A US citizen working in the UK pays income tax to HMRC through PAYE and must still report the same salary on a US return. Two mechanisms stop that salary being taxed twice. The foreign earned income exclusion removes it from US taxable income. The foreign tax credit leaves it in and credits the UK tax already paid against the US tax on it.
Both can bring the US bill on a UK salary to nil in a typical year. They are not interchangeable, though, and the choice has consequences that run for years. The exclusion is an election, and once revoked it cannot be made again for five years without IRS consent.
How does the foreign earned income exclusion work?
The exclusion is claimed on Form 2555 and covers earned income only, up to $130,000 for tax year 2025. To qualify, the taxpayer's tax home must be abroad and they must meet either the bona fide residence test or the physical presence test, which requires 330 full days in a foreign country during a twelve-month period. Interest, dividends, rent and capital gains are not covered.
Excluded income is not simply ignored. The remaining income is taxed at the rates that would have applied had the excluded amount been included, so a salary above the exclusion or a significant amount of investment income can still produce US tax. Claiming the exclusion also rules out a foreign tax credit for the UK tax on the excluded salary.
Form 2555 also offers a housing exclusion or deduction for reasonable housing costs above a base amount, up to a cap that varies by location. Some high-cost cities, London among them, have higher caps set by IRS notice. For someone paying high rent on a salary near the exclusion limit, the housing element can matter, although it brings the same drawbacks as the main exclusion.
How does the foreign tax credit work?
The foreign tax credit is claimed on Form 1116. UK income tax on UK salary is credited against the US tax on that same salary, subject to a limitation calculated separately for each category of income, mainly general income such as wages and passive income such as interest and dividends. The credit generally cannot reduce US tax on US-source income, and UK tax that exceeds the limitation in one category cannot be moved to another.
Because UK income tax rates are generally higher than US rates at most income levels, the UK tax paid on a salary usually exceeds the US tax on it. The surplus is not lost. Unused credits can be carried back one year and forward ten years, and they can absorb US tax in a later year, for example on a bonus, a move to a lower-tax country or a return to the US.
Why does the credit often come out ahead in the UK?
The exclusion suits people whose foreign tax is low, which is rarely the case for UK employees. For most UK taxpayers, the credit reaches the same nil result on salary while keeping the excess UK tax available for future years. It also has no ceiling, so it covers earnings above the exclusion amount without leaving a taxable slice.
Some side effects point the same way. A taxpayer who files Form 2555 cannot claim the refundable part of the child tax credit, which a credit-based return may still produce for families with children. Excluded salary also does not count as compensation for IRA contribution purposes, which can remove the ability to contribute.
- The credit keeps excess UK tax as carryovers; the exclusion does not create any
- The credit has no cap on the earnings it covers
- The exclusion blocks the refundable portion of the child tax credit
- Revoking the exclusion bars re-election for five years without IRS consent
What about timing, and the tax neither one covers?
The UK tax year runs from 6 April to 5 April, while the US uses the calendar year. UK tax has to be allocated to the right US year before a credit can be claimed, and mistakes in that allocation are common where a bonus or a large gain falls near either year end. Carryovers are only as reliable as the years that generated them.
Neither mechanism reliably removes the net investment income tax of 3.8%. Foreign tax is generally not creditable against it under domestic law, and treaty-based claims are contested. For a taxpayer with significant investment income, that tax can remain even when salary is fully relieved, and it has to be budgeted for separately each year.
Self-employed Americans in the UK face a further point. Neither the exclusion nor the credit removes US self-employment tax, which is a social security charge rather than income tax. The totalization agreement between the two countries generally assigns a self-employed person to the social security system of the country where they live, and a certificate of coverage from HMRC is the usual evidence of UK coverage on the US return.
General information, not advice. The right answer depends on your circumstances and the tax year concerned.
