When Indian Tax Is Lower: How FEIE and FTC Shape U.S. Tax

When Indian income tax on Indian earnings is lower than what the United States would charge, a U.S. citizen or U.S. tax resident still must file a U.S. return and may owe the shortfall after claiming available relief. That simple but often surprising outcome is driving urgent questions from U.S.–India professionals, students, and families who work in India, hold Indian investments, or split time across both countries.

The basic rule remains firm: the United States taxes its citizens and tax residents on worldwide income, while India taxes based on tax residency and source. When the two systems meet, the order of steps and the choice between the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC) decide how much extra, if any, must be paid to the U.S. Treasury.

How U.S. reporting and relief tools work

• Under U.S. law, you report global income on Form 1040 and then apply relief tools.
• FEIE can exclude earned salary from U.S. taxable income if you meet either the Physical Presence Test (330 full days abroad in a 12-month period) or the Bona Fide Residence Test (genuine residence abroad for a tax year).
  • For 2025, FEIE can exclude up to $130,000 of eligible earned income.
• FEIE does not apply to passive income (interest, rent, capital gains). Those are handled by the Foreign Tax Credit (Form 1116).
• If Indian tax on a given passive item is lower than the U.S. tax on that item, the difference generally remains payable to the United States even after claiming the credit.

India’s tax anchor and its interaction with the U.S.

• Indian tax residency for the year decides the taxable scope:
  • If resident in India: India taxes global income.
  • If non-resident: India taxes only India-source income.
• A higher Indian tax (for example, when you are an Indian resident taxed on worldwide income) can create a larger FTC to offset U.S. tax.
• The FTC is capped by the U.S. tax attributable to the same income category, so it rarely eliminates U.S. tax when Indian rates are lower.

Order of operations and why it matters

1. Report worldwide income on Form 1040.
2. Apply FEIE for qualifying earned salary (Form 2555) if you meet the tests.
3. For passive income and any salary beyond FEIE, compute FTC on Form 1116.
4. Pay any residual U.S. tax where Indian tax is lower than U.S. tax for that category.

The two-step ordering—exclude earned income first (when eligible) and then credit foreign tax for the remainder—is why you can still owe U.S. tax even after paying India.

Common scenarios and examples

Scenario A — Salary plus rental and bank interest in India:
– You pay Indian tax at local rates.
– On your U.S. return, you report salary, interest, and rent.
– If you qualify for FEIE, you may exclude up to the FEIE limit of salary.
– Interest and rent are not excluded; you compute U.S. tax on them and then claim FTC for Indian tax paid on each.
– If U.S. tax on rent or interest is higher than Indian tax, you pay the difference to the U.S.

Scenario B — Only passive income while living outside India:
– FEIE does not apply.
– You report passive income and claim FTC for Indian tax paid.
– If Indian tax is lower (or zero), expect a residual U.S. tax bill.

Scenario C — Indian tax resident for the year:
– India taxes global income, often increasing Indian tax paid and thereby the FTC available in the U.S. for items not covered by FEIE.
– Salary can still be excluded under FEIE if you meet FEIE tests.
– You still must file in the United States.

The mechanics of the Foreign Tax Credit

• Compute U.S. tax on the foreign income, then reduce it by the Indian tax paid on that same category of income.
• If Indian tax is less than U.S. tax for that category → the shortfall is U.S. tax payable.
• If Indian tax is higher, the FTC is limited to the U.S. tax liability on that income; extra Indian tax does not produce a U.S. refund.
• Income must be categorized (salary, interest, rent, capital gains) and matched to the corresponding foreign tax paid.

FEIE eligibility details and pitfalls

• FEIE helps only if you qualify and only for earned income.
• Physical Presence Test: 330 full days outside the U.S. during any 12-month period.
• Bona Fide Residence Test: establish a genuine home abroad for a full tax year.
• A few extra weeks in the U.S. can break FEIE eligibility for the year.
• If you fail FEIE, you rely solely on the FTC—and that’s where shortfalls often appear when Indian tax is lower.

Compliance items beyond income tax

• FBAR (FinCEN Report 114) if foreign accounts exceed the annual threshold — file electronically with FinCEN.
• Form 8938 (Statement of Specified Foreign Financial Assets) if asset thresholds apply — file with your tax return.
• Keep proof of Indian taxes paid and travel records; missing these attachments or filings can trigger penalties even when no U.S. income tax is due.

Frequent mistakes to avoid

• Assuming local withholding covers U.S. obligations.
• Treating passive income as FEIE-eligible.
• Skipping Form 1116 and leaving credits unclaimed.
• Not keeping supporting documents: Form 16 equivalents, rent agreements, bank statements, and tax payment receipts.
• Failing to file Form 1040 because you owe no U.S. tax — the filing obligation is independent.

Practical advice and checklist

• Track days in and out of the U.S. early to determine FEIE eligibility.
• Separate income into earned salary versus passive income.
• File Form 2555 for FEIE if eligible; file Form 1116 for FTC on passive items.
• Keep all Indian tax proofs by source (Form 16 equivalents, bank interest statements, rent receipts).
• Model U.S. tax before credits to identify potential gaps and set aside cash for any residual U.S. bill.
• Monitor Indian tax residency rules and consider their effect on both Indian tax and the U.S. FTC.
• Review FBAR and Form 8938 thresholds and file if required.
• Always file Form 1040 if you are a U.S. citizen or tax resident.

Simple playbook (numbered):
1. Confirm U.S. citizen or U.S. tax resident status and file Form 1040 each year.
2. Sort income into earned vs. passive.
3. Test FEIE eligibility early; prepare Form 2555 if eligible.
4. For passive income, prepare Form 1116 to claim FTC on Indian taxes paid.
5. Track Indian tax residency and collect proofs (tax receipts, Form 16 equivalents, bank statements).
6. Review FBAR and Form 8938 requirements and file where necessary.
7. Expect and plan for a U.S. shortfall when Indian tax is lower than U.S. tax on any taxable part of income.

Special populations: students, professionals, retirees, entrepreneurs

• Students and scholars: scholarships, grants, and stipends may be partly FEIE-eligible if they are earned income; otherwise they fall under FTC rules.
• Cross-border professionals: short trips back to the U.S. can break FEIE tests; careful calendar planning is essential.
• Entrepreneurs: business income treatments depend on structure and source rules; some compensation may be FEIE-eligible while other parts depend on the FTC.
• Retirees: pensions and investment income are generally not FEIE-eligible; FTC handles these, and residual U.S. tax may apply if Indian rates are lower.

Treaty role and limits

• The U.S.–India Double Taxation Avoidance Agreement helps assign taxing rights and reduces double taxation through credits/exemptions.
• It does not eliminate the U.S. filing obligation or convert passive income into FEIE-eligible income.
• The treaty supports relief but does not negate residual U.S. tax when Indian tax is lower.

Key forms and official links

• File worldwide income on: Form 1040
• Claim FEIE (when eligible) with: Form 2555
• Claim FTC with: Form 1116
• FBAR (FinCEN Report 114): FBAR filing site
• Form 8938: Form 8938 information
• IRS guidance on FEIE tests and limits: IRS Foreign Earned Income Exclusion

Why this matters now

• More people split time between India’s expanding economy and U.S.-linked careers. Stock grants, remote work, and return-to-India moves are common.
• When Indian tax is lower than U.S. tax on a given item, the FTC can only go so far. Without planning, the surprise U.S. bill often arrives in April.
• Cleaner processes, better documentation, and timely planning reduce compliance stress and keep cross-border households financially stable.

Final takeaway

• If you’re a U.S. citizen or U.S. tax resident earning income in India:
  • Pay India first on India-source income (and on worldwide income if you are an Indian tax resident).
  • File U.S. Form 1040, report worldwide income, and use FEIE for qualifying earned salary and FTC for passive income and any salary beyond the FEIE limit.
  • If Indian tax is lower than U.S. tax on any part, you pay the difference to the United States.
  • Maintain clear records, count days carefully, and file all required forms to avoid penalties and surprises.

Keeping travel logs, organized Indian tax proofs, and a simple modeling habit each year will make cross-border tax outcomes predictable rather than painful.