US Worldwide Taxation and the Burden on Americans Abroad
The United States is one of only two countries in the world (along with Eritrea) that taxes its citizens and permanent residents on worldwide income regardless of where they live. An American living and working in Germany, earning only German income, pays both German tax and US tax — and must file US tax returns every year, even if no US tax is ultimately owed after foreign tax credits. This worldwide taxation system creates significant compliance burdens and occasionally double-taxation risk for Americans abroad.
The Foreign Earned Income Exclusion (FEIE) under Section 911 allows qualifying US citizens and residents abroad to exclude up to $126,500 (2024, indexed) of foreign earned income from US taxable income. To qualify, the taxpayer must either pass the bona fide residence test (established residence in a foreign country for a full tax year) or the physical presence test (330 days outside the US in any consecutive 12-month period). The FEIE covers only earned income — wages and self-employment income. It does not cover investment income (dividends, interest, capital gains), which remains fully taxable to US persons abroad.
The Foreign Tax Credit (FTC) under Section 901 allows a dollar-for-dollar credit against US tax for income taxes paid to foreign governments on income that is also taxable to the US. The FTC is generally more valuable than the FEIE for high-income expatriates in high-tax countries because it eliminates double taxation directly rather than just excluding income. The FEIE and FTC cannot both apply to the same income — taxpayers must choose, and the optimal choice depends on the comparison between foreign and US effective rates.