[EX-02] U.S. Taxes Abroad: FEIE vs. FTC

Why the Famous Exclusion Rarely Helps Retirees — and What Actually Does

Pillar: Overseas & Expat Retirement · Applies to: U.S. citizens/green-card holders retiring or semi-retiring abroad Last verified: August 2026 · Refresh cadence: Annual (figures) + event-driven (treaty and destination-regime changes are frequent) Related: [EX-01] Visas · [EX-03] FBAR/FATCA/PFIC · [EX-04] Healthcare Abroad · [EX-06] SS Abroad · ER-02 Roth Ladder · ST-03 Changing Domicile · TX-03 Sequencing

Not advice — and doubly so here. Cross-border tax stacks two legal systems and a treaty on top of each other. This page gives you the map; a cross-border CPA for your specific country pair is the territory.

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TL;DR

• The U.S. taxes citizens on worldwide income for life, wherever they live. Moving abroad changes where else you’re taxed, never whether the IRS is invited.
• The celebrated Foreign Earned Income Exclusion (FEIE) excludes only earned income — wages and self-employment ($132,900 in 2026 ✅). IRA withdrawals, Roth conversions, pensions, Social Security, dividends, and capital gains are not earned income. A pure retiree gets zero from FEIE.
• The retiree’s real tools are the Foreign Tax Credit (FTC), the tax treaty with the destination country, and — most powerful of all — doing the tax-heavy moves before you leave (Roth conversions, gain harvesting, state-domicile exit).
• Three ambushes to clear before booking flights: many countries don’t recognize Roth accounts as tax-free; foreign mutual funds/ETFs trigger the punitive PFIC regime ([EX-03]); and your former state may not consider you gone (ST-03).

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1. The Ground Rules: Citizenship-Based Taxation

• You file Form 1040 forever, reporting worldwide income, plus the disclosure stack: FBAR (FinCEN 114) once foreign accounts exceed $10k aggregate, and Form 8938 at higher thresholds ($200k/$300k single, $400k/$600k MFJ for bona fide foreign residents ◻️) — details and penalties in [EX-03].
• The destination country will usually tax you as a resident once you cross its residency test (commonly 183 days, sometimes vaguer “center of vital interests” tests) — on its definition of income.
• Double taxation is mitigated — not always eliminated — by the FEIE, the FTC, and the treaty. The trio interacts; the rest of this page is about choosing correctly.

2. FEIE (§911): What It Is and Why Retirees Should Mostly Ignore It

Mechanics: exclude up to $132,900 (2026 ✅, Rev. Proc. 2025-32 §3.39; $130,000 in 2025) of foreign-earned income per spouse, by qualifying under the Physical Presence Test (330 full days abroad in any 12-month window) or the Bona Fide Residence Test (a full calendar year of genuine foreign residence). A housing exclusion can stack on top. Elect it on Form 2555.

The catches, even for those with earned income:

• Stacking rule: excluded income still sets your bracket — the unexcluded remainder is taxed at the rates it would have reached. FEIE removes income, not progressivity.
• Excluded income isn’t compensation for IRA/Roth contribution purposes — exclude everything and you’ve disqualified your own retirement contributions.
• Self-employment tax is not excluded (totalization agreements, not FEIE, solve that — [EX-06]).
• Once revoked in favor of the FTC, FEIE can’t be re-elected for 5 years without IRS consent — the choice is sticky.

Who it’s actually for: Barista-FIRE and working-nomad types earning wages abroad, especially in low- or no-tax countries where there’s no foreign tax to credit. For them FEIE is excellent. For the retiree living on portfolio and pension income: it does nothing.

3. FTC (Form 1116): The Retiree’s Workhorse

Dollar-for-dollar credit against U.S. tax for income taxes paid to the foreign country, computed in baskets (passive vs. general), limited to the U.S. tax attributable to that foreign-source income, with a 1-year carryback / 10-year carryforward.

The pattern that emerges:

• Higher-tax destination (France, Spain, Germany, Netherlands): foreign tax ≥ U.S. tax on the same income → FTC wipes the U.S. bill; you effectively pay the higher of the two systems. Your planning energy belongs on the foreign return.
• Lower-tax destination (many territorial or remittance-based regimes): little foreign tax to credit → you pay the U.S. bill as if you’d never left, plus whatever local tax applies. FEIE-for-workers aside, “moving somewhere tax-free” does not make a U.S. citizen tax-free.
• Sourcing nuance: FTC offsets U.S. tax on foreign-source income. U.S.-source income (often including U.S. dividends and gains under sourcing rules, subject to treaty re-sourcing articles) may leave residual U.S. tax the FTC can’t touch — and the NIIT (3.8%) has historically resisted FTC offset, with recent treaty-based litigation (Christensen) opening a narrow, contested path ◻️. Budget for NIIT surviving.

The arithmetic, for an actual retiree

Couple, both 66, MFJ, living abroad. Income: $70,000 of IRA withdrawals plus $20,000 of qualified dividends. Standard deduction $35,500 (both 65+).

Start with what they’d owe as U.S. residents. Ordinary taxable income is $70,000 − $35,500 = $34,500; the $20,000 of dividends stacks on top and lands entirely inside the 0% LTCG band (TX-01).

	Amount
Tax on $34,500 of ordinary income	$3,644
Tax on $20,000 of qualified dividends (0% band)	$0
Total U.S. tax	$3,644

Now apply each tool:

Tool	Effect
FEIE	$0 benefit. It excludes foreign earned income. They have none — not one dollar of their $90,000 is earned.
FTC, higher-tax country (30%)	$27,000 of foreign tax; the credit wipes the $3,644 of U.S. tax; residual U.S. = $0. Total worldwide: $27,000.
FTC, lower-tax country (10%)	$9,000 of foreign tax; credit wipes the U.S. tax; residual U.S. = $0. Total worldwide: $9,000.

Two conclusions, and the second is the one nobody expects.

First, the FTC means you pay the higher of the two systems, never the lower — so a high-tax destination is a tax increase you cannot plan away.

Second: so is a low-tax one. Staying in the U.S. costs this couple $3,644. Moving to a country that taxes them at a modest 10% costs $9,000 — a $5,356 tax increase for moving somewhere “cheaper.” The U.S. already taxes a 65+ couple at this income level very lightly, because the standard deduction and the 0% capital-gains bracket do most of the work. There is no country you can move to that taxes this couple less than the United States does, and citizenship-based taxation means you can never fall below the U.S. floor anyway. Move abroad for cost of living, climate, healthcare, or family. Do not move abroad to cut your U.S. tax bill.

The contrast that shows who FEIE is actually for: the same $90,000, but as wages earned in a zero-tax country. Without FEIE the U.S. bill is $6,044; with it — the exclusion covers all $90,000 — the bill is $0. That is a real saving, and it belongs entirely to workers, not retirees.

4. Treaties: Who Gets First Bite of Retirement Income

The treaty’s pension, Social Security, and residual articles decide which country taxes each stream first — and they differ wildly by country pair:

• Social Security: some treaties assign it exclusively to the residence country (e.g., U.S.–Canada: taxable only in Canada, 85% inclusion), others exclusively to the U.S., others share. This single article can swing thousands a year — check it before choosing between two finalist countries.
• Private pensions / IRA withdrawals: commonly taxable in the residence country, sometimes with U.S. rights preserved. France is the famous outlier — its treaty effectively leaves U.S.-source retirement income and investment income to the U.S. with a full French credit, making France, counterintuitively, one of the most tax-gentle destinations for American retirees ◻️ (verify current protocol before relying).
• The savings clause: nearly every U.S. treaty lets the U.S. tax its own citizens as if the treaty didn’t exist, with listed exceptions. Read treaty benefits as constraints on the foreign country and as a specific exception list on the U.S. side — not as a general shield.
• Roth recognition is a treaty-by-treaty lottery: Canada (with a timely election) and, in practice, France and a few others respect Roth’s tax-free character; Spain, Germany, and many more do not — they tax Roth distributions (or even growth) as ordinary investment income. A Roth-heavy plan can be kneecapped by the destination choice alone.
• Destination regimes churn: Portugal’s famous NHR closed to most new applicants (succeeded by the narrower IFICI/“NHR 2.0” ◻️), Spain layers regional wealth taxes on worldwide assets, Italy sells a flat-tax regime, Greece and others court retirees with special rates. Treat any blog post older than a year as expired.

5. The Pre-Departure Playbook (Where the Real Money Is)

Most expat tax savings are captured before wheels-up:

1. Convert to Roth while U.S.-resident — if the destination won’t tax Roth (or you’ll return before drawing), conversions at U.S.-only rates beat conversions later under two systems. If the destination taxes Roth: reconsider the destination or the Roth strategy — in that order.
2. Harvest gains before establishing foreign residency — many countries tax your gains from original basis with no step-up on arrival (a few offer arrival step-ups ◻️ — worth shortlisting for). Realize at 0/15% U.S. rates first (TX-01).
3. Exit your state properly (ST-03): sever domicile before the big income years abroad, or sticky states may tax your worldwide income from Lisbon. Establishing a no-tax-state domicile (SD/FL/TX mail-forwarding residency is the classic nomad move) before departure is standard practice — and note that moving abroad does not by itself end state domicile. You must establish domicile somewhere, and “nowhere” defaults to the state you left.
   • The federal shield that applies once you succeed: under 4 U.S.C. §114, no state may tax the retirement income of a non-resident — IRA, 401(k), 403(b), 457, SEP — even though you took the deduction there ✅. So the state question for an expat retiree is entirely about being a non-resident, not about what you withdraw once you are one (ST-03 §5).
4. Restructure the portfolio: liquidate anything that would become a PFIC problem, confirm your U.S. brokerage’s policy on non-resident customers (many restrict or close accounts; some are expat-tolerant — [EX-05]), and keep buying U.S.-domiciled funds only.
5. Set the compliance calendar: automatic 2-month filing extension abroad (to June 15; interest still runs from April), quarterly estimateds continue, FBAR by October, and — if working — check whether a totalization agreement exempts you from double social-security tax ([EX-06]).
6. Mind §988 currency gains: paying off a foreign mortgage after the dollar strengthens creates taxable U.S. currency gain — the strangest ambush on this page.

6. The Only Exit: Renunciation, and What It Costs

§1 said the IRS is invited forever. There is exactly one door out, and it is expensive enough that most people who ask about it stop asking once they see the price.

Renouncing U.S. citizenship (or abandoning long-term permanent residence) ends citizenship-based taxation prospectively. But if you are a covered expatriate, §877A imposes a mark-to-market exit tax: you are treated as having sold every asset you own worldwide the day before you expatriate, and taxed on the unrealised gain — whether or not you sold anything.

You are a covered expatriate if any one of these is true:

Test	2026 threshold
Net worth	$2,000,000 or more — not indexed, so inflation pulls more people in every year ◻️
Average annual net income tax over the five years before expatriation	more than $211,000 ✅ (Rev. Proc. 2025-32 §3.37)
Compliance	Failure to certify five years of U.S. tax compliance on Form 8854 ✅

The relief: the first $910,000 of net deemed gain is excluded for 2026 ✅ (§877A(a)(3), Rev. Proc. 2025-32 §3.38).

Three things retirees consistently get wrong here. The net-worth test is not indexed, so a paid-off house plus a normal retirement portfolio clears $2M without anyone feeling wealthy. The compliance test catches people who are otherwise nowhere near the thresholds — years of unfiled FBARs or Forms 8938 ([EX-03]) make you a covered expatriate on a technicality. And deferred accounts are treated separately from the mark-to-market regime, with their own rules ◻️.

The practical takeaway: renunciation is a citizenship decision with a tax consequence, not a tax strategy. For essentially every reader of this page, the answer is to plan around citizenship-based taxation using §§2–5, not to exit it.

7. Three Scenarios

A. Portfolio retirees to Portugal (post-NHR). Income: $70k of IRA withdrawals + dividends. FEIE: useless (nothing earned). Portugal taxes them as residents at progressive rates; FTC wipes most U.S. liability; net cost ≈ Portuguese rates. Pre-departure they ran three fat Roth-conversion years and a 0%-gain harvest, and domiciled in Florida — the moves that mattered all happened before the flight.

B. Barista-FIRE in Thailand. $60k of remote 1099 income + $20k portfolio. FEIE excludes the earned $60k (Physical Presence Test, carefully logged); the portfolio income rides normal U.S. rates with little Thai tax to credit under its remittance rules ◻️. Self-employment tax still due (no U.S.–Thailand totalization). Verdict: FEIE earns its fame here — this is its actual demographic.

C. Roth-heavy couple eyeing Spain. $1.2M Roth built via ladder. Spain taxes Roth distributions as savings income (19–28%+) and layers wealth tax by region. The “tax-free” third of their plan isn’t, there. They shortlist France and Italy’s flat-tax regime instead, and get a cross-border opinion before the visa application — the correct order of operations.

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💡 Pro-Tips

1. Choose the treaty, then the town. Read the pension + SS + Roth treatment for every finalist country before comparing rents.
2. FEIE vs. FTC is an election, not a fact: workers in low-tax countries → FEIE; everyone in high-tax countries and all pure retirees → FTC. Mixed cases can use both on different income.
3. Front-load U.S.-cheap income (conversions, harvests) into pre-departure years — the single highest-ROI move in expat planning.
4. Keep the portfolio boring and U.S.-domiciled — every “convenient” local fund is a PFIC filing.
5. Log days like a pilot if using the Physical Presence Test — 329 days is 0% excluded.
6. Budget NIIT as unavoidable and treat any FTC-against-NIIT outcome as a bonus.
7. Re-verify the destination regime annually — NHR’s fate is the template, not the exception.
8. Medicare doesn’t follow you ([EX-04]) — but most expats keep paying Part B anyway if a U.S. return is plausible; the lifetime penalty math usually favors it.

⚠️ Common Pitfalls

1. Planning around FEIE as a retiree — it excludes a category of income you no longer have.
2. Discovering the destination taxes Roth after executing a decade-long ladder.
3. Buying local mutual funds — the PFIC regime turns them into accounting emergencies ([EX-03]).
4. Leaving a sticky state casually and receiving a residency audit in year three (ST-03).
5. Assuming a no-tax country means no tax — citizenship-based taxation fills the vacuum.
6. Missing FBAR — penalties start five figures per account per year even for non-willful misses.
7. Excluding all income via FEIE, then contributing to an IRA — an excess-contribution unwind.
8. Selling the appreciated portfolio after becoming a foreign tax resident with no basis step-up.
9. Reading the treaty without the savings clause and expecting it to bind the IRS.
10. Dropping Part B “to save $203/month” and repricing a U.S. return at +10%/year for life.

✅ Actionable Checklist

12–24 months out

• Shortlist countries; pull each treaty’s pension/SS/Roth articles + current special regime
• Cross-border CPA consult for the finalist pair (destination-side especially)
• Execute pre-departure conversions/harvests per TX-03; model the destination’s treatment of every account type
• Begin state-domicile exit (ST-03); establish the landing-state footprint if using one

3–6 months out

• Portfolio scrub: no PFICs, expat-tolerant brokerage confirmed, U.S. address/mail plan set
• Decide Part B keep/drop with the penalty math written down; line up expat health cover ([EX-04])
• Banking: a foreign account for living costs (FBAR calendar starts), currency-transfer rails chosen

Ongoing abroad

• June 15 filing (auto-extension), quarterly estimateds, FBAR by Oct, 8938 with the 1040
• Annual: re-verify residency-day counts, destination regime changes, FEIE/FTC election still optimal
• Before any big transaction (property, mortgage payoff, account move): check both systems + §988

Sources & further reading (verified Aug 2026)

• IRC §§911 (FEIE), 901/904 (FTC); Forms 2555, 1116, 8938; FinCEN 114; IRS Pub. 54
• IRS treaty tables and full treaty texts (irs.gov/treaties) — read the pension article and savings clause per country
• [EX-03] for the FBAR/FATCA/PFIC compliance stack; [EX-06] for totalization; ST-03 for state exit
• Destination-regime primary sources (e.g., Portuguese AT on IFICI; Spanish wealth-tax regional rules) — verify annually