math both ways for every expat client to make sure we are choosing the option that produces the lowest overall tax burden.

The Foreign Earned Income Exclusion (FEIE)

The Foreign Earned Income Exclusion is available through Form 2555. It allows you to exclude a portion of your earned income from US taxation. For the 2024 tax year, the exclusion amount is $126,000. For 2025, it increases to $130,000. This is an annual adjustment for inflation.

The key word here is "earned" income. Salary, wages, self-employment income, and bonuses all qualify. Passive income such as dividends, interest, capital gains, and rental income does not qualify for the FEIE. If you are a remote employee earning $80,000 working from Medellin, the FEIE can exclude all of that income from your US tax return. If you earn $150,000, the first $130,000 is excluded, and the remaining $20,000 is subject to US tax.

To qualify for the FEIE, you must meet one of two tests. The Bona Fide Residence Test requires that you are a bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year. The Physical Presence Test requires that you are physically present in a foreign country for at least 330 full days during any 12-month period. The Physical Presence Test is easier for people who move frequently or have not established formal residency abroad, while the Bona Fide Residence Test is better for those who have settled in one country.

The FEIE is the simplest and most common tool for expats. If you live in a country with no income tax or very low income tax, and your earned income is under the exclusion threshold, the FEIE is usually the right choice. It completely eliminates US tax on that income. The drawback is that it does not help with investment income, and if your income exceeds the threshold, you still owe US tax on the excess.

The Foreign Tax Credit (FTC)

The Foreign Tax Credit is available through Form 1116. Instead of excluding income from US taxation, it gives you a dollar-for-dollar credit for income taxes you paid to a foreign country. If you paid $10,000 in Colombian income tax, you can claim a $10,000 credit against your US tax liability. This credit applies to both earned and unearned income, which is a critical advantage over the FEIE.

The FTC is particularly powerful for expats living in high-tax countries. Colombia, for example, has income tax rates that can exceed 33 percent for higher earners. If your Colombian tax rate is higher than your US tax rate, the Foreign Tax Credit can eliminate your US tax liability entirely. The credit is capped at the amount of US tax that would apply to that income, so you cannot get a refund from the FTC, but you can reduce your US tax to zero.

One important distinction: the FTC applies to income taxes, not other types of taxes. Social security contributions, value-added taxes, and property taxes are not creditable. Only income tax paid to a foreign government qualifies. The credit is also calculated separately for different categories of income, which can make the form complex. As an Enrolled Agent, I routinely prepare Form 1116 for clients with income from multiple sources and countries, and the category allocation is where most errors happen.

The FTC also carries forward. If your foreign tax credit exceeds your US tax liability in a given year, you can carry the excess forward up to 10 years or carry it back 1 year. This means that if you overpay foreign tax one year, you can use the credit in a future year when your US tax liability is higher. The FEIE does not have this feature. Once you exclude income, it is gone from the US tax system entirely.

Which to Choose: The Math That Decides

The decision between FEIE and FTC comes down to arithmetic. If you live in a country with no income tax or a very low income tax, the FEIE is almost always better because you exclude the income and pay nothing to either country. If you live in a high-tax country like Colombia, the FTC is usually better because you credit the foreign taxes against your US liability, which often eliminates it entirely.

For expats with both earned and investment income, the optimal strategy is often to use both. You can claim the FEIE on your earned income and the FTC on your investment income in the same tax year. The one hard rule is that you cannot use both on the same dollar of income. If you exclude earned income with the FEIE, you cannot also claim a foreign tax credit on that same income. But the investment income that is not eligible for the FEIE is still eligible for the FTC.

There is one more consideration: the choice is not permanent, but switching is not free. If you claim the FEIE for a year and later decide the FTC would have been better, you can switch, but you may need IRS approval to revoke the FEIE election. This is why I recommend running the numbers both ways before filing. An Enrolled Agent can model both scenarios and show you the actual dollar difference. Getting this right is one of the highest-value decisions an expat can make, and it is worth doing carefully.

Frequently Asked Questions

Can I use the FEIE and the Foreign Tax Credit in the same year?

Yes, but not on the same income. You can use the FEIE for earned income and the FTC for investment income in the same tax year.

What happens if my foreign tax is higher than my US tax?

The Foreign Tax Credit is capped at the US tax amount on that income. Any excess can be carried forward up to 10 years for future use.

Do I need to file a US tax return if my income is below the FEIE threshold?

You may still need to file if your gross income exceeds the standard filing threshold for your filing status. The FEIE is claimed on the return, so you must file to claim it.

Which countries have high enough tax rates for the FTC to beat the FEIE?

Countries with income tax rates comparable to or higher than US rates include Colombia, most of Western Europe, Canada, Australia, and Japan. In lower-tax countries like Panama or Costa Rica for certain income types, the FEIE may be more advantageous.

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This article is general information, not individual tax advice. If you want to talk through your specific situation, book a free 15-minute review or call or text us directly.

 
 
 

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