Which tax deduction is better for which country? FEIE or FTC?
Published on June 24, 2024
by Sparsh Ganeriwala
Sparsh Ganeriwala, an IRS Enrolled Agent with over 11 years of expat tax experience, specializes in filing US taxes for Americans living in Canada, US/Foreign Trusts, and GILTI Tax.
Table of Contents
Whether the Foreign Earned Income Exclusion (FEIE) or the Foreign Tax Credit (FTC) is better depends on the tax rates of the country you reside in compared to the United States. Generally, FEIE is more beneficial in countries with zero or lower income tax rates, while FTC is advantageous in countries with higher income tax rates.
How does the Foreign Earned Income Exclusion (FEIE) benefit US expats?
The Foreign Earned Income Exclusion (FEIE) allows US expats to exclude up to $126,500 of their foreign-earned income from US taxation in 2024. This exclusion is particularly beneficial for those living in countries with lower tax rates than the US, as it reduces the amount of taxable income reported to the IRS.
The FEIE is particularly useful in countries with little or no income tax. For instance, if you work in a country where there is no income tax, you can exclude a large portion of your earnings from US taxes.
To qualify for the FEIE, you must meet one of two tests:
- Physical Presence Test (PPT): You must be physically present in a foreign country or countries for at least 330 full days during a 12-month period.
- Bona Fide Residence Test (BFR): You must be a bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year.
To claim the Foreign Earned Income Exclusion (FEIE), you need to attach IRS Form 2555 to your annual tax return. Do not submit Form 2555 by itself.
How does the Foreign Tax Credit (FTC) benefit US expats?
The Foreign Tax Credit (FTC) allows US expats to offset the taxes they have paid to a foreign government against their US tax liability. This credit is advantageous for those residing in countries with higher tax rates than the US. Using FTCs, US citizenship holders can avoid double taxation on their income.
For instance, if you live in a country with higher tax rates than the US, the FTC can help ensure you are not taxed twice on the same income. The credit reduces your US tax liability dollar-for-dollar by the amount of foreign taxes paid.
To claim the FTC, you must file IRS Form 1116, which calculates the amount of foreign tax credits available.
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Which countries are more favorable for FEIE?
Certain countries have lower tax rates, making the Foreign Earned Income Exclusion more beneficial. Here are the top 20 countries where FEIE is favorable:
Countries – FEIE:
- United Arab Emirates
- Qatar
- Bahrain
- Kuwait
- Oman
- Saudi Arabia
- Singapore
- Hong Kong
- Paraguay
- Bahamas
- Bermuda
- Cayman Islands
- Monaco
- Mauritius
- Georgia
- Armenia
- Belarus
- Malaysia
- Bulgaria
- Panama
In these countries, where income tax rates are low or nonexistent, the FEIE helps to minimize or eliminate US tax liability on foreign-earned income.
Which countries are more favorable for FTC?
For countries with higher tax rates than the US, the Foreign Tax Credit is usually the better option. Here are the top 20 countries where FTC is favorable:
Countries – FTC
- Australia
- Canada
- Germany
- France
- Italy
- United Kingdom
- Belgium
- Denmark
- Finland
- Netherlands
- Norway
- Sweden
- Austria
- Japan
- Ireland
- Spain
- Portugal
- Luxembourg
- Greece
- Israel
In these countries, where income tax rates are higher, the FTC allows expats to claim a credit for taxes paid to the foreign government, effectively reducing or eliminating US tax liability on the same income.
How do I choose between FEIE and FTC in a mixed scenario?
This entirely depends on your income level, the tax laws of the country where you reside, and your individual circumstances. Consulting with a tax professional can help determine the most beneficial strategy you can use to lower your tax liability.
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