Don’t claim the same income twice: using Form 2555 and Form 1116 the right way

Navigating foreign income rules can be tricky, especially when deciding whether to use the foreign earned income exclusion (FEIE) or the foreign tax credit (FTC). If you misapply either, it could mean trouble with the IRS or missed savings for your clients.

With the right approach, you can determine which option works best for each situation and make sure everything is reported correctly the first time.

Below, you’ll find a few of the top questions from a recent webinar on the topic and their corresponding answers. If you choose to attend the on-demand version of this webinar, you can access the full recording and the entire list of Q&As.   

Q: Can Form 2555, Foreign Earned Income, and Form 1116, Foreign Tax Credit (Individual, Estate, or Trust), be used together?

A: Yes, but not on the same income. If you exclude income with Form 2555 (FEIE), you cannot also use it for the foreign tax credit on Form 1116 on the same income. You can, however, use the credit for any remaining eligible foreign income that is not excluded.

Q: If someone arrives in a foreign country in October, when can the 12-month test start?

A: The 12-month period can start on or after the date of arrival; so if they arrive on Oct. 1, the test could begin that day or any later date that allows 330 full days abroad. It doesn’t have to follow the calendar year.

Q: For married filing joint taxpayers, do both spouses need foreign earned income to claim the full $260,000 FEIE?

A: Yes. Each spouse must independently qualify for and claim the FEIE, and each must file their own Form 2555. Only then can they take the full combined exclusion amount of $260,000.

Q: Can you prorate the FEIE if the taxpayer under the physical presence test if taxpayer only spent 320 days abroad?

A: No, the 330-day rule under the physical presence test is strict. Missing it by even one day disqualifies the taxpayer (unless they meet the bona fide residence test instead).

Q: If a U.S. citizen living abroad marries a citizen of another country, does the non-U.S. spouse need to file a U.S. tax return?

A: Only if the couple elects to file jointly. Otherwise, the U.S. citizen can file as married filing separately. The non-U.S. spouse isn’t required to file U.S. taxes unless they have U.S.-source income or make the joint-file election.