For Americans living and working abroad, minimizing U.S. taxes on foreign income can be complicated. The Internal Revenue Service (IRS) offers two primary mechanisms to reduce double taxation: the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (Foreign Tax Credit, FTC). Both tools can significantly reduce your U.S. tax liability, but they work in different ways and apply to different types of income. Understanding the distinction is critical for expats preparing their 2026 tax returns.
What Is the Foreign Earned Income Exclusion (FEIE)?
The FEIE allows qualifying U.S. citizens and residents to exclude a portion of their foreign-earned income from U.S. taxation. For 2025/2026, the maximum exclusion is approximately $135,000 per taxpayer.
Eligibility
To claim the FEIE, you must meet one of the following tests:
- Physical Presence Test:You were physically present in a foreign country (or countries) for at least 330 full days during any 12-month period.
- Bona Fide Residence Test:You establish bona fide residence in a foreign country for an uninterrupted period that includes an entire tax year.
What Income Qualifies
- Salary, wages, or professional fees earned abroad
- Self-employment income generated overseas
Important: Investment income, capital gains, rental income, and pensions do not qualify for FEIE.
What Is the Foreign Tax Credit (FTC)?
The FTC allows U.S. taxpayers to offset U.S. income taxes with taxes paid to a foreign government on foreign-sourced income. Unlike FEIE, the FTC applies to all types of income, including wages, dividends, interest, and capital gains.
How It Works
- Calculate the amount of foreign income tax paidduring the year.
- Use IRS Form 1116to claim a credit against your U.S. tax liability.
- Any excess foreign tax can sometimes be carried back one year or forward ten years.
What Income Qualifies
- Foreign-earned salary and wages
- Dividends and interest
- Capital gains on foreign investments
- Foreign-sourced business income
Key Advantage: FTC allows you to claim credit for taxes paid on income types that FEIE cannot exclude.
FEIE vs. FTC: Side-by-Side Comparison
| Feature | FEIE | Foreign Tax Credit |
| Type of Relief | Exclusion of income from U.S. tax | Credit against U.S. tax owed |
| Income Types Covered | Foreign earned income only | Wages, interest, dividends, capital gains, business income |
| Limit | Approx. $135,000 (2025/2026) per person | No set limit; capped at U.S. tax attributable to foreign income |
| Eligibility Test | Physical Presence or Bona Fide Residence | Must pay foreign tax on income reported |
| Interaction with Other Taxes | Can still claim standard deductions; limited to earned income | Works with all income types, may require foreign tax documentation |
| Carryover/Forward | Not applicable | Excess credits can be carried back 1 year or forward 10 years |
| Best For | Expats with moderate earned income and high foreign residency | Expats with high foreign taxes or multiple income streams |
Strategies for Using FEIE and FTC Together
For many U.S. expats, a combined strategy works best:
- Exclude foreign-earned income first with FEIE, reducing taxable income for wages earned abroad.
- Claim FTC on remaining income, including non-wage income such as dividends, interest, and capital gains.
- Review treaty benefitsfor your host country — sometimes a treaty can further reduce double taxation.
- Plan retirement contributions and housing deductionsstrategically, as these can interact with FEIE calculations.
Important: The IRS does not allow double-dipping — income excluded under FEIE cannot be used to claim FTC.
Which Should You Choose?
- Use FEIEif most of your income is earned abroad and foreign taxes are relatively low.
- Use FTCif you have significant foreign-sourced investment income or your foreign tax rate exceeds the U.S. rate.
- Many expats benefit from a hybrid approach, carefully applying FEIE to wages and FTC to all other foreign taxes.
Key Takeaways for 2026 Tax Filing
- Understand your income mix— earned vs. investment income determines which tool is most effective.
- Document foreign taxes paid— accurate records are crucial for FTC claims.
- Check eligibility for FEIE tests— physical presence or bona fide residence must be substantiated.
- Consider state tax implications— some U.S. states may still tax income excluded under FEIE.
- Plan ahead— proper timing and planning can maximize both exclusions and credits.
Conclusion
For U.S. expats, both the Foreign Earned Income Exclusion and Foreign Tax Credit are essential tools to reduce double taxation. Choosing the right method — or combining both — depends on your income sources, foreign tax rates, and personal circumstances.
By understanding the rules and planning strategically, expats can minimize U.S. tax liability, stay compliant, and make the most of their international earnings in 2026.
