Deductions & credits

LinaJ2018 gives a very good description of how to enter the data into the TurboTax program to calculate either the Foreign Earned Income Exclusion (FEIE) or the Foreign Tax Credit. TurboTax will allow you to choose either of these methods, or in some situations combine them and the IRS allows you to select the method that gives you the best outcome.  The program cannot, however, guide you to which of those options is the right one for you.  Taxes on foreign income for US citizen's can be pretty complex but once you know which option works best for you, TurboTax can certainly assist you in filing your return correctly.  I can't cover all of the possible options related to foreign earned income in one post but I will try to cover the most common situations in hopes that you can apply one of these to your current situation.  

Most folks who work overseas will be familiar with the FEIE and will default to this method, but it isn't always the best choice. 

Here are a few scenarios when using the foreign tax credit makes the most sense:

• The taxpayer has dependent children aged 16 or younger who have a social security number (important note: this number must have been issued by the filing deadline of the tax return being filed, including extensions, and cannot be an ITIN).  Taxpayers with dependents who qualify for the child tax credit are eligible for the refundable portion of this credit of up to $1,000 per child if there is any taxable income shown on the tax return.  The FEIE can reduce the taxable income to zero thereby disallowing the child tax credit (which requires some taxable income).  
• The taxpayer is working in a high tax bracket in the foreign country but anticipates a lower tax bracket in that country in the future.  Unused foreign tax credits can be carried forward for use in future years (against other foreign income) and sometimes this can be beneficial to the taxpayer.
• The taxpayer doesn't yet meet the physical presence or bona fide resident test and doesn't want to extend the tax return filing deadline to do so.

Now, here are a few scenarios where the foreign earned income exclusion makes the most sense:

• The taxpayer is working in a country where there is no income tax or where the income tax rates are lower than the US rates on the same income.
• When the taxpayer has taken the foreign earned income exclusion previously.  When you file your first return using the FEIE, you make a formal "election" to use this method of calculating tax on your foreign earned income.  You must then take it in every subsequent year that you have foreign earned income unless you revoke the election.  You may want to revoke the election in favor of taking the foreign tax credit but if you revoke this election you cannot use this method again for 5 years unless you first request permission from the IRS in the form of a Private Letter Ruling.  

These reasons are not exhaustive and taxes for US citizens residing and working outside of the US can be complicated by a wide variety of other factors, but hopefully these suggestions will give you some things to think about when making your choice.  The TurboTax program can calculate the exclusion or the credit and hopefully this additional guidance will assist you in determining the option that is best for your personal situation.  

If you would like additional information on topics related to citizens living abroad, the IRS has a wealth of related information available HERE.