Foreign Tax Credit v/s Foreign Earned Income Exclusion: A Comparison for Expats
An American expat have to report their income earned in any part of the world to the IRS. However for US expats Foreign Tax Credit (FTC) and Foreign Earned Income Exclusion (FEIE) are important tools that help the US expats optimize the tax situation.
What is Foreign Tax Credit?
Foreign Tax Credit for US Expats allows the US expats to offset taxes paid to a foreign country against their US tax liability. This credit is useful for individuals living in countries with high tax reliefs. The FTC is available US expats or residents paying income tax to a foreign government. It reduces their US tax liability dollar-to-dollar for the taxes paid abroad. FTC includes wages, dividends, interests and other income types. The credits unused can be carried back one year or forward up to ten years.
FTC is ideal for expats in countries where the income taxes are comparable or higher than US rates.
What is Foreign Earned Income Exclusion?
FEIE allows qualifying US expats to exclude a portion of their foreign earned income from US taxation. The exclusion limit is $ 120,000 per qualifying individual.
It is important for the US expats to meet either the physical presence test of 330 days in a foreign country within a year or a bona fide residence test which established their permanent residency in another country to claim FEIE.
The FEIE is ideal for expats living in countries with low or no income taxes.
Difference between FTC and FEIE
- FTC applies to all income types whereas FEIE is limited to earned income.
- FTC reduces US taxes owed and FEIE minimizes taxable income.
- Foreign Tax Credit for US expats is applicable irrespective of physical presence while FEIE requires meeting residency or physical presence norms.
- FTC is better for high-tax countries while FEIE benefits expats in low tax jurisdictions.
Choosing between FTC and FEIE
When choosing between Foreign Tax Credit v/s Foreign Earned Income Exclusion here are some of the points US expats need to consider-
- FTC is ideal for using for high-tax countries to maximize credits.
- If the US expats have a significant unearned income, FTC is more comprehensive.
- If the American expats meet FEIE residency tests, they can exclude earned income and minimize the taxable income.
- In some cases, the expats can use both FTC and FEIE to optimize their tax strategy.
Both FTC and FEIE are valuable tools for US expats. Understanding them and aligning them with the financial situation, expats can minimize their tax burden and ensure compliance with the US tax laws.
