How the foreign earned income exclusion cuts adjusted gross income — and with it your income-driven student loan payment — plus the trade-off against the foreign tax credit, under the 2026 rules.
If you live abroad and repay US federal student loans, the amount you pay each month on an income-driven plan is calculated from the adjusted gross income (AGI) on your US tax return — not from your foreign salary. Because the foreign earned income exclusion (FEIE) removes qualifying foreign wages from gross income, an American working overseas can file a return showing an AGI near zero and owe close to nothing on an income-driven plan. Claiming the foreign tax credit (FTC) instead leaves AGI at full salary level, which can move the same borrower from a floor payment to several hundred dollars a month.
That is not a loophole. It is the arithmetic of two rulebooks written separately: the Department of Education calculates from AGI, and the Internal Revenue Code lets qualifying expatriates exclude foreign earnings from the figures that produce it.
The Working Families Tax Cuts Act, enacted 4 July 2025, rewrote federal student loan repayment. The Department of Education's implementing regulations — the "Reimagining and Improving Student Education" final rule — took effect on 1 July 2026. Three things changed at once: a new income-driven plan, the Repayment Assistance Plan (RAP), opened to any Direct Loan borrower with eligible loans; a new Tiered Standard plan replaced the old flat standard plan, with a term set by balance; and the older income-contingent plans — ICR, PAYE and REPAYE (the plan marketed as SAVE) — were closed to anyone who received a Direct Loan on or after 1 July 2026.
The wind-down has a hard date. Borrowers repaying under PAYE or ICR must elect another plan before 1 July 2028; those who do not choose are moved onto RAP, or onto IBR for loans RAP cannot take. REPAYE remains available only through 30 June 2028, and only for borrowers who have not taken a Direct Loan on or after 1 July 2026.
IBR survives. It is the one long-standing income-driven plan continuing indefinitely, and for expatriates it remains the plan that can produce a genuine $0 payment.
Both surviving income-driven plans start from AGI, but use it differently.
RAP applies a percentage band directly to AGI, with no poverty-line offset. The regulation sets an annual "base payment" for a borrower with AGI:
The monthly payment is that base payment divided by 12, minus $50 for each dependent claimed on the borrower's federal return. If the result is less than $10, the payment is $10 — a statutory floor, not servicer policy.
IBR works from discretionary income: AGI minus 150 percent of the federal poverty guideline for the borrower's family size. The payment is 10 percent of that figure (for a "new borrower" — broadly, someone who first borrowed on or after 1 July 2014 and before 1 July 2026) or 15 percent for everyone else, divided by 12, and capped at what a 10-year standard plan would have cost. If the calculated payment is under $5, the payment is $0. For 2026 the poverty guideline for a single person in the 48 contiguous states is $15,960, so 150 percent is $23,940 — AGI below that produces no discretionary income at all.
Whose AGI counts matters too. Only the borrower's AGI is used for an unmarried borrower, one filing married filing separately, or one who certifies separation from or inability to access a spouse's income; married filing jointly uses the couple's combined AGI.
The FEIE is claimed on Form 2555, and the excluded amount is carried to Schedule 1 (Form 1040), line 8d as a negative figure — reducing total income and therefore AGI on the face of the return. The maximum exclusion is $130,000 for 2025 and $132,900 for 2026, with a separate foreign housing exclusion available on top.
For an American in London earning below the cap, AGI can be close to zero once the exclusion is applied. The servicer does not see a UK salary; it sees the AGI the IRS holds. Under RAP that produces the $10 floor. Under IBR it produces $0.
To qualify you need a tax home in a foreign country and either the bona fide residence test or the physical presence test (330 full days abroad in a 12-month period). The exclusion is an election: once made it continues until revoked, and a revocation locks you out for five tax years without IRS approval. Our guide to FEIE versus the foreign tax credit works through the qualifying tests.
The foreign tax credit works the other way. Foreign salary stays in gross income, so AGI reflects the full amount, and the credit is applied against the US tax computed on it. For Americans in high-tax countries such as the UK the credit frequently removes the US liability entirely and leaves carryover credits for later years, which is why many cross-border returns are prepared on the FTC basis.
The IRS is explicit that you cannot have both on the same income: once a foreign earned income exclusion election is in place you cannot take a foreign tax credit or deduction for foreign taxes on the income you exclude. Two further consequences follow — no additional child tax credit in the same year, and no earned income credit. Claiming any of those later is itself treated as a revocation. So the FTC route can be the better tax answer and the worse loan answer at once.
| Strategy | Effect on AGI | Effect on IDR payment | Effect on US tax |
| --- | --- | --- | --- |
| Exclusion (Form 2555) | Removes foreign wages up to the cap; AGI can fall near zero | RAP at the $10 floor; IBR can reach $0 | Little or no tax on wages below the cap, but no FTC on excluded income, no additional child tax credit, no earned income credit |
| Foreign tax credit (Form 1116) | AGI reflects the full foreign salary | Set by the AGI band or discretionary income — potentially hundreds a month | Foreign tax often offsets US tax in full; unused credits may carry forward |
| Exclusion to the cap, FTC on the excess | AGI reduced by the cap only | Based on the reduced AGI | Credit only on the non-excluded portion |
The figures below are illustrative, apply the 2026 rules, and are not a quotation for any individual. Assume an unmarried American in the UK, no dependents, foreign salary equivalent to $95,000, no other income, repaying Direct Loans on RAP.
On the exclusion. The full $95,000 sits below the 2026 cap of $132,900, so it is excluded on Form 2555 and AGI is approximately $0. RAP's lowest band applies: a base payment of $120, divided by 12, gives $10 — and the $10 minimum applies in any event. Monthly payment: $10.
On the foreign tax credit. No exclusion is claimed, so AGI is $95,000, falling in the band "more than $90,000 and not more than $100,000." That gives a base payment of 9 percent of AGI, or $8,550 a year. Divided by 12: $712.50 a month.
The difference over twelve months is roughly $8,430 — money going to loan principal and interest rather than to the IRS, since in a high-tax jurisdiction the FTC route may well produce no additional US tax at all. Whether that is a cost or a benefit depends on how close the borrower is to forgiveness and what the carryover credits are worth; our note on foreign tax credit carryovers covers that second question.
Certification normally runs automatically: when you enter or recertify an IDR plan you approve disclosure of your tax information by the IRS to the Department of Education, and the payment is built from that data. Expatriates hit two snags — a return filed from abroad may not yet be processed, and the AGI on file may bear no relationship to what you actually earn.
The regulations handle both. If the Secretary has your consent but cannot obtain your tax information from the IRS, you must supply documentation of your income and, for RAP, the number of your dependents. Separately, if the calculated payment does not reflect your circumstances, you may request a recalculation supported by alternative documentation of income (ADOI), which the Department has said can include a pay slip.
A practical sequence:
1. File the US return first — the return, not the payslip, drives the default calculation.
2. Keep your IRS consent in place so the servicer can pull tax data automatically; opting out shifts the work back to you every year.
3. If the IRS data cannot be retrieved, send documentation of income directly — usually an employer letter, a foreign payslip, and the filed Form 1040 with Form 2555 attached.
4. If the AGI on file is stale — a job change, a move, a divorce — request a recalculation under the alternative-documentation route rather than waiting for the anniversary.
5. Keep the servicer's repayment disclosure, which sets out the calculated amount and the 12-month period it covers.
A return showing a very low AGI is not a problem to be explained away — it is the figure the rules ask for. What matters is that the return is correct, filed, and consistent with what you tell the servicer.
An IDR payment is fixed for 12 months, and the Secretary begins recertification once three payments remain in that period. Miss it and the consequences are specific:
Interest capitalization follows. Under RAP, REPAYE, PAYE and ICR the Secretary capitalizes unpaid accrued interest under the general rule at 34 CFR 685.202(b); under IBR it is also triggered when the payment reverts to the standard amount and when the borrower leaves the plan. For a borrower whose payment was near zero and whose interest was accruing, that is an expensive month.
RAP softens the position for those who stay current: unpaid accrued interest is not charged when an on-time payment is made, and where an on-time payment reduces principal by less than $50 the Department matches the difference, up to $50 a month.
RAP forgives the remaining balance after 360 qualifying monthly payments over at least 30 years. IBR forgives after 240 payments (20 years) for new borrowers and 300 payments (25 years) for everyone else.
The tax position has changed. The special rule at section 108(f)(5) excluded discharged student debt from gross income only for discharges after 31 December 2020 and before 1 January 2026, and IRS Publication 54 states plainly that the relief expires on 31 December 2025. Discharge on account of death or total and permanent disability may still be nontaxable, and the older exclusion for cancellation tied to meeting certain work requirements remains — but a straightforward IDR forgiveness at the end of a 20-, 25- or 30-year term is now generally a taxable event in the year it happens, on a US return that has to be filed and paid from overseas.
This is the point most often stated wrongly. Public Service Loan Forgiveness cancels the balance after 120 qualifying monthly payments while employed full time by a qualifying employer, and RAP counts as a qualifying repayment plan.
The obstacle is the definition of "employee." Under 34 CFR 685.219(b), an employee is an individual to whom an organization issues an IRS Form W-2, or who receives one from a payroll provider contracted by the qualifying employer, or who works as a contracted employee where state law prevents the role being filled directly. A qualifying employer means a United States-based government entity, a public child or family service agency, an organization exempt under section 501(c)(3), a tribal college or university, or a nonprofit providing a defined non-governmental public service.
The practical consequence: working for a British charity on PAYE does not qualify, however public-spirited the work, because no W-2 is issued. Working overseas for a US 501(c)(3) that keeps you on its US payroll and issues a W-2 can qualify. The distinction is the payroll, not the postcode — so certify employment annually rather than discovering the position at payment 119.
Servicer autopay is generally set up against a US bank account, so closing your last US account on emigration can cost you the arrangement and any associated benefit. Keep a US mailing address the servicer accepts and check that correspondence reaches you — a missed recertification notice is the commonest way an expatriate's payment jumps to the standard amount. Time international transfers to land before the due date rather than on it, because under RAP the interest waiver and the principal match both depend on the payment being on time. Our guide to paying the IRS from abroad covers the transfer routes.
Most expatriate borrowers can manage this themselves: file the return, keep the IRS consent in place, recertify on time. It is worth paying for advice when the two decisions conflict — a large balance heading for forgiveness, a marriage that changes whose income counts, a move between countries mid-year, or self-employment income the exclusion does not shelter. An election that saves a few hundred dollars of US tax can cost several thousand a year in loan payments, so where the numbers are close the answer is a multi-year projection of both together, not a single-year tax comparison. At Next Tax Source a licensed CPA or Enrolled Agent reviews and signs off every US return we prepare. Our guide to US tax compliance for Americans abroad covers the filing side, and our US-UK expat tax accountants can model both positions before the election is locked in — book a consultation to talk it through. This article is general information, not advice on your own circumstances.