The Foreign Tax Credit (FTC) is a powerful alternative to the Foreign Earned Income Exclusion (FEIE) for Americans living and working abroad. While the FEIE allows you to exclude up to $126,500 of foreign earned income from U.S. taxation in 2025, the Foreign Tax Credit lets you claim a dollar-for-dollar credit against your U.S. tax liability for foreign income taxes you've paid to another country.

For many expats—especially those living in high-tax countries or earning over the FEIE limit—the Foreign Tax Credit results in significantly greater tax savings than the FEIE. This comprehensive guide explains how the FTC works, who should use it, how to file Form 1116, and provides detailed comparisons to help you choose the best strategy for your situation in 2025-2026.

What is the Foreign Tax Credit (FTC)?

The Foreign Tax Credit, established under IRC Section 901, allows U.S. taxpayers to reduce their U.S. tax liability by the amount of foreign income taxes paid to a foreign country or U.S. possession.

Key Features:

Dollar-for-dollar credit: Every dollar of foreign tax you pay reduces your U.S. tax by one dollar (up to the U.S. tax on that income)
No income limit: Unlike FEIE ($126,500 limit in 2025), FTC applies to unlimited foreign income
Applies to all income types: Earned income (wages, self-employment) AND passive income (dividends, interest, rents, capital gains)
Carryback/carryforward: Excess credits can be carried back 1 year or forward 10 years

Example: You live in Germany and earn $150,000. You pay $45,000 in German income tax. The U.S. tax on that income would be $37,000. With the FTC, you claim a $37,000 credit against your U.S. tax, reducing your U.S. tax liability to zero. You have $8,000 of excess foreign tax credits that can be carried forward.

Foreign Tax Credit vs. Foreign Earned Income Exclusion

This is the most important question for expats: Should I use FTC or FEIE?

Feature	Foreign Tax Credit (FTC)	Foreign Earned Income Exclusion (FEIE)
How it works	Credit for foreign taxes paid	Excludes income from U.S. taxation
Income limit	Unlimited	$126,500 (2025)
Income types covered	All: earned + passive (dividends, interest, capital gains)	Earned income only (wages, self-employment)
Best for	High earners, high-tax countries, passive income	Low/moderate earners, low-tax countries, earned income only
Form required	Form 1116	Form 2555
Self-employment tax	Owe on full amount	Owe on full amount
Complexity	More complex (categories, limitations)	Simpler
Roth IRA eligibility	Yes (if you have taxable income)	No (if you exclude all income)
Can combine?	Yes, but not on same income	Yes, but not on same income

When to Choose FTC:

You earn more than $126,500 (FEIE limit)
You live in a high-tax country (UK, Germany, France, Canada, Australia, Nordic countries)
You have significant passive income (dividends, interest, rental income, capital gains)
You want to contribute to a Roth IRA (requires taxable income)
You want to claim Child Tax Credit (better with FTC than FEIE in most cases)

When to Choose FEIE:

You earn under $126,500
You live in a low-tax or zero-tax country (UAE, Qatar, Bahamas, Monaco)
You have only earned income (wages or self-employment)
You want simplicity (FE IE is easier to calculate and file)

How Does the Foreign Tax Credit Work?

The FTC allows you to credit foreign income taxes against your U.S. tax liability, but there are limitations and rules:

1. Qualified Foreign Taxes

To qualify for the FTC, the foreign tax must meet all four of these tests:

Legal and actual liability: You must be legally liable for the tax and actually paid or accrued it
Income tax (or in lieu of): It must be an income tax or a tax in lieu of an income tax
Imposed by a foreign country: Must be imposed by a foreign country or U.S. possession, not a U.S. state
Not for specific economic benefit: The payment cannot purchase a specific economic benefit

Taxes that qualify:

Foreign income tax on wages
Foreign income tax on dividends, interest, capital gains
Foreign self-employment tax (if it's an income tax, not social security)
Withholding taxes on passive income

Taxes that do NOT qualify:

Foreign sales taxes, VAT, GST
Foreign property taxes
Foreign social security taxes (e.g., UK National Insurance, German social security)
Taxes on excluded income (if you use FEIE on that income)
Taxes paid to sanctioned countries (e.g., North Korea, Iran)

2. The FTC Limitation

You cannot credit more foreign tax than the U.S. tax on your foreign income. The limitation formula is:

FTC Limit = (Foreign Source Income ÷ Worldwide Income) × Total U.S. Tax

Example: Sarah has $100,000 of foreign income and $20,000 of U.S. income. Her total income is $120,000. Her total U.S. tax (before FTC) is $24,000. Her FTC limitation is:

($100,000 ÷ $120,000) × $24,000 = $20,000

If Sarah paid $25,000 in foreign taxes, she can only credit $20,000 this year. The remaining $5,000 can be carried forward for up to 10 years.

3. Separate Income Categories

The IRS requires you to calculate the FTC limitation separately for two income categories:

Passive category income: Interest, dividends, rents, royalties, annuities, capital gains
General category income: All other income (wages, self-employment income, active business income)

This prevents you from using excess credits from one category to offset tax on another category.

Example: You have $50,000 of foreign wages (general category) taxed at 40% in your foreign country ($20,000 tax) and $50,000 of U.S. dividends (passive, no foreign tax). You must calculate FTC separately for each category. You cannot use the excess general category credits to offset tax on your U.S. passive income.

How to File Form 1116: Step-by-Step

To claim the Foreign Tax Credit, you must file Form 1116 with your Form 1040. You must file a separate Form 1116 for each income category (passive and general).

Part I: Taxable Income or Loss from Sources Outside the U.S.

Report foreign income by category (passive or general)
List country(ies) where income was sourced
Enter gross income and deductions

Part II: Foreign Taxes Paid or Accrued

List foreign taxes paid, by date
Specify country, type of tax, and amount
Convert foreign currency to USD using the exchange rate on the date paid

Part III: Figuring the Credit

Calculate the FTC limitation using the formula
Determine allowable credit (lesser of foreign taxes paid or the limitation)
Calculate carryback/carryforward if applicable

Part IV: Summary of Credits

Total credit from all categories
Transfer to Schedule 3 (Form 1040), line 1

FTC Carryback and Carryforward Rules

If your foreign taxes exceed the FTC limitation, you can:

Carry back 1 year: Apply excess credits to the prior year's return (file an amended return)
Carry forward 10 years: Apply excess credits to future years' returns

Important: Carrybacks and carryforwards must be applied within the same income category (passive or general).

Example: In 2025, you paid $40,000 in foreign taxes but your FTC limitation was $30,000. You have $10,000 of excess credits. You can:

Amend your 2024 return and apply some or all of the $10,000
Carry forward the excess to 2026-2035

Combining FTC and FEIE

You can use both the Foreign Tax Credit and the Foreign Earned Income Exclusion, but not on the same income.

Strategy: Exclude Earned Income, Credit Passive Income

A common strategy is to:

Exclude up to $126,500 of earned income using FEIE (Form 2555)
Claim FTC on passive income and any earned income over $126,500 (Form 1116)

Example: You earn $150,000 in wages and $30,000 in dividends while living in Germany. German tax on the full $180,000 is $60,000.

Exclude $126,500 of wages with FEIE
Claim FTC on the remaining $23,500 of wages + $30,000 of dividends = $53,500
The FTC will offset most or all of the U.S. tax on that $53,500

Warning: Once You Choose FTC, You're Locked In

If you claim the FTC, you generally cannot switch to FEIE for 5 years without IRS approval. Choose carefully based on your expected income over the next several years.

FTC for Self-Employed Individuals

If you're self-employed abroad, here's how FTC applies:

Foreign income tax: You can claim FTC for foreign income tax you paid on self-employment income
Social security taxes: Foreign social security taxes generally do not qualify for FTC
U.S. self-employment tax: You still owe U.S. self-employment tax (~15.3%), even if you claim FTC (FTC only offsets income tax, not SE tax)

Exception: If you're covered by a Totalization Agreement (e.g., living in Germany, UK, Canada), you may only pay into the foreign country's social security system and not owe U.S. SE tax.

FTC and State Taxes

The Foreign Tax Credit only applies to federal income tax. It does not help with state taxes. As explained in Do Expats Pay State Taxes, you must establish domicile in a zero-tax state to eliminate state tax obligations.

If you're domiciled in California or New York and claim FTC on your federal return, you'll still owe state tax on your worldwide income (though some states allow a partial credit for foreign taxes).

Solution: Establish domicile in Florida, Texas, Nevada, or another zero-tax state before moving abroad. See Best States for Tax Domicile.

FTC for Specific Countries

High-Tax Countries (FTC Usually Better):

Denmark, Sweden, Finland: ~50-55% tax rates
France, Belgium: ~45-50%
Germany, Austria: ~42-45%
UK, Ireland: ~40-45%
Canada, Australia: ~33-45%

In these countries, foreign taxes often exceed U.S. tax liability, so FTC eliminates all U.S. tax.

Low/Zero-Tax Countries (FEIE Usually Better):

UAE, Qatar, Bahrain: 0% income tax
Monaco, Andorra: 0% income tax
Singapore: ~0-22% (progressive)
Hong Kong: ~0-17%
Thailand (certain visas): Territorial taxation

In low/zero-tax countries, you pay little or no foreign tax, so FTC provides no benefit. FEIE is better.

Moderate-Tax Countries (Analyze Both):

Spain, Italy, Portugal: ~24-43%
Mexico: ~1-35% (progressive)
Costa Rica: ~0-25%

In moderate-tax countries, compare FTC vs. FEIE based on your specific income level.

FTC and Tax Treaties

The U.S. has income tax treaties with over 60 countries. Tax treaties can:

Reduce foreign withholding taxes on passive income (dividends, interest)
Determine which country has primary taxing rights on specific income
Provide "tie-breaker" rules if you're considered a resident of both countries

FTC and treaties: If a treaty reduces your foreign tax (e.g., from 30% withholding to 15%), your FTC is based on the reduced amount actually paid.

See IRS: U.S. Income Tax Treaties.

Frequently Asked Questions (FAQ)

Can I claim FTC if I didn't pay foreign taxes?

No. FTC is a credit for foreign taxes actually paid. If you live in a zero-tax country, you cannot claim FTC (use FEIE instead).

Can I claim FTC on taxes I haven't paid yet but accrued?

Yes, if you use the accrual method of accounting. Most individuals use the cash method and can only claim FTC on taxes actually paid during the year.

What if I paid foreign tax on income I excluded with FEIE?

You cannot claim FTC on foreign taxes paid on income you excluded with FEIE. You must choose one or the other for each dollar of income.

Can I use FTC for foreign property taxes?

No. FTC only applies to foreign income taxes, not property taxes, sales taxes, or VAT.

What if my foreign tax return is on a different calendar year?

You claim FTC based on the foreign taxes paid during your U.S. tax year (Jan 1 - Dec 31), regardless of what foreign tax year they relate to.

Can I deduct foreign taxes instead of crediting them?

Yes, you can choose to deduct foreign taxes as an itemized deduction on Schedule A instead of claiming FTC. However, a credit is almost always more valuable than a deduction.

Do I need receipts to claim FTC?

Yes. You should keep foreign tax returns, payment receipts, withholding statements, and any other documentation showing foreign taxes paid. The IRS may request these in an audit.

What if I paid taxes to multiple countries?

You can claim FTC for taxes paid to multiple countries. Report each country separately on Form 1116.

Can I claim FTC on taxes my employer withheld?

Yes. Foreign tax withholding by your employer counts as taxes you paid.

What exchange rate do I use?

Use the exchange rate on the date you paid the foreign tax (for cash-basis taxpayers). See IRS Yearly Average Exchange Rates.

Final Thoughts

The Foreign Tax Credit is often a better choice than the Foreign Earned Income Exclusion for Americans living in high-tax countries or earning over $126,500. By claiming a dollar-for-dollar credit for foreign taxes paid, you can reduce or eliminate your U.S. tax liability while maintaining eligibility for Roth IRA contributions and the Child Tax Credit.

Key takeaways:

FTC is a dollar-for-dollar credit for foreign income taxes paid
No income limit (unlike FEIE's $126,500 limit)
Applies to all income types: earned and passive
Best for high earners in high-tax countries
Use FEIE in low-tax countries where you pay little foreign tax
Can combine FTC and FEIE, but not on the same income
File Form 1116 with your tax return
Excess credits can be carried back 1 year or forward 10 years
Does not eliminate state taxes—establish domicile in a zero-tax state

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Foreign Tax Credit (FTC) 2025: Complete Guide vs FEIE Comparison