I'm a bit confused about the foreign earned income exclusion cap. Let's say you're working in Europe and you make $200,000 in a year. Since you're working in Europe, you pay between 30 and 40% of your gross income as tax, so let's say you pay $60,000 in foreign tax ($200,000 * 30%). However, since the exclusion only goes up to around $105,000, you would have $95,000 that are not covered, and thus are subject to your US federal tax rate. Let's say your federal tax rate is 25% on that $95,000 - are you really subject to another $23,750 ($95,000 * 25%) of tax???
That seems like severe double-taxation and a huge penalty for working abroad. What am I not understanding here?
You can use the Foreign Tax Credit for the other $95,000.
You would enter that you paid $28,500 in Foreign Tax on the $95,000 ($95,000 x 30%), and you will get a credit on your US tax return. It isn't necessarily a direct credit for $28,500 (the calculations are more complex than that), but it will significantly reduce the taxes because of that which avoids the double-taxation.
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