The 2025/2026 expat tax framework
Three federal mechanisms reduce US tax for Americans living abroad:
- Foreign Earned Income Exclusion (FEIE): $130,000 in 2025 (up from $126,500 in 2024), indexed annually. Excludes qualifying foreign EARNED income (wages, salary, self-employment income) from US taxable income. Filed on Form 2555.
- Foreign Housing Exclusion / Deduction: amount above 16% of FEIE base, up to 30% of FEIE (capped at higher amounts in designated high-cost cities). Employees get an exclusion; self-employed get a deduction.
- Foreign Tax Credit (FTC): dollar-for-dollar US tax credit for FOREIGN income tax actually paid. Filed on Form 1116. Available on any type of income (earned or unearned) without the 330-day test.
Key rule: cannot stack FEIE and FTC on the SAME income. If you exclude $130K via FEIE, you cannot also claim FTC on that $130K. But you CAN use FEIE on the first $130K of wages and FTC on wages above the cap. You CAN also use FTC on non-wage income (dividends, interest, capital gains, rental) regardless of whether you also use FEIE on your wages.
Worked example: $150,000 salary in the UK (UK income tax ~£38,000 on that figure).
- FEIE: exclude $130,000. Taxable US income: $20,000. US tax before credit: roughly $2,200.
- FTC: claim foreign UK tax paid on the $20,000 not excluded by FEIE. UK tax on that slice: roughly $7,600 (40 percent marginal). US tax of $2,200 is fully covered. Excess FTC of about $5,400 carried forward.
- Net US tax owed: $0.
Non-FEIE alternative (pure FTC): claim FTC on the full $150,000. US tax before credit ~$25,000. UK tax paid on $150K: roughly $38,000. FTC fully covers US tax. Excess $13,000 carries forward 10 years.
For a UK resident, both approaches yield $0 US federal tax; FTC builds a bigger carryforward but FEIE is simpler to claim and reduces AGI for other thresholds.
Physical Presence Test vs Bona Fide Residence
To use FEIE you must pass either PPT or Bona Fide Residence.
| Physical Presence Test (PPT) | Bona Fide Residence Test |
|---|---|
| 330 full days in a foreign country during any consecutive 12-month period. | Established residence in a foreign country for an entire uninterrupted tax year (Jan 1 to Dec 31). |
| A "day in a foreign country" means a full 24-hour day, beginning at midnight foreign-country time, that you were physically present. | "Bona fide" means real intent to live there indefinitely. Renting an apartment, having a foreign driver license, family with you, paying foreign taxes as a resident. |
| Transit through a foreign country (less than 24 hours) does NOT count. | Short trips back to the US are allowed without forfeiting (unlike PPT 35-day cap). |
| Days in international airspace or international waters do NOT count. | Cannot use Bona Fide on the year you arrive or leave (only complete tax years). |
| Even ONE day over the 35-day US-presence allowance forfeits the test for the entire 12-month period. | Tax treaty residence is helpful evidence (tie-breaker rules in US/UK, US/AU, US/CA, etc.). |
| The 12-month period need not align with the calendar year; choose the most favourable window. |
Which is better?
- New expats year 1: use PPT (need 330 days; can pick a 12-month window straddling the move date)
- Established expats: use Bona Fide (allows more US visits)
- Frequent travellers / digital nomads without a fixed foreign home: PPT only (Bona Fide requires established foreign residence)
Form 2555 has separate sections for each test.
| Country | Foreign tax rate | Best strategy | Why |
|---|---|---|---|
| UAE | 0% | FEIE | No foreign tax to credit |
| Singapore | ~12% | FEIE + FTC mix | FTC available; FEIE on first $130K |
| UK | 20-45% | FTC | High UK tax wipes out US owed; FEIE wastes UK credits |
| Australia | 19-45% | FTC | High AU tax + Totalization for SE |
| Canada | 15-33% | FTC | Combined fed + prov is high |
| India | 5-30% | FEIE + FTC mix | Low rate at low income; FTC at high |
| Germany | 14-45% | FTC | Very high effective; carries forward 10 yrs |
| Spain / Portugal | ~25% | FEIE + FTC mix | Depends on income; PT NHR was eliminated 2024 |
Foreign Tax Credit deep dive (Form 1116)
FTC is more complex than FEIE but works on a wider range of income.
| Qualifying foreign taxes | Passive vs general category | FTC limitation formula (per category) |
|---|---|---|
| Foreign income tax actually paid or accrued | Passive: dividends, interest, capital gains, rental income, royalties | Maximum FTC = (Foreign source taxable income in category) / (Total worldwide taxable income) x US tax on total worldwide income |
| Cannot be refunded | General: wages, salary, self-employment income, business income | Excess foreign tax over the limit can be carried back 1 year or forward 10 years |
| Cannot be in lieu of US tax already excluded under FEIE | Cannot mix; FTC limit calculated SEPARATELY for each category on Form 1116 |
Worked example: high-tax country (UK), high-income expat.
- Worldwide income: $250,000 ($200K UK wages + $50K UK dividends)
- UK tax: $80,000 wages, $7,000 dividends
- US tax before credit: $58,000 (rough)
- FTC general category: $200K / $250K x $58K = $46,400 limit. UK paid $80K. Carryforward $33,600.
- FTC passive category: $50K / $250K x $58K = $11,600 limit. UK paid $7K. No carryforward; can use entire $7K.
- Total FTC: $46,400 + $7,000 = $53,400
- US tax owed: $58,000 - $53,400 = $4,600
For most high-tax countries, FTC alone wipes out US tax. The general category often produces a huge carryforward that you cannot easily use unless you have other foreign-source income in a future year.
For zero/low tax countries (UAE 0%, Singapore avg 14%, Hong Kong 17%): FEIE is the only viable path because there is no foreign tax to credit.
Self-employment tax and Totalization Agreements
SE tax is the Social Security + Medicare equivalent for self-employed Americans. 15.3% on first $168,600 of net SE earnings (2025), then 2.9% Medicare above the cap. Plus 0.9% additional Medicare if combined income exceeds $200K single / $250K joint.
FEIE does NOT reduce SE tax. Even if your entire $130K foreign self-employment income is excluded from income tax, you still owe ~$20,000 in SE tax. This catches many freelancers and digital nomads off guard.
Totalization Agreements (TAs) are the only way to legally carve out SE tax. The US has TAs with 30+ countries including UK, Australia, Canada, Germany, France, Spain, Japan, South Korea, Brazil. Each TA covers Social Security; some also cover Medicare equivalent.
Under a TA, you pay social security in ONE country, not both. If you are self-employed in the UK and obtain a UK Certificate of Coverage (US-UK TA, document called "USA/UK 1A"), you are exempt from US SE tax. You attach the certificate to your US Form 1040 (with Form 8822-B or simple statement) and stop the SE tax bill.
Countries WITHOUT a TA with the US: UAE, Singapore, Hong Kong, India (TA negotiated since 2008 but not yet effective), most of the Middle East. Working as a self-employed American in these countries means double Social Security exposure (you may or may not have to pay the local social security, but you still owe US SE tax 15.3%).
A workaround for non-TA countries: incorporate a foreign company (e.g. UAE freelance license LLC), become an EMPLOYEE of that company, take W-2-equivalent wages. Then you qualify as a regular employee, not self-employed, and FICA depends on the foreign company's US obligations (usually none). This is a Big-4-tax-advisor strategy; expensive to set up but worth it for $150K+ income.
State residency: the expat trap
The IRS rules above are federal. State income tax is a separate problem.
Nine states have no income tax (FL, TX, TN, WA, NV, NH, SD, WY, AK). If you move abroad from one of these, no state tax issue.
The rest of the 41 states + DC have varying rules on continued tax residency after you leave. The aggressive states are:
- California: presumes continued domicile unless you sever 100+ factors (driver license, voter registration, gym membership, doctors, family ties, business ties). FTB audits aggressively. Average expat audit takes 18 months.
- New York: presumes continued domicile if you spent 4+ years in NY then moved out. Particularly tough on hedge fund / finance employees.
- Virginia: similar to CA. Continues to claim tax on worldwide income unless formally severed.
- New Mexico, South Carolina: similar but less aggressive.
Safe-harbor strategy:
1. Move to a no-tax state for 3-6 months BEFORE moving abroad. Establish FL or TX driver license, voter reg, dentist, bank, vehicle reg.
2. THEN move abroad. The departure is from no-tax state, not from CA/NY.
3. File a part-year resident return for the year of departure.
Who continues to pay state tax after moving abroad without severing
- "Statutory residents" who maintain a residence + spend more than 183 days in state in any year.
- "Domicile" residents who maintain ties (especially CA): state tax on worldwide income.
If you owe both federal AND state tax, you can use FEIE on federal but NOT on state (most states do not recognize FEIE). California specifically taxes the FEIE-excluded amount.
Action items
- Formally close residency in your high-tax state before crossing borders.
- File one final state return as part-year resident.
- Keep documentation: lease termination, utility transfers, new state ID, foreign country lease.
- Consider a 2-year buffer in a no-tax state before going abroad.
Run the math for your situation
Use our 🇺🇸 United States calculator to plug in your own numbers.