Yes, let me rephrase everything I just mentioned. OK, first of all, you need to enter his income in the Foreign income Exclusion to report it and to see if he qualifies for the exclusion based on the Physical Presence Test or the Bona fide resident test. If he doesn't qualify, then remove all the entries from this section.
Now, you do need to fill out a Schedule C in the manner I prescribed. This will need to be prepared so that the self-employment taxes can be assessed. If your husband qualified to have his income excluded in the first step, then exclude his net income from this section in the manner I prescribed.
However, if his income could not be excluded, then leave the Schedule C income untouched. You would not want to enter this business income strictly in option 2 because if you did, the self-employment tax would not be reported in the return. That is why your tax payable amount decreased because the self-employment tax is absent in this option.
Since India doesn't have a totalization agreement and since you wish to declare your husband as a resident alien for tax reporting purposes, he does need to pay self-employment tax to the US regardless where he lives.
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