Foreign earned income exclusion not applied correctly

Forum|Forum|2 years ago
July 28, 2023
1 reply
4 views

Hello,

my wive worked in the netherlands for more than 380 days and did not return to the US in between. She also payed taxes in the netherlands and there is a tax treaty in place. After filling out section

"Foreign Earned Income and Exclusion" Turbo tax confirms that she is subject to the foreign earned income exclusion. Her income is below 15000 dollar.

However, when I add her income in this section this increases the taxes we owe by roughly 2800 dollar. This seems a bug in Turbo tax to me as due to the foreign earned income exclusion no tax should be owed on this income as she already payed taxes in the Netherlands.

What am I missing?

Thanks a lot for your help!

Not A Product Question

rjs

Level 15

It's not a bug in TurboTax. When you take the foreign earned income exclusion, the amount of excluded foreign income affects the amount of tax because your other income, that is not excluded, is taxed at the same rates that would have applied to that income 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 you add the excluded foreign income, 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 when you add the excluded foreign income.

So you are not paying tax on your wife's foreign earned income, but having that income makes you pay a higher tax rate on your other income.

ps123Author

Level 2

@rjsThank you! This is very helpful.

What confuses me is the size of the increase 2800$ in my tax coming from adding around 12k of non-taxable income. If this pushes some of our income from the 35% to the 37% percent bracket, this would be consistent with an increase of 2% *12000$, e.g. a tax increase of around 240$. The change in my taxes computed by turbo tax is an order of magnitude larger.

What am I missing?

Thanks again for being so helpful!

rjs

Level 15

Here are a few things to check.

A maximum of $112,000 (for 2022) of foreign earned income can be excluded. If your wife made more than that, her remaining foreign income cannot be excluded and is taxable.

Make sure you did not make a mistake entering the amount of your wife's foreign income. The excluded amount is on Schedule 1 line 8d, as a negative number. Also look at Form 2555 to see if you spot any errors.

You can see how the tax is calculated on the Foreign Earned Income Tax Worksheet. If you are using the CD/Download TurboTax software you can look at this worksheet in forms mode. If you are using TurboTax online you can see the worksheet if you save a PDF of your tax return and select the option to include government and TurboTax worksheets. Or you can see the worksheet on page 35 of the IRS instructions for Form 1040 and work through it yourself.