Quick overview
Deciding between Form 2555 and Form 1116 is a common crossroads for U.S. citizens and resident aliens with foreign income. Use Form 2555 if you qualify to exclude foreign earned income (and possibly foreign housing amounts). Use Form 1116 if you paid foreign income taxes and want a dollar‑for‑dollar credit against your U.S. tax. Which is better depends on the type of income, foreign tax rates, your self‑employment status, and long‑term tax strategy.
Authoritative references: IRS Form 2555 and instructions (https://www.irs.gov/forms-pubs/about-form-2555) and IRS Form 1116 and instructions (https://www.irs.gov/forms-pubs/about-form-1116). For general consumer guidance on cross‑border taxes see Consumer Financial Protection Bureau resources on international tax issues.
How each form works (short)
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Form 2555 (Foreign Earned Income Exclusion): Claims the Foreign Earned Income Exclusion (FEIE) and, where eligible, the foreign housing exclusion or housing deduction. Applies only to earned income (wages, salary, self‑employment earnings) earned while meeting the bona fide residence test or the 330‑day physical presence test. The FEIE limit and housing exclusion are adjusted annually — check the IRS instructions for the current limits.
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Form 1116 (Foreign Tax Credit): Credits foreign income taxes you paid or accrued against your U.S. income tax on foreign‑source income. The credit is generally limited to the portion of U.S. tax attributable to foreign‑source taxable income and can be carried back one year and carried forward up to ten years if it can’t be used in the current year (see IRS Form 1116 instructions).
Key decision factors
- Type of income
- FEIE (Form 2555) applies only to earned income. Investment income (interest, dividends), pensions, and certain other passive income cannot be excluded with Form 2555 and are usually relevant to the credit calculation on Form 1116.
- Foreign taxes paid vs. foreign tax rate
- If you pay significant foreign income tax at a rate higher than your U.S. tax on that income, the foreign tax credit (Form 1116) often yields a greater tax benefit because it can offset U.S. tax on other income as well. If foreign tax rates are low or you pay little/no foreign tax, the FEIE (Form 2555) may be preferable.
- Self‑employment tax
- The FEIE does not exempt you from U.S. self‑employment tax (Social Security and Medicare) if you remain subject to U.S. self‑employment taxes. Form 2555 reduces income subject to income tax but generally not self‑employment tax — plan accordingly.
- Filing complexity and recordkeeping
- Form 1116 requires detailed documentation of foreign taxes paid, allocation of income by source, and may require computing separate limitation categories. Form 2555 requires proof of meeting the bona fide residence or physical presence tests and documentation of days abroad (travel logs, stamps, employer records).
- Interaction with tax treaties and total tax picture
- Tax treaties can change withholding and source rules; sometimes treaty positions, the foreign tax burden, or treaty benefits make one option better. Tax credits can also be used to offset U.S. tax on income you did not (and could not) exclude.
Practical rules and common misunderstandings
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You cannot exclude the same income on Form 2555 and then claim a foreign tax credit on that excluded income. The IRS treats excluded income as not subject to U.S. tax, so you generally cannot claim a credit for foreign taxes paid on income you excluded. (See IRS instructions for Forms 2555 and 1116.)
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You may, however, exclude some earned income and claim a credit on other foreign‑source income in the same year (for example, exclude wages with Form 2555 and claim credit on foreign tax paid on investment or business income not excluded).
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The FEIE applies only to earned income — excluding pension or investment income is not allowed under Form 2555.
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Form 2555 includes the foreign housing exclusion/deduction calculation for qualifying taxpayers; this can matter when housing costs abroad are significant.
Decision checklist (step‑by‑step)
- Identify the type(s) of your foreign income: wages/self‑employment vs. passive (interest, dividends), retirement, rental, capital gains.
- Determine whether you meet either the bona fide residence test or the physical presence test (330 full days in any 12‑month period).
- Add up foreign income taxes paid or accrued and estimate U.S. tax on that foreign income if not excluded.
- Compare outcomes:
- If you qualify for FEIE and excluding earned income reduces or eliminates your U.S. income tax on that income (and you have little foreign tax paid on that income), Form 2555 may be preferable.
- If you paid substantial foreign taxes (often at rates higher than your U.S. rate) or want to offset U.S. tax on non‑excluded foreign source income, Form 1116 may be better.
- Consider self‑employment tax exposure and whether Social Security totalization agreements apply to your situation.
- Revisit annually — the better option can change year to year based on income, foreign taxes paid, and changes in residence.
Examples (illustrative only)
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Example A (FEIE advantage): You are a U.S. citizen living abroad and earned $90,000 in wages, paid little or no foreign tax, and meet the physical presence test. Excluding the earned income under Form 2555 can materially reduce your U.S. taxable income.
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Example B (FTC advantage): You are a contractor in a country with a 30% income tax and paid $30,000 on $100,000 of income. Using Form 1116 to claim the foreign tax credit can eliminate most or all of the U.S. tax on that foreign income, while exclusion might forfeit valuable credit use for other foreign income.
Recordkeeping and documentation
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For Form 2555: keep travel calendars, passport stamps, employer letters, foreign wage statements, and proof of bona fide residence where applicable. If claiming the housing exclusion, retain rental agreements and receipts.
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For Form 1116: retain foreign tax returns, tax withholding statements, bills of assessment, and proof of taxes paid (bank transfers, receipts). You may need to substantiate taxes you claim if the IRS questions them.
Keep digital copies and organized folders; accurate records make either election defensible if audited.
Related FinHelp guides
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Our detailed guide to Form 2555 and the Foreign Earned Income Exclusion: Form 2555 – Foreign Earned Income
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Our guide to claiming the foreign tax credit: Form 1116 – Foreign Tax Credit
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How to qualify for the FEIE (tests and documentation): How to Qualify for the Foreign Earned Income Exclusion
Professional tips
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Run the numbers both ways before making an election: simulate your return with Form 2555 and with Form 1116 to see which reduces total U.S. tax (and consider future carryforwards of credits).
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If you’re self‑employed, factor in self‑employment tax and Social Security Totalization Agreements — in many cases FEIE won’t save you self‑employment tax.
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If you expect to repatriate or receive large non‑earned U.S. taxable income in future years, preserving foreign tax credits (by not excluding income) can sometimes be strategically valuable.
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When in doubt, ask a CPA or international tax advisor. In my practice, a short modeling exercise usually reveals a clear winner for most clients.
Frequently asked questions
Q: Can I use both forms in the same year?
A: You can file both forms on the same return but not for the same income. Income excluded by Form 2555 is generally not available for the credit on Form 1116.
Q: Can I carry unused foreign tax credits forward?
A: Yes. Unused foreign tax credits generally carry back one year and forward up to ten years (see IRS Form 1116 instructions).
Q: Does the FEIE remove my obligation to file a U.S. tax return?
A: No. Claiming the FEIE requires filing Form 2555 with your return and you must still file if your gross income meets filing thresholds. FEIE affects tax liability, not the filing requirement.
Final notes and disclaimer
This article summarizes practical differences between Form 2555 and Form 1116 and is intended for educational purposes only. Tax results depend on facts and circumstances; consult a qualified tax professional to apply these rules to your situation. For authoritative IRS guidance, see the instructions for Form 2555 and Form 1116.
Professional disclaimer: This content does not constitute tax advice. Contact a licensed CPA or tax attorney for personalized guidance.
