It's not a bug in TurboTax. When you take the foreign earned income exclusion, the amount of excluded foreign income affects the amount of tax because your other income, that is not excluded, is taxed at the same rates that would have applied to that income if you did not get the exclusion. The non-excluded income is "stacked" on top of the excluded income for the purpose of calculating the tax. Therefore, when you add the excluded foreign income, some of the other income gets pushed into a higher tax bracket, and is taxed at a higher percentage. That's why your tax increases when you add the excluded foreign income.
So you are not paying tax on your wife's foreign earned income, but having that income makes you pay a higher tax rate on your other income.
