Foreign Earned Income Exclusion bug? Not actually excluding the full amount in tax owed calculation?

[KG31]

I have foreign earned income from one employer (below the maximum threshold for exclusion) and was a resident of that foreign country the entire year 2019 by both physical presence and bona fide tests. I am not taking any foreign housing deductions. TurboTax Online confirms I can exclude all foreign income with the message at the end of the section: "Congratulations! Your foreign earned income exclusion is $X. You will not pay U.S. tax on this amount" (where X is the total of my foreign income).

However, the amount of tax I owe is higher for federal and state after completing this section. If I delete the foreign earned income or reduce the amount to test what's going on, the tax owed for federal and state both decrease. This leads me to believe it is not actually being excluded fully. Can anyone provide insight? Thanks in advance.

[rjs]

You must have some other income that is not excluded. When you take the foreign earned income exclusion, the amount of excluded foreign income affects the tax on your other non-excluded income, even though you do not pay tax on the excluded foreign income itself. This happens 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 the amount of excluded foreign income increases, some of the other income gets pushed up into a higher tax bracket, and is taxed at a higher percentage. This is the way the tax law requires the foreign earned income exclusion to be calculated. TurboTax is doing the calculation correctly.

[KG31]

@rjsThanks for the clarification. Indeed I do have other income, and your explanation makes sense.

[guptanik]

What if the tax bracket remains the same?

[ThomasM125]

You would have to print out the tax return, first with the income excluded, and then with the income not excluded and compare the two to see what is causing the change in tax.

You can view your form 1040 while working in the online TurboTax program as follows:

1. Find the "Tax Tools" option on your left menu bar and click on it

2. Click on "Tools"

3. Click on "View Tax Summary"

4. On your left menu bar find the "Preview my 1040" option and click on it

[ken49]

This is very helpful but I'm stuck on one aspect. I was self-employed all of 2019, and my only source of income was foreign earned consulting income.

Should I enter this income into just the Foreign Earned Income? OR also into the standard Self Employed income?

When I enter my income only into the Foreign Earned Income the amount owed is too low (it does not include contributions for Social Security and Medicare). When I enter the income to both the standard Self Employed and Foreign Earned sections it does not associate the two amounts and instead layers the income as mentioned above. 

What am I missing? How do I tell TurboTax that the standard Self Employment income is eligible for the FEIE? Thanks.

[KarenJ2]

1. Enter your income and expenses in the Business section, 

2. Then you should go to the foreign earned income exclusion section 

3. On the first screen, check box Form 1099-MISC or other self-employment income.  

4. Then on the next screen enter her Gross Profit from her business 

5. When you get to the screen Deductions Related to your foreign earned income you need to enter your business expenses that relate to her foreign income (probably all of your expenses) 

6. Go through the screens answering the questions all the way to the end of that section. 

Please note that the foreign earned income exclusion is only to exclude income tax.  It cannot exclude self-employment tax. 

To delete the Form 2555 to start over, you need to delete both the Form 2555s as well as the Wage Worksheet.

[ken49]

Thank you so much. I had the wrong checkbox checked in step 3. You nailed it!

[KarenJ2]

You are welcome!!

[guptanik]

 I did what you mentioned where I compared to the 2 forms. Lets say I earned X$ from my long term capital gains this year. My foreign earned income was Y$. I qualified for this amount to be excluded. I see that the amount is first added as income and then subtracted after being excluded. But for reason, while calculating the tax amount owed it subtracts Y$ from the lower bracket amount leading the taxed amount effectively being X+Y. Can you tell me where I'm going wrong here? I was not self-employed.

[KarenJ2]

Unfortunately a number of years ago, the IRS changed the tax rules, and the foreign earned income is added back to all income before the US tax is calculated.  Then the tax is calculated on the excluded income.  The difference in tax is your US tax.  This is called the stacking rule. 

You are married filing jointly, have two children and you take the standard deduction ($24,400) and child tax credit ($4,000 for two children). Total wages $112,000 

The US tax on this income is calculated as follows: 

US tax on $112,000 is $6,989 

US tax on $105,900 (amount excluded) would be $5,647 

Net US tax payable 
($6,989 - $5,647) = $1,342 

Before this change, the tax would have been calculated only on the tax rate that applies to $6,100. 

If you have been claiming the FEIE in previous years using Form 2555 and you decide this year to use only the foreign tax credit you cannot go back to the FEIE for the next six years unless you receive permission from the IRS. 

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[guptanik]

Thanks for the reply. The amount I'm trying to exclude is however lower than the upper limit of 105,900. This is then getting taxed at the rate of 15% which is the flat tax rate for tax bracket $78,751 - $488,850 for married filed jointly.

[KarenJ2]

I am not quite sure of what is happening.  Did you try to calculate your tax using the example I provided?. 

Example:  You are married filing jointly, have two children and you take the standard deduction ($24,400) and child tax credit ($4,000 for two children). Total wages $112,000 

The US tax on this income is calculated as follows: 

US tax on $112,000 is $6,989 

US tax on $105,900 (amount excluded) would be $5,647 

Net US tax payable 
($6,989 - $5,647) = $1,342 

Please provide an example of what you are questioning.  Thank you for your assistance with this.

[hk999]

Married filing jointly: 

US Income : $84174

Foreign income : $7000

Total : 91174.

When am entering Foreign income which I claimed as Foreign Income Exclusion my refund for both federal and state is decreasing, isn't the income supposed to be exluded from the tax calcualtions?

The tax bracket did not change before or after adding the foreign income

[rjs]

@hk999  Read my first reply at the top of this thread (at the link below). The foreign income is not taxed, but it affects the calculation of the tax on the U.S. income. The foreign income pushes some of the U.S. income into a higher bracket. Your top tax bracket might not change, but more U.S. income is pushed into that bracket.

Here is a direct link to my earlier reply above.

https://ttlc.intuit.com/community/taxes/discussion/re-foreign-earned-income-exclusion-bug-not-actual...