FEIE vs Foreign Tax Credit: which should Americans in the UK choose?

This is the decision that shapes most Americans' US returns from the UK. Both reliefs stop the same income being taxed twice; they do it differently, and the differences compound over years.

Short version

For most people working in the UK the Foreign Tax Credit is better. The exclusion can win for lower earners whose UK tax is modest, or where simplicity matters more than optimisation and there is no investment income or desire to fund an IRA.

What each does

The exclusion (Form 2555) removes up to US$130,000 (2025) of foreign earned income from your US taxable income. It applies only to wages and self-employment income, it has a hard cap, and it needs the bona fide residence or physical presence test.

The credit (Form 1116) reduces your US tax, dollar for dollar, by UK income tax paid, up to the US tax attributable to the foreign income in each basket. It applies to all income types, has no cap, and unused credit carries back one year and forward ten.

Ten points of difference

1. Investment income. The exclusion cannot cover UK dividends, interest or gains. The credit can, within the passive basket.
2. IRA contributions. Contributions need US taxable compensation. Exclude all your earnings and you have none. The credit leaves your compensation in the base even when the net tax is nil.
3. The stacking rule. Excluded income still sets the rate on everything else, so remaining income is taxed as though the excluded amount were there. The credit has no equivalent.
4. Income above the cap. A £150,000 salary is roughly US$190,000; US$60,000 of it is outside the exclusion and taxed at stacked rates. The credit has no cap.
5. Self-employment tax. Neither relief touches the 15.3%. The US–UK Totalization Agreement and an HMRC certificate of coverage do.
6. Carry-forwards. The exclusion produces none. Excess credit carries forward ten years and can shelter later gains.
7. Child Tax Credit. Using the exclusion generally removes the refundable Additional Child Tax Credit for the year; the credit route preserves it.
8. Complexity. Form 2555 is simpler than Form 1116 with its baskets and limitation. The extra work is usually worth it.
9. Changing your mind. Revoking the exclusion locks you out for five years without IRS consent. The credit is claimed year by year.
10. Pensions and NIIT. The exclusion does nothing for pension income and does not reduce modified AGI for Net Investment Income Tax. The credit integrates better with both, although foreign tax cannot be credited against NIIT itself.

Worked example: £120,000 salary, single filer, 2025

Assume roughly US$152,000 of salary and about US$48,000 of UK income tax at typical exchange rates.

Exclusion. US$130,000 excluded; after the standard deduction about US$6,250 remains, taxed under the stacking rule at the rates that apply above US$130,000. Rough US tax: around US$1,500. No credit for the UK tax, no IRA contribution.

Credit. US tax before credit on US$152,000 is in the region of US$25,500. The UK tax of US$48,000 exceeds it, so the US tax is nil and roughly US$22,000 of credit carries forward. IRA contribution still permitted.

The numbers are approximate and ignore state tax, NIIT and other credits; the estimator runs your own figures.

When the exclusion may still be right

• You live and work somewhere with little or no income tax (not the UK).
• Your earnings are modest, UK tax is low because of the personal allowance, and you have no investment income or IRA plans.
• You already elected the exclusion years ago and the modelling shows the five-year lock-out makes switching unattractive.

Using both

You can exclude earned income and credit UK tax on other income, but you cannot credit UK tax on income you have excluded. Whether the combination beats credit-only depends on the figures and needs to be modelled, not assumed.

Our approach

We model both routes for every new client before the first return is filed, write down the reasons for the choice, and revisit it when circumstances change.