Foreign income not being excluded from federal tax calculation

[guptanik]

I notice that after passing the physical presence test for foreign income exclusion, I'm still being asked to federal tax on this amount even though it does not cross the upper limit of 105,900$. My long term capital gains place me in the 15% tax bracket for married filing jointly. I see that during the calculation for federal tax, my income is subtracted from the tax bracket lower limit effectively meaning I'm being taxed 15% for this amount as well. What am I missing?

[pk]

@guptanik , I need a little bit more info , please ---(a) are you citizen/Resident of the USA ;  (b) when did you arrive  at the foreign site  & when did you establish  your tax home;  (c) for  form 2555 what test period are you using -- the 12 month for qualification of physical presence test;  (d) is this your first year  and if not did you elect to not use Foreign Earned Income exclusion ;  ( e)  which country is your current tax home and is this the same as on 12/31/2019; (f) are you using desktop or on-line version of TurboTax ?

Namaste ji

[guptanik]

I am a citizen. I've been in the foreign country for all of 2019. I'm using the 12 month for qualification of physical presence test. I'm using the desktop version of Turbotax.  However, the online version gives me the same result.

[pk]

@guptanik ,  both the on-line and the desktop should give you the same answers-- the reason for  my pref. with desktop is that it allows one to view the not only the forms but also the underlying worksheet.

On your form 1040 you will notice that your Foreign  Earned Income  exclusion is shown as a subtraction   (  from schedule-1 line -9 ) on line 7 -- thus your AGI  is reduced by the excluded amount.   But your  tax computation is not based on this AGI.   Tax computation shown on  FR. EI worksheet  ( Foreign Earned Income Worksheet ) , uses  your world income before exclusion to compute the  tax burden and then subtracts from this  the portion contributed by the  excluded income.  Thus even with excluded income you are at a higher marginal rate ( for the taxed income ).

For dividends and  capital gain there is a similar worksheet used to determine the rate of taxation -- it is based on utilizing the world income without regard to excluded income as to whether the tax rate is zero, 15 or higher.

Go to the forms mode  and you should be able to see these worksheets and possibly explain the situation better

Does this answer your query ?

[guptanik]

Thanks for the reply. I do see what you mention. But I guess it comes down to what exclusion actually means then. Suppose my foreign income bumped my tax bracket to 20%, would this apply to the whole amount (income+capital gains)?

[JulieS]

No, the Foreign Earned Income Worksheet does not prevent you from getting a break on your long term capital gains.

The excluded income is included to determine whether your capital gains tax rate is 0%, 15% or 20%, but you still get a lower tax rate on your long-term capital gains.

For instance if you are single and your taxable income, including the excluded foreign income, is between $39,376 and $434,550, your capital gains tax rate is 15%, even though your ordinary tax rate would be at least 22%.