Chapter 19: Is it better to take the “Foreign Tax Credit” or the “Foreign Earned Income Exclusion” – a discussion

Even for a basic U.S tax return, I have often said that:

Two different tax preparers could produce five different U.S. tax returns.

When filing their U.S. tax returns Americans abroad are faced with tho threshold questions:

1. What filing category should they use? Single, Married Filing Jointly, Married Filing Separately or Head of Household?

2. Assuming they have “earned income”, should they use the Sec. 911 FEIE (Foreign Earned Income Exclusion” or should they use the Sec. 901 FTC (Foreign Tax Credit Rules).

In most cases the Sec. 901 FTC rules lead to better results.

The above tweet references an excellent discussion by CPA Olivier Wagner which explains why in most cases the Sec. 901 Foreign Tax Credit rules would be preferred to the Sec. 911 Foreign Earned Income Exclusion.

The following discussion on Facebook illustrates the general points.

The above tweet references the following Facebook discussion. You will have to log in to your Facebook account to read it live. Note by the way the reference to the article about your “local pension”, which by the way, is considered to be “foreign” (with all the attendant horror) from a U.S. perspective. Note the title refers to  your pension as an “unexpected tax trap”. This article had about 43,000 views. On the issue of “foreign pensions” see:

But back to the “Foreign Earned Income Exclusion” vs. the “Foreign Tax Credit” discussion (better to read on Facebook if you can):

Naomi Hoffman
September 25 at 5:58pm · Edited

I’m partway through my 2nd attempt to complete our US tax return, and getting much further with TaxAct than I was a few months ago with HR Block. We emigrated mid 2014, so we have some income from the US, and a lesser amount from the UK. Here is my frustration: after all our foreign income was ‘excluded’ (Form 2555) we owed the IRS $1000 more than before the foreign income was added. In short, our (minuscule) foreign income for 2014 appears to have bumped us into a higher tax bracket and cost us $1000! I will experiment with the Foreign Tax Credit, but meanwhile can anyone please explain WHY a foreign earned income exclusion would negatively effect tax brackets? I don’t see how this is not double taxation. Thanks so much.
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2 people like this.
Tricia Moon

Tricia Moon Are you converting the UK income to US values before you apply the FEIE?
Like · Reply · 2 · September 25 at 8:40pm · Edited
Ashraf Khatib
Ashraf Khatib Did you use Form 2555 for each you and your spouse? Each can dedcut $99,200 from 2014 income for a total of $198,400, MFJ with both spouses working. Also, if you have any deductable income (i.e. mortgage interest) you stilll claim that on Schedule A.
Like · Reply · 2 · September 25 at 9:20pm
Scott Hochgesang
Scott Hochgesang It’s hard to imagine a scenario where taking the exclusion causes you to pay more US tax. Is it a partial year issue perhaps as you said you moved part year?
Like · Reply · 3 · September 25 at 9:24pm
Orlando Gotay
Orlando Gotay There’s something called the “Stacking rule”. The exclusion in effect excludes income at the lower ends of the tax “ladder” and not from the top where it is taxed at a higher rate. I’m not surprised you get that result.

Trivia: California does an analogous thing to its part year residents, too.
Orlando Gotay’s photo.
Like · Reply · 2 · September 25 at 11:28pm · Edited

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Naomi Hoffman

Naomi Hoffman Good to know you can take a FTC on tax paid on passive income. Looking for glimmers of hope to level the playing field!
Like · Reply · 20 hrs
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Susan De Paul
Susan De Paul You can only exclude “earned” foreign income on the 2555, but other types of foreign income (such as contributions of a foreign employer to a foreign pension plan) are added directly to your income and cannot be excluded. Is something like that causing the problem?
Like · Reply · 1 · Yesterday at 1:18am
Tom Paine
Tom Paine If you are in the UK, it is probably NOT to your advantage to use the Foreign Earned Income Exclusion period. To summarize the reasons given in the previous comments: (1) only what qualifies as “earned income” (not investment or pension income) can be …See More
Like · Reply · 2 · 21 hrs
Naomi Hoffman
Naomi Hoffman Orlando Gotay you are spot on. After seeing your email this morning my husband and I spent the last few hours doing calcs and reading through the article you linked (very informative & helpful article BTW) and that is exactly what is happening. Unbelie…See More
Like · Reply · 21 hrs
Sigrid Ore
Sigrid Ore To determine the actual tax bracket, your total income before exclusions is used. That means if your US income plus your foreign income is for example 120.000$, you are in the 28% tax bracket. Let’s say your income from the US is only 40,000$, than this income is taxed at 28%. The foreign earned 80,000$ is tax excempt.
Like · Reply · 20 hrs · Edited
Naomi Hoffman
Naomi Hoffman Many thanks everyone for your comments, the ‘Stacking Rule’ mentioned by Orlando is the cause. Tricia we did make the conversion to USD, Scott I agree hard to imagine but the FEIE does indeed cause us to pay more US tax -$1000 more. I will include my c…See More
Like · Reply · 1 · 20 hrs
Naomi Hoffman
Naomi Hoffman Scott in our preliminary calcs we would owe $75 using the FTC instead of $1000 using the FEIE. Now to go see if we can master Form 1116 & see if it concurs with our calculations…
Like · Reply · 20 hrs
Scott Hochgesang
Scott Hochgesang You must have a lot of passive income (interest, dividends, rent) which is not picked up by FEIE. Many here use local US tax accountants Down Under – they cost around $400-500 but do tax returns and FBARs too.
Like · Reply · 20 hrs
Susan De Paul
Susan De Paul Yes, I’m really saying that your employer’s contributions must be added to your income IF the foreign pension is not considered “qualified” under U.S. tax law. [This will depend on the nature of the tax treaty between your country and the U.S. I don’t …See More
Like · Reply · 1 · 20 hrs · Edited
Susan De Paul
Susan De Paul Here’s an article that explains the situation with the foreign pension plans:…/pensions-create-yet-another…/…See More
Pensions Create Yet Another Tax Trap For U.S. Expatriates|By Janet Novack
Like · Reply · 1 · 20 hrs
Naomi Hoffman
Naomi Hoffman Thanks so much for your response Susan. Its just all unbelievable. And of course, because the foreign employers contributions are pre-tax, you could not claim tax credit on your 1040. I just don’t see how it is legal to tax ‘potential’ vs ‘actual’ inco…See More
Like · Reply · 1 · 19 hrs

John Hanson replied · 2 Replies · 6 hrs

Marco Sewald
Marco Sewald I like the FTC, you can carry unused credits forward or carry back if needed for several years – so the only U.S. tax you may face, while living in a high tax country and having a quite high income, might be the 3,8% Net Investment Income Tax / Medicare surtax…which is bad enough if you will never get any benefits from medicare…
Like · Reply · 16 hrs


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