Expat Taxes Made Easy: FEIE vs Foreign Tax Credit Explained
Living abroad as an American can be exciting but when it comes to taxes, things can get confusing fast. Even if you’re earning money in another country, the IRS still expects you to file a U.S. tax return. The good news? There are tools that can help you avoid being taxed twice.
In this article, we’ll break down two of the most important ones: the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC). We’ll also go through the forms that go with them Form 2555 and Form 1116 and help you understand how they work and when to use each. Let’s make sense of your expat tax options in layman language.
Form 2555: Foreign Earned Income Exclusion
If you are a US citizen or resident living and working in another country, you may be able to exclude some of your foreign income from US taxes using Form 2555. This tax break is called the Foreign Earned Income Exclusion.
For tax year 2024, the maximum exclusion is $126,500 per person. If two individuals are married, and both work abroad and meet either the bona fide residence test or the physical presence test, each one can choose the foreign earned income exclusion. Together, they can exclude as much as $253,000 for the 2024 tax year.
Who Can Use Form 2555?
To qualify for the exclusion, you must meet two main rules:
1. Your Tax Home Must Be in a Foreign Country
Your “tax home” is generally where you live and work most of the time. It must be outside the U.S.
2. You Must Meet One of These Residency Tests:
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Physical Presence Test:
You must be physically present in a foreign country (or countries) for at least 330 full days during any 12-month period.
Short visits to the U.S. usually don’t disqualify you, as long as you meet the 330 full-day rule.
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Bona Fide Residence Test:
You must be a bona fide resident of a foreign country for an uninterrupted period that includes a full calendar year.
This means you have truly settled there, and your stay shows you intend to live there long-term.
What Income can be excluded with Form 2555?
You can exclude income you earned by working in a foreign country. In other words, if you go to work, do a job, and get paid, and that work was done outside the US, it likely qualifies.
Example: - Salary/wages/freelance income earned while living and working abroad.
What income cannot be Excluded with Form 2555?
You cannot exclude money you did not earn from working, or money tied to the US. The thumb rule is if the income is passive or form the US government, it is not excluded.
Example: - Interest form a bank account/ Dividends from stocks/ Rental Income/ US Government pay/ Income you earned while physically in the US.
Form 1116 – Foreign Tax Credit
If you are an American who earned income from another country and paid taxes on it, you might be able to get a credit on your US taxes using Form 1116. This credit helps you avoid being taxed twice on the same income once by the foreign country and again by the IRS.
This form is typically used by individuals, estates and trusts to claim a credit for foreign taxes paid on foreign-source income.
When Do You Use Form 1116?
You may need to file Form 1116 if:
- You paid or owed foreign income taxes (like on wages, interest, or dividends).
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You received foreign income reported on:
- Form 1099-DIV (dividends),
- Form 1099-INT (interest),
- or Schedule K-1 (partnerships, S corps, trusts).
- You are a U.S. citizen, green card holder, or a U.S. trust/estate with income from abroad.
- You want to claim a tax credit (which reduces your tax bill), instead of a deduction (which just lowers your taxable income on Schedule A).
It calculates how much of the foreign taxes you paid can be credited against your U.S. tax liability, based on the formula:
(Foreign-Source Taxable Income ÷ Total Taxable Income) × U.S. Tax
The IRS only gives you credit for the part of the foreign tax that applies to income also taxed by the US. This limits your credit to the portion of your US tax that applies to foreign income – so you don’t get a bigger credit than what you actually owe on that income.
When You Don’t Need to File Form 1116
You might be able to skip Form 1116 and just claim the credit directly on your Form 1040, if all of the following are true:
1.Have foreign taxes are $300 or less (or $600 or less if married filing jointly).
2.Only have passive income (like interest or dividends), and it’s not from a country with low taxes.
3.The foreign income and taxes are reported on standard IRS forms, such as:
- Form 1099-DIV (dividends)
- Form 1099-INT (interest)
- Schedule K-1 (partnerships, trusts, etc.)
4.Not be carrying over or carrying back any foreign tax credits from other years i.e you are only using credits from this current tax year.
FYI:
Unlike Form 1116, which is used by individuals, estates, and trusts, Form 1118 is designed specifically for corporate taxpayers. It allows companies to reduce their U.S. tax liability by applying a credit for foreign taxes paid, helping avoid double taxation.
Form 2555 vs Form 1116
How Braj Aggarwal CPA, P.C could assist?
Filling US taxes while living abroad can be complex, but a CPA firm experienced in expat tax matters can simplify the process and help you choose the best option available between the Foreign Earned Income Exclusion (Form 2555) and the Foreign Tax Credit (Form 1116).
We as a Licensed CPA will ensure full compliance with IRS rules, accurately complete forms, and optimize your tax savings sometimes even combining both benefits where allowed. We at Braj Aggarwal CPA, P.C can also manage carryovers, handle multi country income, and give you personalized advice to avoid double taxation and reduce your overall US tax burden. Let’s make us your success partner today.
