Treasury’s Claim That The FEIE Is A Costly Expenditure, Whether True Or False, Is A Strong Argument FOR Tax Reform

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Prologue

On January 29, 2025 a post by Keith Redmond on X.com suggested that Treasury had identified the Foreign Earned Income Exclusion (“FEIE”) – found in Internal Revenue Code 911 – as a tax expenditure costing the Treasury 5.6 billion dollars a year.

Keith’s post immediately generated discussion with CPA Phil Hogan. Phil noted that those Americans abroad who used the FEIE probably would not owe tax on income excluded by the FEIE. He noted that Foreign Tax Credits could be used to offset the taxes owed on the income excluded by the FEIE. Phil’s point (confirmed by CPA Kevyn Nightingale) is incredibly important.

(I have included, as an Appendix to this post an analysis of WHY many (if not most) Americans abroad who file using the Foreign Earned Income Exclusion would NOT owe U.S. tax, if the income excluded under the FEIE were included as U.S. taxable income. The short explanation is that if the income were INCLUDED on the U.S. tax return, taxes paid in the country of residence, would be used to effectively pay the U.S. tax on that included income. See the Appendix for further discussion).

Is The Claim That The Foreign Earned Income Exclusion Costs The U.S. Tax Revenue Really Credible?

To put it simply (as the following tweet states) the FEIE does NOT cost Treasury the tax revenue that it thinks. Treasury’s estimate of the tax revenue lost resulting from the use of the FEIE is likely an exagerration.

The claim that the FEIE costs the U.S. Treasury significant tax revenue generated a lively discussion. I then became aware of the following article from Thomson Reuters (a generally credible organization). The article titled: “Pieces Of The 2025 Tax Reform Puzzle” listed items that were identified as costs to the U.S. Treasury. The article included:

Congress is also looking into bringing back full expensing of research and development costs and lowering the corporate tax rate from 21% to 15%. During his campaign, President Trump mentioned eliminating taxes on tip income, overtime pay, and Social Security benefits, so Congress will also consider those. Click here for a comprehensive list of the possible tax reform provisions being considered by the Committee.

https://tax.thomsonreuters.com/blog/pieces-of-the-2025-tax-reform-puzzle/

The article included a link to the following list of items identified by the “Ways and Means Committee” as tax expenditures.

budget_optionspdf

https://www.finance.senate.gov/imo/media/doc/budget_optionspdf.pdf

Of particular interest to Americans abroad was the following:

This estimate (apparently coming from Tax Foundation) suggests that exempting Americans abroad from U.S. taxation would cost U.S. Treasury 10 billion per year. Interestingly this is a far greater number than many of the other items included in their list.

It’s fairly obvious that the number of 10 billion is difficult to justify. Confirming comments on X included:

I received a message (referring to the original 5.6 billion tweet) stating that:

“The estimate of $5.6 billion is from the JCT, and it’s grossly exaggerated. They just multiplied the excluded income of $28 billion by a tax rate of 20%. But the average tax rate under the FEIE limit is about 15%, and about half of the tax on the excluded income would be compensated by a foreign tax credit if the FEIE didn’t exist. I find it irritating that the JCT doesn’t consider this. The revenue loss of the FEIE is actually about $2 billion.”

What does all this mean? I agree with the following advice from another commentator who stated that:

The best strategy I can think of is to help as many people as possible understand what data is available, that the cost is not huge, and that various approaches (simple elimination of double taxation, the LaHood bill) aren’t very different. I guess the biggest difference between the cocktail napkin and the LaHood bill is the exit tax.

My personal view is reflected in this tweet from @Giornio

Yes, we must shape the narrative. But we also must understand how to best make use of the differing perceptions of reality. There are at least two possibilities.

Possibility 1 – The FEIE Really Is A Huge Cost To The U.S. Treasury: Eliminating The FEIE Could Be A Way Of Paying For Eliminating Double Taxation Of Americans Abroad

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The argument is that eliminating the cost of the FEIE would be a “revenue neutral” to allow Americans abroad to opt to be taxed as though they were nonresident aliens.

Possibility 2 – Treasury’s Estimates Are Completely Wrong – Supporting The View That It Would NOT Cost The U.S. Treasury Much To Tax Americans Abroad As Though They Were Nonresident Aliens

The argument is that there would be little loss of revenue if Americans abroad were taxed as though they were nonresident aliens.

Proponents of tax reform for Americans abroad need to be flexible in making their arguments.

The point is that:

Treasury’s claim that the FEIE is a large expenditure, whether true or not, can be used as an argument for why Americans abroad should be taxed as nonresident aliens!

John Richardson – Follow me on X.com @ExpatriationLaw

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Appendix – Practical Education – Understanding How The Foreign Tax Credit Rules Work, How The Foreign Earned Income Exclusion Work And How The Rules Impact Americans Abroad On A Country By Country Basis

How The 911 Foreign Earned Income Exclusion Works:

Internal Revenue Code 911 allows Americans abroad to EXCLUDE from their income approximately $126,000 USD annually or what is defined as “earned income” (think wages). Obviously if the income is EXCLUDED from U.S. income/taxation then the individual would NOT be subject to U.S. taxation on that income at all. Let’s imagine a U.S. citizen living in Canada excluded $100,000 USD income from his/her employment. The U.S. would NOT be able to tax that $100,000.

How The Foreign Tax Credit Rules Work:

Under the foreign tax credit rules, the $100,000 USD would be included as taxable U.S. income. The U.S. would absolutely assess tax on that $100,000 USD. The U.S. citizen in Canada would owe that tax. But, Internal Revenue Code 901 (along with other sections) would allow the U.S. citizen in Canada to effectively pay the U.S. tax imposed on the $100,000 USD of income by using the Canadian tax paid on that amount. Because Canada generally has higher taxes there would generally be enough tax paid to Canada to be used to effectively pay the U.S. tax owing. That is how the foreign tax credit rules work.

You will notice that whether the U.S. citizen in Canada files his U.S. taxes using the foreign earned income exclusion or by using the foreign tax credit rules, the U.S. does NOT actually collect any tax from that U.S. citizen in Canada.

Why Neither The Foreign Tax Credit Rules NOR the Foreign Earned Income Exclusion Affect Different Americans Abroad Differently Depending On What Country Where They Reside

General Tax Filing Considerations: Should U.S. Citizens Abroad File Using The Foreign Earned Income Exclusion Or By Using Foreign Tax Credits?

Many Americans abroad use the FEIE as a convenience because of ease of filing. But, with the exception of Amerians abroad who reside in countries with little of no income tax and “digital nomads” the FEIE is of no practical use to most Americans abroad. In fact, for reasons discussed here, even those who use the FEIE would be better off not using the FEIE and achieve a better result by using foreign tax credits.

One thought on “Treasury’s Claim That The FEIE Is A Costly Expenditure, Whether True Or False, Is A Strong Argument FOR Tax Reform”

  1. Charles Buckley

    The FEIE is used often by low-income workers who go abroad for no increase in salary, but for less tax. Tax progression curves vary dramatically from country to country. The US progression curve starts off relatively high at low income, but progresses comparatively mildly to those of other countries that stay low, sometimes at 0, but then shoot up dramatically like a hockey stick to cover their ‘good earners,’ (thereby resolutely dampening any incentive to succeed). So low-income US workers have more take-home pay when they work abroad and use the FEIE. This would not be offset by the FTC.

    Many policy makers nurse a simplistic view of tax differences, simply trotting out tired nostra like “the UK have higher taxes than the US.” Beware of simple-minded policy makers!

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