US citizens abroad: the exclusion or the tax credit

Two ways to avoid paying tax twice on the same pay

A US citizen on a salary abroad is taxed by the US on income from anywhere in the world, and the country she lives in will usually want its own tax on the same pay. Form 2555 (the foreign earned income exclusion) and Form 1116 (the foreign tax credit) exist to ease that overlap.

The exclusion lets you leave part of your foreign pay out of US taxable income. The credit lets you subtract foreign income tax you have paid from your US tax bill. For earnings you choose to exclude you cannot also take the credit, so the real decision is which one fits each slice of your income. [T1] [T5]

How the exclusion works: the tests and the cap

To use Form 2555 you need a tax home in a foreign country, income from personal services you performed in a foreign country, and one of two tests.

• The bona fide residence test, met when you are a bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year. It depends on your intention about the length and nature of your stay, and your acts carry more weight than your words.
• The physical presence test, met when you are physically present in a foreign country, or countries, for at least 330 full days in any period of 12 months in a row. A full day is the 24 hours from midnight, and the days do not have to be consecutive.

The exclusion reaches earned income only. Pensions, dividends and rent are not earned income, so it will not cover them.

The cap is set each year. The instructions for 2025 give a maximum exclusion of $130,000. The early release draft of the 2026 form shows $132,900, but drafts can change before the final version, so check the final 2026 form before relying on it. If you and your spouse both work abroad and each qualifies, each of you can claim up to the cap.

Income above the cap is not free of US tax, and it is not taxed from zero. The tax on your non-excluded income is worked out using the rates that would have applied if you had not claimed the exclusion. [T1] [T2] [T3] [T5]

The housing amount and what the exclusion costs you

Families with children should look first at what the exclusion removes. You cannot take the additional child tax credit or the earned income credit in a year you claim it, so price that in.

A separate housing exclusion or deduction sits on top of the earnings exclusion. Employees use the exclusion, for housing paid with employer-provided amounts, and self-employed people use the deduction, for housing paid from self-employment earnings. Rent, utilities, insurance and furniture rental count. Lavish costs, buying property and domestic staff do not.

You only get the part above a base amount of 16% of the maximum exclusion, which for 2025 is $20,800 (our calculation from the $130,000 cap). The limit on housing expenses for most places in 2025 is $39,000, and Notice 2025-16 lists higher limits for certain cities, so the benefit in most locations is at most $18,200 (our calculation). [T1] [T2] [T6]

How the foreign tax credit works

Form 1116 claims a credit for income taxes you paid or accrued to a foreign country. The credit is for the tax you legally owe, not necessarily what was withheld.

Two limits matter. The credit cannot exceed your actual foreign tax liability, and it is limited to the share of your total US tax that matches your foreign-source income. Different kinds of income, such as wages (general category) and dividends (passive category), are limited separately, which means a separate Form 1116 for each. Unused credit is not lost straight away, since foreign tax above the limit can be carried back 1 year and forward 10 years.

You can skip Form 1116 only in a narrow case: your only foreign income is passive income reported on a payee statement, and your qualifying foreign tax is $300 or less ($600 on a joint return). Salary does not fit that case. [T1] [T4]

Low-tax and high-tax destinations

Where foreign income tax on your pay is high, it may equal or exceed the US tax on that pay. The credit may then reduce the US tax on that income to a small amount or none, with any excess carried over. The exclusion would use up your cap on income that foreign tax has already covered, and you could not then claim the credit for tax on the excluded part.

Where foreign income tax is low or nil, the credit has little to offset, because it cannot exceed the foreign tax you actually paid. The exclusion can leave more of your earnings outside US income tax, up to the cap. The cost is the lost credits above and the lock-in covered next.

A higher earner can also combine them: take the exclusion up to the cap, then claim the credit for foreign tax paid on the wage that was not excluded.

The Portugal guide and Thailand guide set out how each country taxes residents, and the compare page for Portugal and Thailand puts them side by side. [T1] [T4]

Revoking the exclusion and the five-year lockout

Once you claim the exclusion, the choice stays in force for that year and every later year until you revoke it. Skipping it in a later year counts as a revocation, even if the reason is a net loss, and so does claiming the foreign tax credit, the additional child tax credit or the earned income credit. To revoke on purpose, you attach a statement to the return for the first year you do not want the exclusion. The earnings exclusion and the housing exclusion are revoked separately.

Five years is the cost that lasts longest. After revoking, you cannot claim the same exclusion for the next 5 tax years without IRS approval. You request approval through a ruling request, and the IRS considers facts such as a period of residence in the United States, a move to a foreign country with different tax rates, a substantial change in the foreign country's tax laws and a change of employer.

Choosing the exclusion because it is simple can therefore narrow your options for years. Check what you would do if your pay, country or tax rate changed. [T1] [T2] [T5]

Self-employment tax and totalization agreements

A consultant abroad with a $68,000 net profit still pays self-employment tax on the full $68,000. The exclusion does not reduce self-employment tax, and all your self-employment income counts, including income excluded from income tax.

Totalization agreements can change that. The United States has agreements with some countries so that the same work is not charged social security tax twice. For self-employed people in a dual-tax position, the usual result is that they are covered only by the system of the country where they live. To claim the exemption from the other country's tax, you request a certificate of coverage from the Social Security Administration.

The agreements list includes Portugal, Spain, France and Italy. Mexico, Costa Rica, Thailand and Malaysia are not on it, so no agreement applies there (our reading of the list as of 10 October 2026). The Spain guide and the Mexico guide cover the local side of each. [T1] [T5] [T7] [P1]