Combination Foreign Earned Income Exclusion (FEIE) and Foreign Tax Credit (FTC)

[Gregbert]

All, I am struggling with the right way to exclude my foreign earned income up to the maximum, and then get a foreign tax credit for the remainder of the amount. My income exceeds the FEIE limit, but I get ZERO foreign tax credit (FTC) on the remainder. I have started my tax return over from scratch, and taken the steps below to reproduce the issue. But I think that there are three questions where I am most likely going wrong - they are BOLDED below

Thank you so much for your thoughts.

INCOME SECTION:

• Foreign income Topic: entered foreign income for my wife and I
• Question #1: Should I enter my FULL foreign income here? or just the amount that will get excluded. I have proceeded by entering the FULL amount of foreign income
• My income is higher than $106k, but my wife's is not.
• When asked whose foreign income i would like to exclude, i say 'both'
• We are both US citizens, and can pass the physical presence test
• I am given a 'foreign earned income and housing exclusion' of $103,066
• My wife is given a smaller amount, equal to her incom

DEDUCTIONS AND CREDITS

• then i go to deductions and credits, and select the foreign tax credit
• i select to take the credit rather than the deduction, and I select to use the simplified method for 'simplified limitation election for AMT'
• when asked if all my foreign taxes were paid with interest and dividends - i say no (since they come from wages)
• i edit the general category income and add a country (switzerland)
• It tells me that I entered foreign earned income exclusion of $103,066 and the lower amount for my wife, on form 2555
• It asked me if this foreign income was earned in switzerland (it was) and was included in 'other gross income' for this country...
• I say 'both of our forms 2555'
• It asks me for 'other gross income' from my two employers, not enterered on form 2555.
• Question 2: Do I enter My foreign income MINUS $103,066, or do I say that I have 0 additional income, as I entered the full amount on the foreign income topic earlier? I will proceed assuming the latter.
• A few screens later, it wants 'Foreign Taxes on other income'
• I enter the Full amount of taxes that I paid in the foreign country (switzerland)
• Question 3: Am I correct that I should not apportion it based on portion that was excluded, assuming that the software will do that for me. As per above bullet, i have entered full amount.

The results of my choices are a foreign tax credit of ZERO, and very high taxes.
Have I done something incorrectly?

[Gregbert]

Dear all - I think that this is a BUG in Turbotax.

I went back to the Deduction/Credit topic again, and returned to the question on whether the income was reported on mine, and/or my wife's 2555. I had previous selected "both", but this time I changed it to only MINE - and the taxes dropped tremendously. then I switched it back to "both" and the taxes did not go back up.

And now I have a foreign tax credit amount...

maybe somebody else can reproduce it.

[SusanY1]

When entering your income in the foreign earned income section - enter the full amount of your income, even though it exceeds the amount of the allowable exclusion.  This will cause the software to automatically populate the excess amount to the form that calculates the credit for you.  

Don't forget to include the amount that you pay for your housing as well in the foreign housing allowance section. This goes on the screen "Enter [Your name's] House Expense."  Expenses allowed here include rent, repairs, utilities (except phone), parking fees, insurance, taxes, security deposits, and rentals of furnishings (but not purchases) if any of these apply to you. 

This can allow you to exclude a little bit more, but typically only works for taxpayers who rent.  Those who own their property overseas generally don't benefit from this provision.  

In the foreign tax credit section, it sounds like you navigated through the toughest parts very well.  

You will want to select both for the 2555 question, and then enter no additional income (assuming that you enter the full amount of your income in the foreign earned income and exclusion section).  This allows TurboTax to automatically carry the excess for you.  You can then leave the question about other income blank (no need to even enter 0.)

Including the income for you both allows the ratio of total income to foreign income to properly calculate which gives you the higher credit that is appropriate in your case.  When you do not include your wife's excluded income, it apportions less of your foreign tax to you in the form of a credit.  This is why you see the numbers change fairly dramatically when you don't make that selection.  

[Gregbert]

Thanks @SusanY1 

Indeed, it took me awhile to figure out thats how to do things. I also noticed another possible bug, where it is impossible to choose to try to exclude just one person's income (mine, but not my wife's).  Even though you can select just one persons name, in the background it proceeds like you had selected both - which makes it impossible to finish your taxes.

But in the end, I found that:

* It was more advantageous for me to take the foreign tax credit

* It is more advantageous for me to itemize my taxes, despite that I have virtually zero deductions, because it allowed me to use more of my foreign tax credit for some reason due to AMT. 

I find the second bullet very counter intuitive - every year turbotax recommends to me that i should take the standard deduction, which always results in me paying $2-4k more in taxes (and leaving me with a larger foreign tax credit carryover). I always override that, and force it to itemize my deductions as cash in hand in more important than a larger foreign tax carryover that i will likely never be able to use. 

I am in Switzerland...

[Mr--Memo]

@SusanY1   @Gregbert 

Hi Susan - thank you for your guidance on this topic - it was really appreciated as I have the same situation.  (would like your thoughts as well, Greg).

One thing that worries me is that the IRS guidance says we must be very careful - that the FEIE applies on income X, and Foreign Tax Credit (FTC) applies on income Y;  and X and Y can not overlap.

So if I enter all my foreign earned income (say $200K) as Foreign Earned Income in that section in TurboTax, and then exclude the max $107K, and then go to the section on TurboTax for the FTC and claim the remaining $93K - would that still show up in a way that it looks fine (e.g. the same income did not get FEIE and FTC) ?

Thank you!

[Gregbert]

@Mr--Memo 

Turbotax automatically accounts for this. You should enter the $200k in the foreign income section, claim the FEIE. When you go to the foreign tax credit area later, you should NOT enter any additional income. It should be a zero or a blank. Turbotax automatically carries over the remaining 93k as income from the form 2555 that is filed as a result of trying to claim the FEIE. If you enter it again here, you may see a false hope as your taxes decline - but you will later see that it thinks you paid your taxes against 293k in foreign income rather than 200k, falsely allowing you to bring in more of your foreign tax as credit. 

You may find as I have that it is more tax beneficial to not to exclude any income in the foreign income section (and thus, no form 2555 is created), and instead claim it all as FTC. In this case, you need to entire your full FTC in the foreign tax credit area. Make sure you also try the 'Itemized' deduction, even if turbotax recommends the standard deduction. 

I have laid out, step by step what I was doing earlier in this thread. I have learned that it was correct. If @SusanY1 has a different point of view, be sure to follow her advice as it has been flawless.

Greg 

[Mr--Memo]

@Gregbert 

Wow fast reply - thanks Greg,

Great - so I will go for that and try what you said.  I had two sources of foreign income.  One was remote work (while residing as a resident in a foreign country) for a US company - for which I got a W2.  The other was work for a foreign company that does not provide a W2, nor withhold any US taxes.

Question 1: So far I have entered the foreign company income inside the section for foreign income.  Seems to work fine.  Or should I put this into the W2 section instead (with a substitute W2)?

Question 2:  The 2555 form in Turbo Tax asks for a single source only (I have 2 sources) - which one should I enter?

Thanks!

[Gregbert]

No problem @Mr--Memo . I am trying to complete all of my tax returns and FBAR, etc. today.

I am hesitant to give advice here, because I do not have a W2 that relates to remote work, and for which I assume you were ALSO charged foreign taxes. But I will say that you should not create a 'substitute W2' for foreign income on which you did not receive a W2 for. You should enter that only into the foreign income section. (thats the answer to question 1, for which i am fairly certain)

Then in the foreign tax credit section, it should allow you to recognize both your W2 foreign income as well as your non-W2 foreign income, and all of the foreign tax that you paid against these 2 sources.

With regards to question 2, I have not tried to create a Form 2555 using W2 foreign income as that is not my situation. Following a rule of "do no harm", i will refrain from guessing. 

[Mr--Memo]

@Gregbert 

Thanks Greg - I am glad we connected, as expertise on international taxes is rare, and I think we the brave self-service expats, should band together to share knowledge.

I went through all the steps - and generated the PDF return to review - and checked-out everything and all looks well.

Except Form 1116, Line 3e, which looked weird.  It is called "Gross income from all sources" and was high.  As I read about it, I see it includes capital gains without any losses substracted, and other income without any deductions for expenses.  Its a bit strange - if one traded a lot of stocks and had gains and losses, then excluding the losses would show a big "gross income".  If I add back all losses (on stocks) and all expenses (on rental income), I get something close to what TurboTax computed.  Did you find that - and also feel comfortable that its all explainable from the definition?

From IRS:  "For lines 3d and 3e, gross income means the total of your gross receipts (reduced by cost of goods sold), total capital and ordinary gains (before subtracting any losses), and all other income (before subtracting any deductions)."

Almost there man!

[Gregbert]

@Mr--Memo 

Yes, I am with you. I have my Swiss taxes done by the professionals, and only because of the language issue, but I don't trust anybody with my US taxes except myself. I have 5 tax returns to file every year and its a crazy mess.

Yes, I believe turbotax even gives a helpful message at some point about this number. They are dividing 3e by 3d to determine the % of your income that was foreign, which then they apportion the deduction on 3a by.  This reduces your apparent taxable foreign income (see line 15 on the next page) , in order to make the calculation of how much of your foreign tax to allow as a credit. (e.g., only 87% of my foreign tax paid ends up reflected on line 35 as a foreign tax credit).  I am sure I am getting screwed here, but I am confident that this is intended by the IRS.

I dont believe that if you traded a lot of stocks it would show up on 3e unless you did really well - as they are talking about gross income, not gross proceeds - the cost basis is subtracted out. Aside: I can tell you this confidently as I sold a significant amount of stock last year thinking that the new administration is likely to do something unfavorable with capital gains taxes. (this sale was a big mistake, as despite not having a state residence to pay capital gains tax to, it added onto my tax bill disproportionately).

Good luck. Dont forget your FBAR and stay away from open windows when you see the tax bill.

[Mr--Memo]

Hey Greg - quick question,

Since I live abroad, I worry my refund check will get lost.  I am getting a physical check due to amending a prior tax year.  I can get mail within US at a friend's home, but I don't want the IRS to get confused and think I live in USA.  Am I able to indicate a mailing address (local in US), different from my physical address (the address I provide to IRS so they know I live abroad)?

P.S. Have you gotten physical mail from IRS during your time abroad - and did it arrive fine?  (I feel that regular mail has a high risk).

Thank you!

[Gregbert]

@Mr--Memo 

I've had mail take months to get here during covid. I've always used a US address for my IRS mail. I dont think that they will get confused or question it.

[JM1031]

@SusanY1 

Living abroad for 14 years. Always filed taking only FEIE and no foreign tax credit even though tax rate is higher than in the US. The reason was my total income was less than FEIE limit+standard deduction and I did not have to pay any US taxes. This year, this may not be the case and I may have to pay US taxes if I follow the old approach.  I want to still keep FEIE as in the next 3 years I will retire and my income will fall below FEIE limit. At that time, using FEIE+ standard deduction (as i have  no other us income), I can start moving money from IRA to Roth IRA and keep my foreign income covered through FEIE without incurring tax.  

How do I claim FEIE up to the limit and FTC (for the excess ) in Turbo tax? It shows Standard deduction is right for you if I choose FEIE. How do I force it to also allow me to add FTC?

Thank you

[DaveF1006]

Yes, you can claim the FEIE up to $108,700 and claim a foreign tax credit for the amount of Foreign Tax levied on the excess income over the exclusion amount. You will report these two events as separate taxable transactions.

1. First you will report to exclude $108,700 of your income by:

• Click on Federal 
• Click on Wages and Income  
• Click on I'll choose what I work on (if shown)
• Scroll down to Less Common Income
• On Foreign Earned Income and Exclusion, click on the start or update button.
• Answer the questions as these appear in the interview to claim this exclusion. 
• Once claimed, you will now need to claim your foreign tax credit on the excess income over $108,700.

To claim the Foreign Tax Credit.

• Go to wages and income>deductions and credits>
• estimates and other taxes paid>foreign taxes. 
• As you answer the questions throughout the interview, keep in mind two things.

1. When it asks for income, make sure you enter the excess amount.
2. When it asks for the category of income, you will say this is General Category income
3. Check back at us as often as you need if you have questions. we are here to help.

@JM1031
 

[JM1031]

@DaveF1006 

Thank you. It worked flawlessly. Learned something new in Turbotax for the first time.