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OverviewFEIE limitsWhy the credit usually winsWorked comparisonSwitching between methodsCommon questionsOverview
US citizens abroad have two main ways to keep earned income from being taxed twice. The foreign earned income exclusion (FEIE, Form 2555) removes a capped amount of foreign earned income from US taxable income entirely. The foreign tax credit (FTC, Form 1116) leaves the income on the return and credits foreign income tax paid against the US tax on it.
The same tax cannot do both jobs
The IRS does not allow a foreign tax credit for taxes on income excluded under the foreign earned income exclusion.
- Income exclusionCheck qualifying foreign earned income and the exclusion rules.
- Foreign tax creditCheck eligible foreign tax and the income it relates to.
Both work. The question is which fits a resident of a country that charges real income tax, and for most people settled in Portugal the credit wins. This guide explains why, and where the exceptions live.
FEIE limits
For tax year 2026 the maximum exclusion is $132,900 per qualifying person, adjusted annually for inflation. A housing exclusion can sit on top for renters with qualifying housing costs: for 2026 the base amount is $21,264, with expenses above the base excludable up to a general cap of $39,870, higher in some designated cities.
Qualifying requires the bona fide residence test or the physical presence test. A settled Portuguese resident with a lease, a NIF, and a life here typically passes bona fide residence without difficulty after the first full year.
Worked example
Maya, a bona fide resident of Porto, earns the equivalent of $150,000 in salary, a round figure for illustration, and measures it against the 2026 exclusion cap.
The $17,100.00 above the cap stays taxable in the US and can only be relieved by crediting Portuguese tax, which is one reason higher earners in Portugal usually skip the exclusion and use the credit for everything.
Why the credit usually wins
The FEIE was designed with low-tax and no-tax postings in mind. Portugal charges progressive income tax at rates that meet or exceed US rates across most of the income range, and that changes the calculus.
- The credit scales without a cap. The exclusion stops at $132,900 of earned income. The credit applies to all of it, and to income the FEIE never touches, such as dividends, interest, rent, and pensions.
- Excess credit banks. When Portuguese tax exceeds the US tax on the same income, which is common, the surplus carries back one year and forward ten. The exclusion builds no such cushion.
- Refundable child tax credit survives. Income excluded under the FEIE cannot support the additional child tax credit. Families using the FTC frequently receive it; families on the FEIE generally cannot.
- IRA contributions need included income. Excluded income does not count as compensation for IRA purposes. Exclude everything and you may be unable to contribute.
Worked comparison
Take a freelancer in Lisbon with the equivalent of $110,000 in self-employment profit, taxed in Portugal at normal progressive rates, no special regime.
| FEIE route | FTC route | |
|---|---|---|
| US taxable earned income | Roughly zero, income sits under the cap | Full amount reported |
| US tax before relief | Near zero | Computed normally |
| Relief applied | Exclusion | Credit for Portuguese tax, which at these income levels typically exceeds the US tax |
| US tax after relief | Zero on earned income | Zero, with excess credit carried forward |
| Left behind | No carryover, no ACTC, no IRA compensation | Credit carryover banked, ACTC and IRA eligibility preserved |
Both routes reach zero US tax on the earned income. The credit route reaches it while leaving options open, which is the general pattern from Portugal. Note that neither tool touches US self-employment tax; that question is settled by the totalization agreement, covered in the dual filing guide.
Switching between methods
The choice is stickier than it looks. Using the FEIE is an election that continues year to year. If you revoke it, or effectively abandon it by switching to the credit, you generally cannot re-elect the exclusion for five tax years without IRS consent. Moving from the credit to the exclusion is easy; the expensive direction is leaving the exclusion and wanting it back.
The practical advice for new arrivals in Portugal: do not default onto the FEIE because an online tool suggested it. Model both in your first filing year, since the first election shapes the next five.
Common mistakes
- Defaulting onto the FEIE because software suggested it. The election continues year to year, and leaving it generally locks you out of re-electing for five years; model both routes in your first filing year.
- Excluding everything, then funding an IRA. Excluded income does not count as compensation for IRA purposes, so a full exclusion can leave you unable to contribute.
- Expecting the FEIE to cover investment income. It applies to earned income only; dividends, interest, rent, and pensions rely on the credit no matter which route you elect for earnings.
- Giving up the refundable child tax credit. Income excluded under the FEIE cannot support the additional child tax credit, while families on the FTC frequently receive it.
- Thinking either tool touches self-employment tax. Neither does; that question is settled by the totalization agreement covered in the dual filing guide.
Common questions
Can I use both in the same year?
Yes, on different income. People near the cap sometimes exclude up to the limit and credit foreign tax on income above it, though the credit is then reduced for the tax tied to excluded income. This split rarely beats a clean FTC position from Portugal.
Does the FEIE cover my dividends and rental income?
No. It applies to earned income only, meaning wages and self-employment income. Investment income relies on the credit regardless of what you do with earnings.
Which route is less paperwork?
They are comparable. Form 2555 wants travel and residence detail; Form 1116 wants foreign tax detail by basket. Since your Portuguese assessment already itemizes tax paid, the credit's paperwork mostly writes itself.
I used the FEIE for years before moving to Portugal. Should I switch?
Quite possibly, and this is exactly the five-year-rule decision worth professional eyes. If Portugal remains your long-term base, the credit usually serves better from here on.
Sources
- IRS, tax year 2026 inflation adjustments (foreign earned income exclusion $132,900; housing amounts) and Form 2555 instructions (checked August 2026)
- IRS, Form 1116 instructions and foreign tax credit carryover rules
- IRS guidance on revoking the foreign earned income exclusion election
- Greenback Tax Services 2026 FEIE guide and KPMG 2026 inflation adjustment alert (checked August 2026)
This guide is general information, not personalised tax advice. Rules and rates change, and your facts can move you off the defaults described here. Confirm your position with a qualified professional before acting on it.