Every American working abroad eventually meets the question: exclusion or credit? The foreign earned income exclusion (FEIE) and the foreign tax credit (FTC) both exist to stop the same income being taxed twice — but they work in entirely different ways, they interact, and the choice between them can bind you for years. It deserves more than a software default.

The two tools

The FEIE (Form 2555) lets a qualifying American abroad simply exclude foreign earned income from US tax — up to US$130,000 for 2025, indexed annually — plus, in many cases, a housing exclusion for rent above a base amount. To qualify you must have a foreign tax home and pass either the physical presence test (330 full days abroad in a 12-month window) or the bona fide residence test (a genuine, settled residence abroad for a full calendar year).

The FTC (Form 1116) instead gives you a dollar-for-dollar credit for foreign income tax paid, limited to the US tax attributable to the same basket of income. Unused credits carry back one year and forward ten.

The geography rule of thumb

The single best predictor of the right answer is the local tax rate:

  • High-tax countries (Canada, Japan, most of Europe): the FTC usually wins. Local tax exceeds the US tax on the same income, the credit wipes out the US bill entirely, and excess credits bank for the future. The FEIE adds little — and can subtract.
  • Low- or no-tax locations (Hong Kong, Singapore, the Gulf): the FEIE usually wins, because there is little or no foreign tax to credit. Salary up to the ceiling escapes US tax; the housing exclusion extends the shelter in expensive cities.
  • Mixed situations — moderate local tax, income above the ceiling, or income split between countries — are genuinely two-sided and worth modelling both ways.

What the rule of thumb misses

The FEIE covers only earned income. Salary and self-employment income, yes; dividends, interest, capital gains, rent and pensions, no. Investment income needs the credit (or simply bears US tax) regardless of your election.

Excluded income can’t support credits — or contributions. Foreign tax paid on income you excluded generates no FTC. And excluding all your earned income leaves nothing on which to base IRA contributions; expats who want to keep funding US retirement accounts sometimes deliberately leave income unexcluded.

The child tax credit interaction. Families using the FEIE generally lose access to the refundable portion of the child tax credit; FTC filers in high-tax countries often collect it as a cash refund. For families with several children this single line can decide the whole election.

Self-employment tax is untouched by both. Neither tool reduces US self-employment tax for freelancers abroad — only a totalization agreement between the US and your country can (Canada and Japan have one; Hong Kong, Singapore and Taiwan do not). Self-employed Americans in Asia owe US self-employment tax on top of everything else, and structuring around it is its own planning topic.

GILTI and company owners. For Americans running their business through a local company, salary paid out and excluded under the FEIE interacts with the corporate anti-deferral rules in ways that change the optimal mix of salary and retained profit. The election is part of a larger structure question.

The trap: revoking the FEIE

The FEIE is an election that continues year to year — and if you revoke it (by switching to the credit), you generally cannot re-elect it for five years without IRS permission. A move from Toronto to Hong Kong, two years after dropping the exclusion, can leave you stuck in credit-land in a city with almost no creditable tax. Anyone whose career may cross tax-rate borders should treat the revocation decision as a five-year commitment, not a one-year optimisation.

(The reverse direction is safer: you can use the FEIE one year and simply claim the FTC on income above the exclusion in the same year — stacking the two is normal.)

How the decision actually gets made

In practice we model the realistic cases: this year’s numbers under exclusion, under credit, and under the stack; then the same with next year’s plans layered in — a move, a bonus, a business, children. The arithmetic takes an afternoon. Recovering from the wrong default after three years of filings takes considerably longer.

If your situation has been on software autopilot — especially if you have moved countries since the election was first made — it is worth a deliberate second look.