FEIE vs Foreign Tax Credit: Which is better?

The choice between the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC) depends on your specific financial situation, and in some cases, using a combination of both may be optimal. Here is a framework for determining which approach works best.

The FEIE is generally better when: you live in a low-tax or no-tax country (like the UAE, Singapore, or Hong Kong) where you pay little or no foreign income tax and need to reduce your US tax liability; your earned income is below the FEIE limit ($126,500 for 2024); or you have straightforward earned income without significant investment income.

The FTC is generally better when: you live in a high-tax country (like Canada, UK, Germany, or Australia) where your foreign tax rate exceeds your US effective rate; you have significant unearned income (investments, rental, pensions) that does not qualify for FEIE; your earned income exceeds the FEIE limit; or you want the flexibility to carry forward excess credits for up to 10 years.

You can use both FEIE and FTC on the same return, but not on the same income. For example, you might exclude your first $126,500 of earned income under FEIE and then use the FTC on any remaining earned income and on investment income. However, be aware that combining them can create a higher effective tax rate on non-excluded income due to how the FTC limitation is calculated when FEIE is also claimed.

Once you elect the FEIE, revoking it has consequences — you cannot re-elect it for 5 years without IRS approval. So this is not a decision to make lightly. The FTC has no such restriction and can be claimed or not claimed year by year.

We run both scenarios for every client to determine the optimal strategy. The difference can be thousands of dollars, and the best choice may change from year to year as your income, tax rates, and personal circumstances evolve.