The United States taxes its citizens and green card holders on their worldwide income, wherever they live. To stop the same income being taxed twice, the tax code offers two main tools: the foreign earned income exclusion (FEIE) and the foreign tax credit (FTC). Most Americans abroad use one, the other, or a mix of both.
The basic difference is simple. The FEIE removes up to $132,900 of foreign earned income from US tax for 2026. The FTC lets you subtract foreign income taxes you have paid from the US tax on the same income, with no dollar cap. Which one fits depends on how much tax your country of residence charges, what kind of income you have, and whether you have children, retirement savings or self-employment income.
This guide compares the two side by side, using IRS guidance as of October 2026.
Key takeaways
- The FEIE excludes up to $132,900 of foreign earned income for 2026 ($130,000 for 2025), plus a separate housing amount, if you meet the bona fide residence or physical presence test.
- The FTC gives a dollar-for-dollar credit for foreign income tax paid, limited to the US tax on that foreign income. Unused credits can be carried back 1 year and forward 10 years.
- In general, the FEIE tends to suit people in low-tax countries, and the FTC tends to suit people in high-tax countries.
- Choosing the FEIE blocks the additional child tax credit and IRA contributions based on the excluded pay, and it does not reduce self-employment tax.
- If you revoke the FEIE, you generally cannot claim it again for 5 tax years without IRS approval.
Why Americans abroad need relief at all
Almost every country taxes people who live there. The US is unusual in also taxing its citizens who live elsewhere, a system known as citizenship-based taxation. Our guide on citizenship-based taxation explains how rare that is.
The result is that an American in Lisbon, Dubai or Mexico City still files a US return every year, even if they pay all their tax locally. The FEIE and the FTC are the main mechanisms to avoid paying full tax twice. Neither removes the filing obligation, and neither affects other reporting duties such as FBAR and FATCA, covered in our guide to FBAR and FATCA.
How the foreign earned income exclusion works
The FEIE is claimed on Form 2555. To qualify, you need foreign earned income, a tax home in a foreign country, and one of two tests:
- Bona fide residence test: you are a bona fide resident of a foreign country for an uninterrupted period that includes a full tax year.
- Physical presence test: you are physically present in foreign countries for at least 330 full days during any 12-month period.
The exclusion limit is adjusted for inflation each year. The IRS set it at $132,900 for tax years beginning in 2026 in Revenue Procedure 2025-32. Married couples who both work abroad and both qualify can each exclude up to the limit.
Key limits on the FEIE, from the IRS foreign earned income exclusion page and Publication 54:
- Earned income only. Wages, salaries, professional fees and self-employment income for work done abroad qualify. Dividends, interest, capital gains, rent, pensions and Social Security do not.
- Stacking rule. Income above the exclusion is taxed at the rates that would apply if the excluded income were still included, so it starts in a higher bracket.
- No credit on excluded income. You cannot claim a foreign tax credit for foreign tax paid on income you exclude.
- Housing amount. You can also exclude or deduct certain foreign housing costs above a base amount, set at 16% of the exclusion limit (about $21,264 for 2026). Eligible costs are generally capped at 30% of the limit (about $39,870 for 2026), with higher caps for many expensive cities.
How the foreign tax credit works
The FTC is usually claimed on Form 1116. It reduces your US tax by the foreign income tax you paid or accrued on foreign-source income.
- Limitation. The credit cannot exceed the US tax on your foreign-source taxable income. The limit is calculated separately for categories of income, mainly general income (such as wages) and passive income (such as dividends and interest).
- Carryovers. Foreign tax that exceeds the limit can be carried back 1 year and forward 10 years.
- Simplified election. If your only foreign income is passive income reported on a payee statement and your creditable foreign taxes are $300 or less ($600 on a joint return), you can claim the credit without Form 1116, but you lose carryovers for that year.
- Covers all income types. Unlike the FEIE, the FTC can offset US tax on investment income and pensions, as long as foreign income tax was paid on it.
Instead of the credit, you can deduct foreign income taxes as an itemized deduction, but that is usually worth less than a credit.
FEIE vs foreign tax credit at a glance
| Feature | FEIE (Form 2555) | Foreign tax credit (Form 1116) |
|---|---|---|
| What it does | Excludes income from US tax | Credits foreign tax against US tax |
| Cap | $132,900 for 2026, plus housing amount | No dollar cap; limited to US tax on foreign income |
| Income covered | Foreign earned income only | Earned and unearned foreign income |
| Needs foreign tax paid | No | Yes |
| Residency test | Bona fide residence or 330 days | None |
| Carryovers | None | 1 year back, 10 years forward |
| Additional child tax credit | Not available | Available |
| IRA contributions | Excluded pay does not count as compensation | Pay counts as compensation |
| Self-employment tax | Not reduced | Not reduced (totalization agreements may help) |
| Switching rules | Revoking blocks re-election for 5 years without approval | Can be chosen each year |
Where each option tends to fit
These are general patterns, not recommendations. Actual results depend on income mix, family situation and local rules.
Low-tax or no-tax countries
In places with little or no income tax, such as the UAE, there is little foreign tax to credit. The FEIE is often the main source of relief for employees and freelancers there. Income above the limit, and all investment income, remains taxable in the US. Our article on tax-free countries for US citizens explains what moving to such a country does and does not change.
High-tax countries
In countries where income tax rates are similar to or higher than US rates, such as much of Western Europe, the FTC often eliminates US tax on earned income entirely and builds up carryover credits for later years. It also avoids the side effects of the FEIE on credits and retirement savings.
Families with children
The additional child tax credit is the refundable part of the child tax credit. Anyone claiming the FEIE, the housing exclusion or the housing deduction cannot claim it for that year. For families with modest US tax, that can make the FTC the more valuable route, even in moderate-tax countries.
Retirement savings
Excluded income does not count as compensation for IRA purposes. Someone who excludes all of their pay may have no room to contribute to a traditional or Roth IRA. With the FTC, the pay stays in income and can support contributions.
Self-employed people
Neither option reduces US self-employment tax. Self-employed Americans abroad pay it on net earnings unless a totalization agreement between the US and their country of residence assigns social security coverage to that country.
Investment income
The FEIE never covers dividends, interest or capital gains. People with large portfolios often use the FTC for that income, where foreign tax has been paid, regardless of how they treat their salary.
Using both together
You can use the FEIE and the FTC in the same year on different income. A common pattern is to exclude wages up to the limit and claim credits for foreign tax on wages above it and on investment income. The catch is that you cannot take a credit for the share of foreign tax that relates to excluded income, so the credit is reduced in proportion.
Switching later: the five-year rule
The FEIE is an election. You can revoke it at any time, for example by attaching a statement or by claiming the FTC, the additional child tax credit or the earned income credit on income that could have been excluded. But once you revoke it, you generally cannot choose it again for 5 tax years without asking the IRS for a ruling. That makes a switch from the FEIE to the FTC a multi-year decision.
Two simple illustrations
The examples below are simplified and ignore state tax, housing amounts and other details.
Example 1: a contractor in a no-tax country. Jordan earns $120,000 as a freelancer while living in the UAE for all of 2026 and pays no local income tax. With the FEIE, all $120,000 is excluded from federal income tax, but self-employment tax is still due on the net earnings. With the FTC, there is no foreign tax to credit, so the full income would be taxed.
Example 2: an employee in a high-tax country. Sam earns $150,000 in Germany and pays more in German income tax than the US tax on the same salary. With the FTC, the German tax generally wipes out the US tax on that salary, and the excess becomes a carryover. With the FEIE, $132,900 is excluded and the remaining $17,100 is taxed at the higher stacked rates. German tax on that $17,100 can still be credited, but the German tax on the excluded part cannot, and no carryover builds up from it.
Other points to check
- State taxes. Some states, including California, do not follow the federal exclusion, and former residents can still be treated as state residents if they keep ties there.
- Deadlines. Americans living abroad get an automatic two-month extension to 15 June to file, but interest runs from the April deadline. Form 2350 can extend the deadline for people waiting to meet the residence or presence tests.
- Reform proposals. Bills to move the US to residence-based taxation have been introduced in Congress, but they are proposals, not law.
People planning a move can find a broader list of steps in our checklist for moving out of the US. Some Americans also weigh more drastic options, covered in our guide to renouncing US citizenship.
Frequently asked questions
What is the FEIE limit for 2026?
The maximum foreign earned income exclusion is $132,900 per qualifying person for tax years beginning in 2026, up from $130,000 for 2025. A separate housing exclusion or deduction may apply on top.
Can I use the FEIE and the foreign tax credit in the same year?
Yes, but not on the same income. You can exclude earned income up to the limit and claim a credit for foreign tax on other income, but foreign tax that relates to excluded income cannot be credited.
Is the foreign tax credit better than the FEIE?
Neither is better in all cases. In general, the FTC tends to produce a better result in high-tax countries and for families who can use the additional child tax credit, while the FEIE often helps more in low-tax countries. The answer depends on your full set of facts.
Does the FEIE reduce self-employment tax?
No. The exclusion applies to income tax only. Self-employment tax may still be due unless a totalization agreement assigns your social security coverage to your country of residence.
What happens if I stop claiming the FEIE?
Stopping, or claiming the FTC or certain credits on income you could have excluded, revokes the election. You then generally have to wait 5 tax years, or get IRS approval, before claiming the FEIE again.
Important: This article is general information, not tax, legal or financial advice. Rules change often and depend on your personal circumstances. Speak with a qualified professional in each relevant country before you act.