Foreign Earned Income Exclusion (FEIE) and mid-year move back to US

[RS3]

In 2022 I lived abroad for part of the year until we moved back to the US in July of that same year and started working for a US employer in August. I’ve gone through the Foreign Earned Income Exclusion (FEIE) steps in TT and the result was that my foreign income qualified for the FEIE, but it bumped up my federal tax due anyway. I do pass both the Bona Fide Residence test and Physical Presence Test since we’ve lived abroad for 5+ years. I wonder why it bumps up my taxes, I read the FEIE is prorated in my case? Thanks

[RalphH1 · Accepted solution]

Your maximum possible Foreign Earned Income Exclusion is reduced if you're not abroad all year, but you can still exclude all of your income if it's lower than that reduced max amount (and you seem to be describing that scenario). However, when the tax goes up despite foreign income being excluded, it’s often a result of a very unpopular little catch in the rules which is commonly referred to as “The Stacking Rule” (discussed here).

Although the foreign income itself is indeed excluded, the rest of your income is taxed as if that foreign amount were included (it’s “stacked” on top of the ghost foreign income), so some or all of it can end up in a higher bracket.

This could happen with a lower total income amount (where the standard or itemized deduction would normally render much of it non-taxable, but the excluded foreign income pushes it up into the 10% bracket), or a higher income amount (where some 12% income ends up being taxed at 22%, 24% income at 32%, etc.). And the amount of the (unexpected and frustrating) tax increase depends on exactly how much income is pushed into higher brackets, and the difference between the brackets.

When you’re able to print out your return, you should see a “Foreign Earned Income Tax Worksheet,” where you can see this playing out (if you want to do the math). But you can also just locate your 1040 line 15 income amount in the IRS Tax Tables, and if you’re mysteriously paying significantly more than the result, then we probably have our answer.

Of course, it’s always a good idea to check for incorrect entries in the foreign exclusion section, and (especially) on the actual tax forms. (If you double-entered the foreign income, for example, you’d see it on some other line of the 1040 besides just 1h and 1z, or you’d see it twice on Schedule 1...) And it's also possible I misread your post, and you're only excluding part of your foreign income (which could be an additional reason for the tax increase, or maybe the only reason...).

But assuming that's all irrelevant and it’s the Stacking Rule, there’s unfortunately nothing we can do about it. I hope I at least helped with some clarification though, @RS3!