FEIE vs. Foreign Tax Credit (FTC): A Practical Guide for U.S. Expats

Introduction - Why FEIE vs. FTC Matters for U.S. Citizens Living Abroad

U.S. citizens living overseas remain subject to U.S. taxation on worldwide income. Although foreign income may be taxed in another jurisdiction, the United States requires U.S. citizens and residents to file an annual U.S. tax return regardless of where they live. Two of the most commonly used mechanisms for reporting and mitigating double taxation under U.S. law are:

• the Foreign Earned Income Exclusion (FEIE)
• the Foreign Tax Credit (FTC)

Understanding the differences between FEIE and FTC is important for expats because the choice can affect:

• whether income is eligible for Roth or Traditional IRA contributions,
• how investment income is treated,
• whether self-employment taxes may apply,
• the long-term impact on retirement savings,
• eligibility for certain deductions and credits,
• potential outcomes when moving between countries,
• planning for future U.S. residency or repatriation.

This guide provides a neutral, factual overview of FEIE and FTC, how they differ, and which factors individuals commonly evaluate when deciding how to report income while living abroad. It is not tax advice and does not take into account individual circumstances. Tax outcomes vary significantly based on jurisdiction, treaty position, and personal situation.

Section 1 - Overview of U.S. Taxation for Citizens Living Abroad

U.S. citizens and U.S. tax residents must:

• file annual U.S. tax returns,
• report worldwide income,
• comply with FATCA and FBAR reporting,
• follow U.S. rules for investment taxation,
• continue U.S. retirement account rules (401(k), IRA, Roth IRA).

Living abroad does not eliminate U.S. tax obligations.

Many individuals rely on FEIE, FTC, or a combination of the two to adjust how foreign income is treated under U.S. law.

Section 2 - What Is the Foreign Earned Income Exclusion (FEIE)?

FEIE allows qualifying individuals to exclude a certain amount of foreign earned income from U.S. taxation, provided they meet the eligibility requirements.

Key characteristics of FEIE:

FEIE excludes earned income only

This includes:

• wages,
• salaries,
• self-employment income (with limitations).

It does not apply to:

• dividends
• interest
• capital gains
• rental income
• pensions
• investment income
• passive income

Requires meeting one of the two tests:

1. Physical Presence Test
2. Bona Fide Residence Test

FEIE reduces U.S. taxable income

Excluded income does not appear as taxable income on the U.S. return.

FEIE does not eliminate:

• self-employment taxes (for self-employed individuals),
• U.S. capital gains tax,
• tax on passive income,
• state-level obligations (in certain cases).

FEIE may affect eligibility for:

• Roth IRA contributions
• Traditional IRA deductions
• Certain tax credits
• Child Tax Credit calculations

Because FEIE reduces taxable income, it can influence whether an individual qualifies for Roth contributions.

Section 3 - What Is the Foreign Tax Credit (FTC)?

FTC allows individuals to claim a credit for foreign taxes paid on income that is also subject to U.S. tax.

Key characteristics of FTC:

Reduces U.S. tax liability based on foreign tax paid

If foreign tax is equal to or higher than U.S. tax on the same income, FTC may reduce or eliminate U.S. income tax.

Applies to more types of income than FEIE

FTC can apply to:

• earned income,
• investment income,
• passive income,
• interest,
• dividends,
• capital gains.

FTC can be carried forward or backward

Unused FTC may be available to offset tax in different years, depending on IRS rules.

FTC requires documentation

Individuals must submit Form 1116 and maintain proof of foreign tax paid.

FTC may be preferable in high-tax jurisdictions

When foreign tax rates exceed U.S. tax rates, FTC may eliminate U.S. tax liability.

Section 4 - Major Differences Between FEIE and FTC

Below is a neutral comparison for educational purposes.

Neither option is inherently “better.” Suitability depends on individual tax position, residence, and long-term plans.

Section 5 - How FEIE Affects Investment and Retirement Planning

Because FEIE excludes earned income from U.S. taxable income, it can influence an individual’s ability to:

• make Roth IRA contributions,
• make Traditional IRA contributions (depending on income and filing status),
• qualify for certain tax credits and deductions.

FEIE-excluded income does not count as eligible compensation for IRA contributions

This is a key point for Americans abroad.

Example (hypothetical only):

If an individual excludes all earned income using FEIE, they may not have U.S.-taxable earned income to support contributions to a Roth IRA or a Traditional IRA.

FEIE does not prevent IRA rollovers or conversions

Conversions follow different rules.

FEIE may affect Social Security taxation

Treatment varies based on income and location.

FEIE-excluded income does not count as eligible compensation for IRA contributions.

Example (hypothetical):
If an individual excludes all earned income using FEIE, they may not have U.S.-taxable earned income to support IRA contributions.

FEIE does not prevent IRA rollovers or conversions. FEIE may also affect Social Security taxation depending on location.

Section 6 - How FTC Affects Investment and Retirement Planning

FTC does not exclude income.

Instead, it provides a credit for foreign tax paid.

This means:

• income remains part of U.S. taxable income,
• but U.S. tax liability may be reduced,
• and individuals may preserve Roth IRA eligibility (depending on circumstances),
• investment income may be eligible for FTC,
• foreign withholding on dividends may contribute to FTC calculations.

FTC may be relevant for individuals living in:

• the UK
• France
• Germany
• Spain
• Canada
• Australia
• Singapore (for certain income types)

These countries often impose taxes that may be creditable.

Section 7 - Situations Where FEIE May Be Considered

FEIE may be evaluated by individuals who:

• live in low- or no-tax jurisdictions (e.g., UAE, Qatar, Bahrain)
• have foreign employment income
• meet the physical presence or bona fide residence test
• want to simplify annual tax filings

However, suitability depends on whether:

• they wish to make Roth IRA contributions,
• they have significant passive income,
• they expect income to fluctuate,
• they plan future moves to high-tax jurisdictions.

Section 8 - Situations Where FTC May Be Considered

FTC may be evaluated by individuals who:

• live in higher-tax jurisdictions,
• pay foreign tax rates that equal or exceed U.S. tax,
• have income beyond wages (dividends, interest, gains),
• expect to repatriate to the United States,
• hold foreign investments generating local tax,
• receive foreign pension income,
• want to preserve Roth contribution eligibility.

FTC may help avoid double taxation in many treaty countries.

Section 9 - Interaction With Country of Residence

Local rules vary significantly.

Countries with high tax rates

France, Spain, Germany, Denmark

• FTC may be more relevant
• FEIE may eliminate eligibility to use FTC on passive income

Countries with moderate tax rates

Switzerland, Malaysia

• either approach may apply depending on income type

Countries with low/no income tax

UAE, Qatar, Saudi Arabia

• FEIE may be common
• FTC may be limited due to low foreign tax paid

Countries with participation exemptions

Hong Kong, Singapore

• FEIE may remain relevant depending on income structure

Local tax advice is generally essential.

Section 10 - FEIE vs. FTC Decision Factors

Their country’s tax rate

High-tax jurisdictions → FTC

Low-tax jurisdictions → FEIE

Earned income vs. investment income

FEIE covers only earned income

FTC covers both

IRA contribution eligibility

FEIE may reduce eligibility

FTC may preserve it

Future relocation plans

Returning to the U.S. may favour one approach over the other

Access to employer-provided pensions

Certain pensions may be taxed differently locally

Whether self-employment taxes apply

FEIE does not eliminate self-employment tax

FTC may integrate differently depending on income type

Impact on global retirement planning

Especially when coordinating 401(k), IRA, Roth IRA strategies

Section 11 - Hypothetical Case Studies (Illustrative Only)

Case Study 1 - U.S. Citizen in the UAE

Profile:

• Earns foreign salary
• Lives in country with no income tax
• No foreign investment income

Considerations:

• FEIE may reduce U.S. taxable income
• Roth contributions may not be possible if income excluded
• FTC may be limited because foreign tax is low

Case Study 2 - Living in France

Profile:

• Pays foreign tax on wages and investment income
• Long-term plan to retire abroad

Considerations:

• FTC may help reduce U.S. tax liability
• Investment income may be eligible for FTC
• FEIE may reduce ability to claim FTC on other income

Case Study 3 - Self-Employed Individual in Asia

Profile:

• Consulting income
• Foreign tax rate depends on country
• Uses FEIE

Considerations:

• self-employment tax applies regardless of FEIE
• Roth contribution eligibility depends on U.S.-taxable income
• FTC may apply if income becomes taxable locally

Case Study 4 - Globally Mobile Household

Profile:

• Moves between treaty and non-treaty countries
• Income varies year to year

Considerations:

• FEIE may apply some years
• FTC may be appropriate in high-tax years
• Multi-year consistency may be important for planning

Section 12 - Combining FEIE and FTC

FEIE and FTC cannot be applied to the same income. However, individuals may use:

• FEIE for earned income
• FTC for certain unearned income

This requires careful coordination, and suitability depends on:

• income categories
• foreign tax rules
• long-term planning
• treaty benefits

Section 13 - Impact on Investment Accounts and PFIC Considerations

FEIE and FTC do not directly change PFIC rules. However, they may influence:

• cash flow for tax payments,
• Roth contribution eligibility,
• long-term planning for global portfolios,
• U.S.-domiciled versus foreign-domiciled investment choices.

Individuals often evaluate FEIE/FTC decisions together with:

• cross-border investment strategy,
• long-term residency plans,
• currency exposure,
• PFIC considerations.

Section 14 - Impact on Roth Conversions

Roth conversions generate U.S.-taxable income:

• FEIE does not apply to conversions,
• FTC may apply in certain jurisdictions depending on local taxation,
• timing conversions around low-income years may be a factor.

This is a tax-sensitive area and depends heavily on:

• the individual’s country of residence,
• anticipated moves,
• long-term retirement planning.

Section 15 - Checklist for Evaluating FEIE vs FTC

Skybound USA assists individuals with:educational guidance on FEIE vs FTC

• educational guidance on FEIE vs FTC considerations,
• coordination with tax professionals when needed,
• cross-border investment planning,
• evaluating how FEIE/FTC decisions influence IRAs and Roth IRAs,
• planning for relocation or long-term residency abroad,
• PFIC-aware investment structuring,
• multi-currency and global planning through MoneyMap.

Conflict Disclosure:
As disclosed in our Form ADV, Skybound USA may receive compensation when individuals choose advisory services involving assets under management. Individuals should consider all available options before making decisions.

Next Steps

If you wish to review how FEIE or FTC considerations may relate to your long-term financial planning as a U.S. citizen abroad, you may schedule a discussion with Skybound Wealth Management USA to review your situation.