Foreign earned income increases tax due even after exclusion!

[t-roth]

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 :(

[pk]

@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

[rwh03001]

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? 

[DawnC]

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?

[pk]

@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.

Is there more I can do for you ?

[rwh03001]

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. 

[pk]

@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 ?

[matt_SG99]

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.

[caniviton]

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

[KristinaK]

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

[rwh03001]

So here's the best practice answer. Take the Foreign Earned Income Exclusion to reduce your overall global taxable income. Then, use the Foreign Tax credit to assess the total percentage of your foreign income against that reduced global income amount and take the credit for the remainder of your foreign income.

This approach pulls double duty in the sense that the exclusion reduces your global income, so the tax credit becomes more valuable because the denominator in the equation used to calculate FTC is smaller.

I've had 3 HRBlock advisors do work for me. 2 of them used this approach to perfection. The 3rd was completely out of his depth, got our taxes wrong (said we owed $17k, and had to be rescued by one of the other advisors who got that number down to $5k using the approach described above). 

[pk]

@rwh03001 ,  the process outlined by you  is  not  correct.  Please see the definition  of total foreign source  taxable income.   Section 902 through 911  of the  IRC  does not support  your  contention.    Please do not use this  method of reducing the world  income by excluded income  ( if I understand  your post correctly  ).     IRS tax software  generally runs  their own software  to check your claim and if no match  then you are likely to hear from them.  IMHO, so much for H&R Block experts

I apologize , if I  mis-understood  your suggestion.

I stand down.

pk 

[rwh03001]

It is honestly far more likely that I misunderstood what my tax prepairers did. Given that two distinctly different prepairers used the same strategyt, one that I never thought of, across a span of 5 years, my guess is it's more likely than anything else that I've understood/explained it incorrectly