US Citizens Abroad: Foreign Earned Income Exclusion vs Foreign Tax Credit, and When to Use Each

A US citizen living in another country owes US tax on worldwide income, regardless of where they live or where the income is earned. Two provisions prevent double taxation: the foreign earned income exclusion (FEIE) under IRC 911, which excludes up to $130,000 (2025, indexed) of foreign earned income from US tax, and the foreign tax credit (FTC) under IRC 901, which credits foreign taxes paid against the US tax liability. These are not equivalent choices. In many situations, one produces significantly better results than the other, and choosing wrong can cost thousands of dollars per year.

How does the FEIE work?

The FEIE under IRC 911 allows a qualified individual to exclude foreign earned income from US gross income. The maximum exclusion for 2025 is $130,000 (indexed annually for inflation). A separate housing exclusion (or deduction, for self-employed individuals) allows additional amounts for qualifying housing costs above a base amount.

Who qualifies: A US citizen or resident who has a “tax home” in a foreign country and meets either:

1. The bona fide residence test: the taxpayer is a bona fide resident of a foreign country for an uninterrupted period that includes an entire calendar year.
2. The physical presence test: the taxpayer is physically present in a foreign country for at least 330 full days during any 12-month period.

For a US citizen living in Canada full-time, the bona fide residence test is typically met. For someone who splits time between Canada and the US, the physical presence test (330 of 365 days outside the US) is harder to meet.

What income qualifies: Only earned income (wages, salary, self-employment income, professional fees). Investment income (dividends, interest, capital gains, rental income) does not qualify for the FEIE.

The stacking rule: The FEIE excludes income from taxable income, but the excluded income is treated as if it fills the lowest tax brackets first. This means any remaining taxable income (above the exclusion) is taxed at the rate that would apply if the excluded income were still included. A US citizen in Canada who earns $200,000 and excludes $130,000 pays US tax on the remaining $70,000, but at the marginal rate for $200,000 of income, not the rate for $70,000.

The credit limitation: A taxpayer who claims the FEIE cannot also claim a foreign tax credit for foreign taxes paid on the excluded income. The credit is available only for taxes paid on income that is not excluded. This is the key tradeoff: the FEIE reduces taxable income but forfeits the credit for taxes paid on that income.

How does the foreign tax credit work?

The FTC under IRC 901 credits foreign income taxes paid (or accrued) against the US tax liability. The credit is limited to the US tax attributable to foreign-source income (the “limitation” under IRC 904).

How the limitation works: The maximum FTC in any year is: (Foreign-source taxable income / Worldwide taxable income) x US tax

If all income is foreign-source (typical for a US citizen living abroad), the limitation equals the full US tax, and the FTC can offset the entire US liability.

Excess credits: If the foreign tax exceeds the FTC limitation (because the foreign tax rate is higher than the effective US rate), the excess can be carried back 1 year or carried forward 10 years.

Separate baskets: The FTC is calculated separately for different categories of income: general category (earned income, business income), passive category (investment income), and others. Credits from one basket cannot offset US tax on income in another basket.

No stacking rule: Unlike the FEIE, the FTC does not push remaining income into higher brackets. All income is included in taxable income, and the FTC offsets the US tax directly.

When is the FTC better than the FEIE?

For US citizens in high-tax countries (Canada, most of Europe, Australia, Japan), the FTC is almost always better. The reason: the foreign tax paid exceeds the US tax on the same income, so the FTC eliminates the US tax and generates excess credits. The FEIE would exclude the income but forfeit the credit, leaving no way to use the foreign taxes paid against US tax on other income.

When is the FEIE better than the FTC?

The FEIE is better in low-tax or no-tax countries where the foreign tax paid is less than the US tax on the same income:

• A US citizen in the UAE (no income tax) earns $120,000. With the FEIE, US tax on the excluded income is zero. Without the FEIE, the US taxes the full $120,000 with no foreign tax credit (because no foreign tax was paid). The FEIE saves the entire US tax bill.
• A US citizen in Singapore (top rate 22%) with $100,000 of earned income pays less foreign tax than the US would charge. The FEIE eliminates the US tax on the excluded income; the FTC would only partially offset the US tax.

The FEIE can also be useful in combination with the FTC for taxpayers with income above the exclusion amount in a low-tax country. The first $130,000 is excluded (FEIE), and the remaining income is offset by FTCs. But this combination requires careful planning because the FEIE forfeits FTCs on the excluded income, which may be more valuable if the taxpayer has other income categories.

Can you switch between FEIE and FTC?

Yes, but with a catch. A taxpayer who has claimed the FEIE and wants to switch to the FTC can do so by not claiming the FEIE on the current year’s return. But once the FEIE is revoked, the taxpayer cannot re-elect it for 5 years without IRS approval (IRC 911(e)).

This means the decision is somewhat sticky. A US citizen in Canada who has been claiming the FEIE and realizes the FTC would be better should switch, but should be aware that switching back (if circumstances change) requires waiting 5 years or getting IRS permission.

The reverse is less restricted: a taxpayer who has been claiming the FTC can elect the FEIE at any time by filing Form 2555 with their return.

What about the housing exclusion?

The FEIE includes a housing exclusion (for employees) or housing deduction (for self-employed individuals) under IRC 911(c). This allows the taxpayer to exclude qualifying housing costs (rent, utilities, insurance, but not mortgage interest or property taxes on an owned home) above a base amount (16% of the FEIE maximum, or approximately $20,800 for 2025).

The housing exclusion is subject to a location-based cap. High-cost cities (London, Hong Kong, Tokyo, Toronto) have higher caps than low-cost locations. The IRS publishes the caps in Notice 2025-XX (updated annually). For Toronto, the cap is typically in the $30,000 to $40,000 range.

The housing exclusion can add significant value to the FEIE for taxpayers in expensive cities, but it does not change the fundamental analysis: if the foreign tax rate exceeds the US rate, the FTC is still likely better.

What about self-employment tax?

The FEIE and FTC address income tax. Self-employment tax (Social Security and Medicare, 15.3% on net self-employment income) is a separate issue. The FEIE does not reduce self-employment tax. A US citizen in Canada who is self-employed pays US self-employment tax on their full self-employment income, regardless of the FEIE.

The US-Canada Totalization Agreement prevents double social security taxation. If the self-employed US citizen is covered by the Canada Pension Plan (CPP) and obtains a Certificate of Coverage from the Canada Revenue Agency, they are exempt from US self-employment tax and vice versa. Without the certificate, both countries may assert their social security tax claim.

For employees, the Totalization Agreement generally keeps the worker in the social security system of the country where they work. A US citizen employed in Canada by a Canadian employer is covered by CPP and exempt from US Social Security.

What about state taxes?

Some US states tax former residents on worldwide income even after they move abroad:

• California: may consider a US citizen who moved to Canada but maintained California ties (a house, investments managed by a California advisor) to be a California resident. California does not recognize the FEIE (it has its own, less generous exclusion).
• New York: similar to California in asserting residency claims on former residents.
• Virginia: taxes former residents on Virginia-source income.

States that do not impose income tax (Florida, Texas, Washington, Nevada) have no state-level issue. If a US citizen plans to move abroad, establishing residence in a no-income-tax state before departing can eliminate state tax entirely.

Related guides:

• Foreign Earned Income Exclusion for US Expats in Canada covers FEIE eligibility, the housing exclusion, and Form 2555 for US citizens living in Canada
• FEIE vs FTC (Form 2555 vs Form 1116) covers a side-by-side comparison with worked examples for the Canada context
• Foreign Tax Credit Limitation and Carryover covers the IRC 904 limitation, separate baskets, and how excess credits carry forward
• Form 1116: Foreign Tax Credit for Canadian Tax covers how to complete Form 1116 when claiming credits for Canadian taxes paid
• Self-Employment Tax for US Citizens in Canada covers the Totalization Agreement and how CPP contributions interact with FICA
• US Tax Filing Deadlines for Americans Abroad covers the automatic two-month extension, further extensions, and FBAR deadlines
• Renouncing US Citizenship: Exit Tax and Form 8854 covers the tax consequences if a US citizen abroad decides to expatriate

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.