Foreign Income Tax Rules
Tax rules for US expats and remote workers: the Foreign Earned Income Exclusion vs the Foreign Tax Credit.
TL;DR
- 01The US taxes citizens on worldwide income, regardless of where they live.
- 02The FEIE can exclude up to $132,900 of foreign wages yearly.
- 03FBAR filing is required if foreign accounts exceeded $10,000 at any point.
Tips
- 01The FEIE works best when you have little foreign income tax to credit, like in low-tax or zero-tax countries such as the UAE.
- 02Expats in high-tax countries often find the FTC eliminates US tax liability entirely and generates a carryforward credit for future years.
Warnings
- 01Renouncing US citizenship triggers the expatriation tax for covered expatriates with net worth above $2 million or high average net tax.
- 02Self-employment income excluded under the FEIE still owes US self-employment tax of 15.3% unless a totalization agreement applies.
- 03Many foreign banks now refuse US person clients due to FATCA compliance costs, making accounts abroad harder to open.
US Citizens Are Taxed on Worldwide Income
The United States uses citizenship-based taxation (CBT) — meaning US citizens and permanent residents (green card holders) are required to file US federal tax returns and pay US tax on their worldwide income, regardless of where they live or work. This applies even if you have lived abroad for decades and earn no US-source income.
This is fundamentally different from how most countries operate: the vast majority of nations use residence-based taxation, taxing only income earned within their borders. As a result, US expats face potential double taxation — the country where they live wants to tax their local income, and so does the US.
| Tax System | Who It Covers | Examples |
|---|---|---|
| Citizenship-based (US, Eritrea) | All citizens globally, regardless of residence | US citizen living in Germany files US and German returns |
| Residence-based (most countries) | Only residents; emigrants stop filing | German citizen living in Spain files only Spanish return |
Two primary tools exist to prevent true double taxation for US persons abroad: the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC). Most expats use one or the other — rarely both on the same income.
Foreign Earned Income Exclusion (FEIE)
The Foreign Earned Income Exclusion (FEIE), claimed on Form 2555, allows qualifying US citizens and residents abroad to exclude a specified amount of foreign-earned income from US federal income tax each year. For 2026, the exclusion amount is up to $132,900 (adjusted annually for inflation).
| Feature | Details |
|---|---|
| 2026 exclusion limit | Up to $132,900 per qualifying individual |
| Qualifying income types | Wages, salaries, self-employment income earned in a foreign country |
| Excluded income types | Passive income (interest, dividends, capital gains), pensions, Social Security |
| Housing exclusion / deduction | Additional exclusion for housing expenses above a base amount of $21,264 for most locations in 2026, up to a cap of $39,870 |
| Required residency tests | Bona Fide Residence Test OR Physical Presence Test |
- Bona Fide Residence Test: You must be a bona fide resident of a foreign country for an uninterrupted period that includes a full tax year. Requires domicile and genuine integration into the foreign country.
- Physical Presence Test: You must be present in a foreign country (or countries) for at least 330 full days in any consecutive 12-month period. More mechanical — days in country simply count.
- Tax cost of FEIE: Excluded income is removed from your tax base, but the remaining income is taxed as if it were piled on top of the excluded income — this is the stacking rule, which can push other income into higher brackets.
Foreign Tax Credit (FTC)
The Foreign Tax Credit (FTC), claimed on Form 1116, allows US persons to offset their US federal tax liability dollar-for-dollar with foreign income taxes paid or accrued. Unlike the FEIE (which excludes income), the FTC reduces the actual tax owed.
| Feature | Details |
|---|---|
| Credit type | Dollar-for-dollar reduction of US tax liability |
| Qualifying taxes | Income taxes paid to foreign governments; not VAT, sales tax, or property tax |
| Limitation | US tax on foreign income only; cannot exceed US tax attributable to foreign source income |
| Carryback / carryforward | Unused FTC can be carried back 1 year or forward 10 years |
| Per-basket rules | Credits are calculated separately for passive income, general income, and other baskets |
The FTC is most powerful when you live in a high-tax country (Germany, France, Scandinavia, UK) where the local tax rate exceeds or matches the US rate. In that case, the foreign taxes paid fully offset US tax, often resulting in zero US tax owed. The FTC cannot create a refund — it can only reduce tax to zero.
- Simplified limitation election: Available for taxpayers with less than $300 ($600 MFJ) of foreign tax paid who can skip Form 1116 and claim the credit directly on Schedule 3.
- Accrual vs cash basis: The FTC can be claimed on either a cash (taxes paid) or accrual (taxes accrued) basis. You must be consistent year to year.
FEIE vs FTC: Which to Choose
The choice between the FEIE and FTC is one of the most consequential decisions for US expats — and it is not always obvious which is better. You can switch between them, but revoking the FEIE election locks you out of it for five years.
| Factor | Use FEIE | Use FTC |
|---|---|---|
| Local tax rate vs US rate | Low-tax country (no FTC available to offset) | High-tax country (FTC fully offsets US liability) |
| Income type | Earned income only (wages, self-employment) | Passive income (dividends, interest) only eligible for FTC |
| Social Security contributions | FEIE does not reduce SE tax — you still owe SS on excluded income | FTC reduces income tax but SE tax still applies without totalization agreement |
| Roth IRA contributions | FEIE reduces earned income, which can reduce Roth IRA eligibility | FTC does not reduce earned income for IRA purposes |
| US tax result | Often zero US tax in low-tax countries | Often zero US tax in high-tax countries; carryforward generated |
A common expat mistake: claiming the FEIE while living in a high-tax country means forfeiting foreign tax credits on the excluded income — wasting valuable credits. Conversely, using FTC in a zero-tax country means you owe full US tax with nothing to credit against it.
FBAR and FATCA Reporting Requirements
Beyond income tax, US persons with foreign financial accounts and assets face two additional reporting regimes: FBAR and FATCA. Both carry severe penalties for non-compliance — and neither is triggered by owing tax. These are pure information reporting requirements.
| Requirement | Form | Threshold | Deadline | Filed With |
|---|---|---|---|---|
| FBAR (Foreign Bank Account Report) | FinCEN Form 114 | Aggregate foreign account balances > $10,000 at any point during the year | April 15 (auto-extended to October 15) | FinCEN (not IRS) via BSA E-Filing |
| FATCA (Foreign Account Tax Compliance Act) | Form 8938 | $200,000 at year-end or $300,000 at any point (single abroad); $400k/$600k for MFJ abroad | With your tax return | IRS, attached to Form 1040 |
- FBAR penalties: Non-willful failure: up to $10,000 per violation (per account per year). Willful failure: up to the greater of $100,000 or 50% of account balance per violation. Criminal penalties possible for willful violations.
- FATCA penalties: $10,000 failure-to-file penalty plus $10,000 for each 30-day continuation period after notice from IRS, up to $50,000.
- Streamlined procedures: US persons who failed to report foreign accounts non-willfully can use the IRS Streamlined Filing Compliance Procedures to come into compliance with reduced penalties (5% penalty on foreign assets for US residents; $0 penalty for expats).
- Foreign accounts covered: Bank accounts, brokerage accounts, mutual funds, pension plans, and certain foreign insurance policies. Does not generally include real property owned directly (use FBAR only for accounts holding real estate, not direct real property).
FAQ
The United States uses citizenship-based taxation (CBT) — meaning US citizens and permanent residents (green card holders) are required to file US federal tax returns and pay US tax on their worldwide income, regardless of where they live or work. This applies even if you have lived abroad for decades and earn no US-source income.
The Foreign Earned Income Exclusion (FEIE) lets qualifying expats exclude up to $132,900 of foreign wages from US tax in 2026; the Foreign Tax Credit (FTC) offsets US tax dollar-for-dollar with taxes paid abroad. Most expats use one or the other, rarely both on the same income.
Use the FEIE if you live in a low-tax or zero-tax country, since there is little or no foreign tax to credit against US liability. Use the FTC if you live in a high-tax country, since foreign taxes paid often offset US tax entirely and unused credits carry forward. You can switch between them, but revoking the FEIE locks you out of it for five years.
You must file an FBAR (FinCEN Form 114) if your combined foreign financial accounts exceeded 10,000 dollars at any point during the year. The form is filed with FinCEN, not the IRS, and is due April 15 with an automatic extension to October 15. Non-willful failure to file can carry a penalty of up to 10,000 dollars per violation.
The stacking rule means that even though excluded income is removed from your tax base, your remaining taxable income is taxed as if the excluded amount were still on top of it. This can push your other income into higher tax brackets than it would otherwise face. It is one reason high earners should run projections before choosing the FEIE.