US taxes while living abroad
Foreign tax credit or foreign earned income exclusion: how do they compare?
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The foreign tax credit reduces US tax by qualifying foreign income tax, up to a limit based on your share of foreign-source income. The foreign earned income exclusion removes qualifying earned income from US tax instead. You cannot take a credit for foreign tax on income you excluded, and the better route depends on income types, tax rates and election history. A licensed tax professional should apply these rules to your own facts.
Key facts
| Fact | What the source says | Source |
|---|---|---|
| Credit limit | Total US tax × taxable foreign-source income ÷ total taxable income | Official source |
| Credit cap | No more than the qualifying foreign taxes paid or accrued | Official source |
| Unused credit | Generally a one-year carryback and a ten-year carryforward | Official source |
| Election without Form 1116 | Passive income on payee statements, qualified foreign taxes up to $300, or $600 joint | Official source |
| Excluded income | Foreign tax on excluded income cannot also be credited | Official source |
How is the foreign tax credit limit worked out?
The IRS describes a general limit: your total US tax multiplied by your taxable income from foreign sources, divided by your total taxable income. Your credit is the smaller of that limit and the qualifying foreign income taxes you paid or accrued. Form 1116 and its instructions require separate limits for different categories of income, so the real calculation can have several parts.
Fictional example: Dana has $10,000 of US tax, and half of her taxable income is from foreign sources. Her general limit is $5,000. If she paid $4,000 of qualifying foreign tax, the credit is no more than $4,000. If she paid $7,000, the limit holds the credit at $5,000, and the rest may carry over.
What happens to foreign tax you cannot use this year?
The IRS says unused qualifying foreign tax can generally be carried back one year and forward ten years, subject to the rules. Carryovers are tracked by category. Keep the worksheets from every year, because a later year may need them.
What is the small foreign tax election without Form 1116?
The IRS describes a limited election to claim the credit without Form 1116. It applies when all foreign-source income is passive income reported on payee statements and qualified foreign taxes are no more than $300, or $600 on a joint return. If you make the election, you cannot carry back or carry over unused foreign tax to or from that year. It is not a general small-tax exemption.
How do the credit and the exclusion differ?
Publication 54 explains that foreign tax attributable to excluded income cannot be used for a credit. A comparison has to avoid counting the same benefit twice.
| Question | Foreign tax credit | Foreign earned income exclusion |
|---|---|---|
| What it does | Reduces US tax by qualifying foreign income tax, up to a limit | Removes qualifying foreign earned income from US income tax |
| Income covered | Foreign-source income in each category, including passive income | Foreign earned income only |
| What it needs | Foreign income tax paid or accrued, Form 1116 unless the election applies | Foreign tax home, one of two tests, Form 2555 |
| What it does not do | Credit more than the limit or the foreign tax paid | Reduce self-employment tax or cover pensions and investment income |
| Unused amounts | Carryback one year, carryforward ten years | No carryover of an unused exclusion amount |
How do housing amounts fit in?
Publication 54 distinguishes the housing exclusion, tied to employer-provided amounts, from the housing deduction, tied to self-employment earnings. Both depend on eligible expenses, a base amount, location limits and qualifying days. A housing benefit is not simply a year of rent.
Checklist before you start
- Gather foreign tax returns and assessments for each year.
- Separate income into wages, self-employment, passive and other types.
- Note when foreign tax was paid and for which year.
- Find any earlier Form 1116 or Form 2555 and carryover worksheets.
- List housing costs and any employer housing payments.
- Bring this list to a licensed preparer to compare both routes.
Common questions
Can I use the foreign tax credit and the exclusion in the same year?
You can use both on different income, but you cannot take a credit for foreign tax on income you excluded.
What if my foreign tax is higher than my US tax?
The credit is limited. Unused qualifying tax can generally be carried back one year and forward ten years.
Do I always need Form 1116?
No. A limited election covers passive income on payee statements with qualified foreign taxes up to $300, or $600 joint, but it blocks carryovers for that year.
Official sources
- Foreign tax credit: how to figure the credit. IRS.
- Publication 54, Tax Guide for US Citizens and Resident Aliens Abroad. IRS.
Sources checked . Official pages change. Use the source over this summary if they differ.
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General information from IRS and FinCEN publications, not tax advice. Rules depend on your facts and the tax year. Confirm with a licensed tax professional before you file. US Expat Desk is a private company. We are not affiliated with the US government, the State Department, or the FBI.