Tax professionals increasingly encounter clients who earn income abroad through employment, consulting or investments. Understanding how to classify and treat that income under U.S. tax law is vital for minimizing double taxation and ensuring compliance with tax requirements.
The global scope of U.S. tax obligations
The U.S. applies a worldwide taxation system; all income of U.S. persons (citizens, green card holders and those meeting the substantial presence test) must be reported, regardless of where it is earned. This creates potential double taxation in cases where foreign jurisdictions and the U.S. both tax the same income.
To mitigate this, two primary tools are available:
- The foreign tax credit (FTC), claimed on Form 1116, Foreign Tax Credit (Individual, Estate, or Trust)
- The foreign earned income exclusion (FEIE), claimed on Form 2555, Foreign Earned Income
FTC principles
The FTC allows a dollar-for-dollar credit for foreign income taxes paid, but only for taxes imposed on foreign-source income. Not all foreign levies qualify. To be eligible for the credit, the tax must meet certain conditions, including being an income tax imposed on net gain and attributable to the foreign jurisdiction.
Key limitations include:
- Per-country basket rules: Income is categorized into baskets such as passive, general, branch and GILTI. Credits can offset U.S. tax only within the same basket.
- An overall limitation formula caps the credit based on the ratio of foreign-source taxable income to total taxable income.
FEIE eligibility and pitfalls
The FEIE allows up to $130,000 (2025) of earned income to be excluded from taxable income. This applies to earned income only; wages or professional fees qualify, while passive income such as dividends or interest do not.
To claim the exclusion, a taxpayer must:
- Establish a tax home in a foreign country, and
- Meet either:
- The bona fide residence test, which considers intent, integration into the community and duration of stay (typically an entire year)
- The physical presence test, requiring at least 330 full days of presence in a foreign country during a flexible 12-consecutive-month period
Tax practitioners must recognize situations where a taxpayer, despite living abroad, cannot claim the FEIE if their abode remains in the U.S.
Foreign housing exclusion
The foreign housing exclusion allows certain taxpayers to exclude qualifying housing costs above a statutory floor (16% of the FEIE limit) and below a ceiling (30% of the FEIE limit). For example, the 2025 housing cost ceiling for Paris is $180 per day.
Only employer-provided amounts qualify for the foreign housing exclusion; self-employed individuals may claim a deduction instead. Common eligible expenses include rent, utilities, insurance and parking, but not furniture or capital expenditures.
Example scenario
Consider Jake, a U.S. citizen who has worked in France for over a year. Jake pays rent, utilities and parking and receives both wages and dividends.
In Jake’s case:
- He likely qualifies under the physical presence test but not the bona fide residence test
- Most housing costs would qualify for exclusion, excluding furniture
- Dividends would not qualify for FEIE but may be eligible for FTC under the passive basket
Properly applying these rules ensures accuracy and reduces client liability.
Learn more about foreign tax planning
To find out which of these options your clients will qualify for, and which may be most beneficial for their tax situation, check out our upcoming webinar, Credits & Exclusions for Foreign-Sourced Income. Gain practical insights on when to claim Form 2555 versus Form 1116, navigate basket limitations and help clients minimize double taxation while remaining compliant.
Information included in this article is accurate as of the publish date. This post is not reflective of tax law changes or IRS guidance that may have occurred after the date of publishing.