Overview
If you have foreign-source income — whether from working abroad, a foreign pension, or investment income taxed by another country — the US offers two main tools to avoid being taxed twice on the same income: the Foreign Tax Credit (FTC) and the Foreign Earned Income Exclusion (FEIE). They work differently, apply to different types of income, and choosing the wrong one (or failing to choose deliberately) can cost real money.
Why It Matters
This page is the bridge between National and International tax planning. Retirees who are purely US-based generally don't need either tool. But the moment you have foreign pension income, foreign investment income, or you're doing any work while abroad, understanding which mechanism applies — and that they can't both be used on the same dollar of income — becomes essential.
How It Works
Foreign Earned Income Exclusion (FEIE):
- Only applies to earned income — wages, self-employment income. It does NOT apply to pensions, Social Security, retirement account distributions, dividends, interest, capital gains, or rental income.
- To qualify, you must pass either the Bona Fide Residence Test or the Physical Presence Test (330 full days outside the US in any 12-month period).
- For 2026, up to $130,000 of qualifying foreign earned income can be excluded from US taxation.
- Because most retirement income (pensions, IRA distributions, Social Security) is NOT earned income, the FEIE is largely irrelevant for most retirees — it matters mainly if you're doing consulting or part-time work while living abroad.
Foreign Tax Credit (FTC):
- Applies to income taxed by a foreign country, regardless of whether it's earned or unearned — this is the relevant tool for most retiree income types (pensions, investment income, foreign wages).
- You claim a dollar-for-dollar credit against US tax for foreign tax already paid on the same income, via Form 1116.
- Unlike the FEIE, the FTC doesn't require passing a residency test — it's based on foreign tax actually paid.
- Excess credits (foreign tax paid beyond what offsets US tax) can sometimes be carried back one year or forward up to 10 years.
2026 Key Numbers
- FEIE exclusion amount: $130,000 (2026, inflation-indexed annually).
- FTC is claimed via Form 1116; the credit is limited to the US tax attributable to the foreign-source income — it can't offset US tax on US-source income.
Common Mistakes
- Assuming the FEIE applies to pension or retirement account income (it doesn't — that's the single most common misunderstanding retirees have about this topic)
- Using the FEIE and FTC on the exact same dollar of income (not permitted — you choose per income category)
- Not tracking foreign tax paid carefully enough to substantiate an FTC claim on Form 1116
- Assuming a tax treaty automatically eliminates double taxation without checking which credit/exclusion mechanism actually applies to your specific income type
Sources
- IRS — Foreign Earned Income Exclusion (irs.gov)
- IRS Form 1116 Instructions — Foreign Tax Credit
- Costa Luz Lawyers — US Expat Tax Guide for Spain 2026
This is general education, not personalized advice. FTC and FEIE elections are complex and country-specific — work with a cross-border tax specialist, especially if you have both earned and unearned foreign income.