When I include my wife's foreign income which is tax exempt my tax increases, can someone please explain why my tax increases ? Thank you

[rjs]

When you take the foreign earned income exclusion, your tax is not just calculated on the taxable income amount on Form 1040 line 43. The amount of excluded foreign income affects the tax because your other income, that is not excluded, is taxed at the same rates that would have applied if you did not get the exclusion. The non-excluded income is "stacked" on top of the excluded income for the purpose of calculating the tax. Therefore, when the amount of excluded foreign income increases, some of the other income gets pushed into a higher tax bracket, and is taxed at a higher percentage. That's why your tax increases even though the taxable income is the same.

To perform this stacking of income the tax calculation has to be done on the Foreign Earned Income Tax Worksheet. You can look at this worksheet in forms mode in TurboTax, or on page 43 of the IRS instructions for Form 1040. Basically the calculation is three steps.

1. Calculate what the tax would be if you did not have the exclusion. That is, add the excluded amount to your taxable income and calculate the tax on the total. (Income on worksheet lines 1 - 3, tax on line 4)

2. Calculate what the tax would be on the excluded amount only, if that were your only income. (Worksheet line 5)

3. Subtract the result of step 2 from the result of step 1. (Worksheet line 6)

[jrbetschel]

We had the same situation last year and the tax payable did not rise. Something just does not make sense.

[rjs]

It's possible that last year, even with the income stacking, your non-excluded income stayed in the same bracket and did not get pushed into a higher bracket. (It got pushed up within the bracket it was in, but not high enough to cross the upper boundary of the bracket into the next higher bracket.) It depends on the amounts of income and how the income falls in the bracket structure. The only way to analyze it is to look at the details of the tax returns for both years, which we can't do here. If you compare the Foreign Earned Income Tax Worksheets for last year and this year you might be able to see why the effect is different.

[jrbetschel]

I really need to get this right, can some one help? I called turbotax and they could not help.

[rjs]

I'm not sure what kind of help you are looking for. It's not clear that there's anything wrong with your tax return. There is certainly nothing unusual about the tax increasing because of excluded foreign income.

As I said earlier, we can't help you any further here because we can't see your tax returns. I'm a bit surprised that TurboTax support couldn't help you. They should have let you talk to a tax expert, and I believe they have the ability to look at your return with your permission. You might want to try calling again and ask specifically for a tax expert who is familiar with the foreign earned income exclusion.

If that doesn't work, you should probably visit a local tax professional, and bring copies of this year's and last year's tax returns.