FEIE Form 2555, line 44 - Deductions allowed in figuring your adjusted gross income that are allocable to the excluded income

[davidchl]

Hi all, it's my first post and thanks for having me in this community.

This is my situation but numbers are made up for ease of explanation (I am doing an amended return because I forgot to take advantage of FEIE).

- My W2 wages are $120,000.

- My gross self-employed business income is $1000.

- Self-employed business expenses is $100

- I was physically abroad for the entire 2023.

- The FEIE limit for tax year 2023 is $120,000.

- No Housing Exclusion

I looked at the examples in Publication 54, How To Report Deductions section but none have this W2 + business income example.

I'm confused when there is both W2 income and business income. If we allocate the Full FEIE $120k to the W2's $120k then we can put $0 for line 44 because the full FEIE was used for the W2 earned income?

I think that makes sense because in IRS Form 2555, line 44 description, it reads: "Deductions allowed in figuring your adjusted gross income (Form 1040 or 1040-SR, line 11) that are allocable to the excluded income."

So since the FEIE $120,000 is used for the W2's $120,000, the business deductions are not allocated to the excluded income because the excluded income was the W2's  $120,000, not any of the business income.

Is this correct?

I asked ChatGPT and here is what it said:

Yes, your understanding appears to be mostly correct, and you are interpreting the Foreign Earned Income Exclusion (FEIE) and the associated deductions logically. Let me walk through your example and reasoning:

1. W-2 Income and Full FEIE Allocation:

• You have W-2 income of $120,000.
• You are allowed to use the full Foreign Earned Income Exclusion (FEIE) of $120,000 for this W-2 income.

In this case, you are excluding the full $120,000 of your W-2 income through the FEIE, so this entire amount is treated as excluded from U.S. taxation. As a result, this excluded income is not counted in your adjusted gross income (AGI).

2. Business Income and Expenses:

• You have business income of $1,000.
• You also have business expenses of $50.

When it comes to the business income and expenses, they are separate from your W-2 income and the FEIE exclusion. Because your W-2 income is already fully covered by the FEIE, none of your business income is "excluded" under the FEIE. As a result, the business income and deductions are treated as part of your taxable U.S. income.

3. Form 2555 Line 44 – Deductions Allocable to Excluded Income:

Line 44 on Form 2555 asks for any deductions (like business expenses) that are allocable to excluded income. Since your excluded income is solely from the W-2 ($120,000), and your business income is not part of the excluded income (because the FEIE has already been used for the W-2 income), there is no need to allocate the $50 business expense deduction to the excluded income.

Therefore, your interpretation is correct: since the excluded income is entirely from the W-2, the business deductions are not allocable to excluded income. You would not report any deductions on Line 44 of Form 2555 in this case.

4. Conclusion:

You are using the FEIE to exclude the W-2 income entirely, and since the business income ($1,000) is outside of this exclusion (it hasn't been excluded), the business expenses ($50) apply to your taxable income, not to the excluded income.

So yes, you would correctly report $0 on Line 44 of Form 2555 because your business deductions are not allocable to excluded income. Your business income and deductions are handled separately from the FEIE.

Of course I would like someone to confirm this!

Thanks!

[tagteam]

I'm not 100% certain @pk can help with this but we'll see. Check back later.

[pk · Accepted solution]

@davidchl ,

(a) Assuming that you are US person ( Citizen/GreenCard ) and  having a tax home abroad   ( which country please ? ),

(b)  You were employed  by local entity with an income of US$120,000; you are claiming no other  employer paid  benefits like housing etc.

(c) You self-employment income ( work  performed  outside of USA ) is  ( and as reported on Schedule-C )  shows a gross income of US1000 and allowable expense of  US$50 i.e. a Schedule -C net i taxable income of  US$950.

 In such a case,  you would report your total Foreign source income ( for purposes of form 2555) as  US$12950.   Thus your  Foreign Earned Income Exclusion amount would be  US120,000, leaving you with  US$950 of unexcluded income.

This would mean that your US taxable income  would be  US950 LESS your Deductions .  Thus your US tax liability should be zero and therefore any foreign tax credit would be nil.

However, unless you assert  " certification of participation" in SECA/ Social Security  of  your tax home, you would be liable for SECA  ( 15.3% on approx. 92% of your net self-employment income).

Does this make sense ?

Is there more i can do for you ?

[davidchl]

Hi, thanks for your reply 🙏

Here's some more details about my situation:

- I am living abroad in Thailand

- W2 is from my US employer (so not a Thailand company)

- My business income is also from the US, and I am a sole-proprietor

I consulted a BrightTax CPA and he said that the business deductions need to be on line 44.

"This is how the IRS would like the calculation completed. The current year foreign expenses that are allocated to excluded foreign earned income must be considered. Even though the W-2 wages are theoretically matching the total foreign earned income exclusion, the business income and therefore the business expenses would also need to be considered for the deductions allocable to excluded earned income (Line 44)."

So I guess ChatGPT was wrong and I have to reduce my FEIE by the business deductions on line 44

[pk]

@davidchl , my suggested method also does the same thing because the expenses  ( for the foreign source) income stream is included  on Schedule-C   -- thus creating a net income.  It is also included on  your Foreign gross income eligible for FEIE.  The  unexcluded portion  ( that foreign income  above the  max allowed for the year  ) is subject to US tax.

So I see no difference between my suggested path  and your consultant ( Bright Tax ).

I rest my case  

[davidchl]

Awesome, thank you for your help!