Is Foreign Tax Credit better than Foreign Earned Income Exclusion ?

Foreign Earned Income Exclusion (FEIE) as we have already discussed in the earlier article, can be claimed on “foreign earned” income. Thus, primarily, salary and business income qualify for a deduction under FEIE.

On the other hand, Foreign Tax Credit (FTC) can be claimed on any type of income on which tax has been paid in a foreign country and which is subject to double taxation.

Thus, salary and business income can be claimed under Foreign Earned Income Exclusion(FEIE) as well as under FTC. There is some amount of tax panning and calculations which will have to be done on a case to case basis depending on the tax filing status and tax brackets in order to find out whether FEIE or FTC works better.

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But, in general, FTC works better in the following cases:

  1. If your foreign income tax rate is higher than the US tax rate, FTC generally works out to be better.
  2. If the taxes paid or accrued exceed the credit limit for that year, you may be able to carry back the excess to the prior tax year or carry it forward for up to 10 years.
  3. You do not have to meet the bona fide residence or physical presence tests
  4. You may more easily qualify for tax benefits such as the Child Tax Credit or the ability to make a contribution to a Roth IRA (these are not available when you claim a deduction under FEIE)

If you have been claiming the Foreign Earned Income Exclusion for the prior years, you cannot switch over to FTC in a particular year because it is beneficial to you.

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