You Earned it Abroad. Now Who Gets to Tax it?

One of the first questions every American working outside the United States asks is: do I really have to pay US tax on income I earned and already paid tax on in another country? The short answer is yes — you are required to file a US tax return regardless of where you live or work. But the longer answer is more nuanced, and there are legitimate mechanisms designed to reduce or eliminate the double taxation that would otherwise result.

The two primary tools are the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC). They are not interchangeable, they cannot always be combined, and choosing between them — or structuring how you use both — is one of the most consequential tax decisions a US-Connected Person living abroad will make.

The Foreign Earned Income Exclusion (FEIE)

The FEIE allows qualifying US persons to exclude a set amount of foreign earned income from US taxation. For 2024, the exclusion amount is $126,500 — adjusted annually for inflation. If you also pay housing costs abroad, a Foreign Housing Exclusion or Deduction may allow you to exclude additional amounts.

To qualify, you must meet one of two tests:

• Bona Fide Residence Test: You have established a genuine, ongoing residence in a foreign country — typically demonstrated by living there for a full calendar year with no intent to return to the US permanently in the near term.

• Physical Presence Test: You were physically present in a foreign country for at least 330 full days in any consecutive 12-month period.

The FEIE sounds straightforward. In practice, it carries some significant hidden costs that are easy to overlook:

• The 'tax bracket stacking' effect: excluded income still occupies the lower rungs of the US tax bracket ladder. Your non-excluded income gets taxed as if the excluded income sits below it, often at higher rates than you'd expect.

• Self-employment tax: the FEIE does not exclude income from self-employment tax. If you're self-employed abroad, you may still owe 15.3% SE tax on your excluded income.

• Retirement contribution limitations: FEIE income is not 'earned income' for IRA contribution purposes. If all your income is excluded, you may not be able to contribute to a traditional or Roth IRA.

The Foreign Tax Credit (FTC)

The Foreign Tax Credit allows you to offset your US tax liability with taxes paid to a foreign government — dollar for dollar, up to the amount of US tax attributable to that foreign income. It's claimed on Form 1116 and is generally more valuable than the FEIE for people in high-tax jurisdictions.

For US-Connected Persons in Hong Kong, this is where things get complicated.

Hong Kong's income tax rates — Salaries Tax — are significantly lower than US federal rates. This means the Foreign Tax Credit often doesn't fully offset US tax liability, leaving a residual US tax bill on income that has already been taxed in Hong Kong.

The FTC is also subject to a basket system that separates different categories of income. You cannot use excess credits from one basket (say, passive income) to offset tax in another (general income). Excess credits can be carried back one year or forward ten — but for many expats in low-tax jurisdictions, the carryforward just accumulates without ever being usable.

FEIE vs. FTC: Which Should You Choose?

The answer depends on your specific income level, the tax rates in your country of residence, whether you have self-employment income, and your retirement planning goals. As a general framework:

• High-tax jurisdictions (Germany, UK, Japan): FTC often eliminates US tax liability entirely, making it the preferred choice.

• Low-tax jurisdictions (Hong Kong, UAE, Singapore): FTC may not fully offset US liability; FEIE may shelter more income, but at the cost of SE tax and IRA contribution limitations.

• Mixed situations: some taxpayers use FEIE for earned income and FTC for passive income — but coordination is complex and requires careful planning.

Making the wrong election — or switching between them without understanding the consequences — can result in owing taxes you wouldn't otherwise owe. The election to revoke the FEIE, in particular, comes with a five-year lockout before you can re-elect it.

The Bigger Picture

The existence of the FEIE and FTC reflects a genuine congressional acknowledgment that citizenship-based taxation creates real double taxation risks. But the mechanisms provided to address it were designed decades ago for a simpler world of single-country employment and straightforward salary income. They were not designed for the reality of internationally mobile professionals with complex income streams, equity compensation, and multi-country tax exposure.

Navigating them well requires proactive planning — not just annual tax preparation. The choices made in year one have compounding effects that play out over a career.

Next in the series: why the investment products your non-US colleagues use freely can become a tax nightmare the moment a US person touches them. We'll dig into PFICs — the foreign fund trap.