Foreign earned income increases tax due even after exclusion!

@Taxsmith , cannot answer the question with much confidence ( i.e. Turbo is computing tax in error or what  ), without more details  -- general figures of world income, foreign income, country of foreign income, when did you start your foreign stay -- tax home start date , are you still abroad  etc. etc.

However, even though the foreign income is  excluded , its effects still are  there in the computation of the  tax  ( the world income is without regard to excluded income, then the excluded  tax contribution is excluded ).

 I will circle back once I hear from you --yes ?

@pk, as I mentioned, all of the foreign earned income qualifies for exclusion. I have been 100% abroad (Iceland) since 2019 and am still abroad. The foreign income is below the exclusion limit, so all of it can be excluded. Other income items are capital gains, interest, and K-1 business income (all US-source income). The K-1 business income is taxed in the US. The capital gains and interest income are taxed in Iceland (under the US-Iceland tax treaty, capital gains and interest income are re-sourced to Iceland, and Iceland has the first right to tax it).  Therefore, I take foreign tax credit on the US return for the tax paid to Iceland on capital gains and interest income. For the wage income earned in Iceland, I use the foreign earned income exclusion.

All the mechanics of the calculations are going through correctly as I checked in the forms mode. The foreign earned income, if all of it is excludable, does not (and should not) change the AGI and taxable income.  If AGI and taxable income do not change with the FEIE, then why does the tax liability double?

@Taxsmith , agreeing with your position that  excluded income should not  affect the  tax computation.  However the realities are different ---in the forms mode  select the tax computation worksheet and you will see that the calculation actually uses the world income without regard to exclusion to compute the tax and then from it subtracts  the taxes due to / allocated to excluded  Foreign income.   Personally I disagree with this allocation method  but it is blessed by the IRS and therefore  .....

Is there more I can do for you ?

@pk,I found the tax computation in the Schedule D Tax Worksheet; is that the one you meant? That explains it, so thank you!  That entire calculation is so convoluted. The guiding principle of the IRS rules is - why simplify when you can complicate, confound, and confuse?

The IRS never seems to wish to make things simple but that is what PK meant.

Sorry to bring this back up, but what was the solution here? Was the software right or did you manually adjust something in the forms?  Facing the exact same situation as you where adding foreign income increases taxable amount even though it should all be excluded.

@taxguy69420 , from your post I cannot  determine exactly why your taxes went up on  taking FEIE.   However, here are a few  areas  that may explain  :

Assuming that you had entered all the US income and saw your tax liability  ( federal )  and then  entered the  foreign earned income and used form, 2555 to exclude  all of it ( ?), 

(a) note that the  tax liability is computed  now  on world income ( i.e. including the excluded foreign income and then  the taxes  due to the excluded income is subtracted  --- the  computation that is used by TurboTax , IMHO, does put taxpayer at a slight dis-advantage though.

(b) unless you claim  relief from SECA ( at 15.3% of most of net wages/ active earnings ) is still computed  on Schedule-SE and included in the tax liability.

(c) there  may also be disqualification of some credits  based on world income, depending on exact circumstances and  facts.

If this does not explain your issue with TurboTax ( in your particular case ), please consider  providing some details of your situation.

Is there more I can do for you ?

I will circle back once I hear from you 

pk

@Joseph56 , do you haver a question ?   Please provide some details and  I will circle back once I hear from you 

pk

@pk Since as you say, the "computation that is used by TurboTax , IMHO, does put taxpayer at a slight dis-advantage though", will TurboTax do anything to correct this computation? It causes a significant change in the tax return even though this income is fully excluded. 

@MWH2  the computation method, I believe is approved by the IRS , so I do not know if there is anything   to be done about it.  What  I am talking about  is that  while the excluded  income is added to the  rest of the world income , (thus pushing one to a higher marginal  bracket ),  the tax on the excluded amount is  computed as if that was the total amount -- thus  reducing the effect of the exclusion.   To my mind this puts the taxpayer at a disadvantage.  Unless taxpayers complain about  this , nothing will be done by the IRS and therefore by  the  tax prep. industry.     Sorry.

Is there more I can do for you ? 

pk

A quick internet search shows that Turbo Tax is not recommended for those claiming foreign income exclusion.  I'm gonna try TaxAct.  Unfortunately, I already paid for Turbo Tax.  However,  the extra amount Turbo Tax would make me pay in taxes makes it worthwhile to use different software. 

@matt_SG99 ,  I cannot  understand your dis-satisfaction with the TurboTax computation of tax liabilities  in cases with foreign earned income exclusion .   I have personally used TurboTax for foreign earned income exclusion ( but of course I did not go a check other services computation .  I agree there may be a small difference because rounding method and the use of tax table or computation---- but these are usually  in the range of a few dollars net.   I have been helping people in this arena for at least 18 years and have not seen this issue ( of course this does not mean that the issue does not exist).

I would feel privileged to work with your facts and see  where the issue is.   Would you help me by providing the details of your case ( no personally identifiable information please ) ?   Please .   And oif you feel that your situation is  unlikely to be of interest to the general population you can always  PM me .  Either way, once I get your details I will simulate and see why the  TurboTax is misbehaving.

Please will you help ?    Please note that I am not an employee   nor  have any financial ( or otherwise) benefit/connection to TubroTax / Intuit --- I just volunteer.

I will circle back once I hear from you 

pk

Did TaxAct compute any differently?  As far as I can tell, TurboTax is computing this correctly but it's the tax rules themselves that are unfavorable. But I'd be glad to know if other programs are computing more favorably.

I would also like to know if TaxAct computes this differently.   I seem to of fallen into the same issue as some others.  My wife worked the last year in South Korea.  I entered all my info before coming back and entering the FEI section.  My tax liability immediately jumped 4K even with the last step of the FEI section saying that the entire amount would be excluded from my taxes.  Seems like there is something strange in the calculation, and I was hoping that the Review section would sort it out, but no luck :(

@t-roth , generally speaking  the  tax computation  post Foreign Earned Income Exclusion, is pretty ,much dictated by the IRS  ( using a worksheet ) --  the tax liability is first computed  disregarding the exclusion i.e. Tax on world income -- this pushes you into a much higher bracket.  Then you are given credit  ( a subtraction ) for   the  tax liability  caused ONLY the excluded income  ( not using a blended  rate or any other mathematical  regimes. Thus the increase due to higher bracket  is much and credit for the  excluded income is minimized.   I have issues with this mechanism but this is the accountants at the IRS' perspective of how  it should be done.

Don 't believe any tax software does it any different -- I could be wrong here since I do not have first hand knowledge on this aspect.

While a  approx. 4000 rise  mildly surprises me , I would be happy to confirm the figures  ( by doping it by hand  using the tax tables  or calculations if you provide me the following:

Filing  status; US sourced income; Foreign Earned income;   Country of foreign tax home for spouse,    Taxable income  ( i.e. AGI adjusted for  deductions -- standard or otherwise ).  This should allow me top compute the tax.

Is there more I can do for you ?

pk

This came as a total shock to me as well. Thinking I was going to owe 0 and learning that I owe $16k is hugely disappointing. This seems to me like a complete oversight by the IRS. How is it an exclusion if it boosts your tax bracket? 

Any idea if claiming the foreign tax credit would be more favorable for people with some foreign income but primarily US income? 

To be eligible for the Foreign Tax Credit, you must be a U.S. citizen or resident alien or a U.S. nonresident alien who is a full-year resident of Puerto Rico.   @rwh03001 

You must have paid, accrued, or owe taxes on foreign income that is also subject to U.S. income tax. This foreign tax must be an income tax or a tax in lieu of an income tax that is imposed on you and is a legal and actual foreign tax liability.

Foreign taxes that don't qualify:

• Taxes that are refundable to you
• Taxes used to provide a subsidy to you or a relative
• Non-mandatory taxes that could have been avoided
• Taxes paid or accrued on income earned in countries designated as a State Sponsor of Terrorism or that the U.S. has severed ties or diplomatic relations
• Social security or Social Security taxes paid to countries with which the U.S. has an International Social Security (Totalization) agreement
• Taxes on foreign mineral income
• Taxes from international boycott operations
• A portion of taxes on combined foreign oil and gas income
• Taxes paid by U.S. persons controlling foreign corporations and partnerships who fail to file required information returns

Where do I enter the foreign tax credit (Form 1116) or deduction?

@rwh03001 as I have mentioned above, the  FEIE  ( Foreign Earned Income Exclusion ) does push you into a higher bracket for the unexcluded  or US remaining income.  Also unless  your host country has a  totalization treaty with the USA, you are still subject to  Social Security and Medicare (   except in this case  like self-employed in the US  called SECA,, you pay the whole amount at 15.3% ) but you get an adjustment of 50%  of SECA on your AGI.

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Thank you for this. It sounds like I would most certainly qualify for the foreign tax credit based on your explanation.  Really hoping this is the case. Between the FEIE boosting my US bracket, and the 40% taxes paid on this income in the foreign country, I'm effectively paying like 70% taxes on this income.

FEIE seems like it's never the right approach for foreign wage income. 

@rwh03001  there is really  not much  you can do  --- FEIE pushes you into higher bracket.  Foreign tax credit would compute  using the total foreign income, thus you are at the higher bracket but then instead of subtracting the tax on the excluded income, it will recognize the full foreign taxes paid.  On form 1116 where you claim the foreign taxes credit however, there is a limitation --- the foreign tax credit allowed  will  essentially be based on a ratio of  total Foreign Income to World income but never more than  what US would have taxed you on that income -- two limitations.

There is no winning on this

Is there more I can do for you ?

Thanks for all the helpful advice. It all makes sense now after I started reading pub 54. The IRS makes it clear at the very beginning, under the "reminders" section that"you must figure the tax on your nonexcluded income using the tax rates that would have applied had you not claimed the exclusions." I had mistakenly assumed that "excluded" meant "no impact on taxes" rather than "we will tax your remaining income at a higher rate."

Turns out this is not a turbo tax issue but an IRS policy that is stated upfront.  However, it would be nice if they changed the name to The Overseas Moolah Toll so that you know you will end up paying extra regardless.

This is exactly my question. I cannot see if you got an answer. 

Did you read the entire thread? Which part of the question is still not answered for you?