Foreign earned income increases tax due even after exclusion!

Forum|Forum|3 years ago
April 15, 2023
2 replies
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I am a US citizen living abroad. Income items on my tax return are foreign earned income, capital gains, and income from K-1 statement. All the foreign income qualifies for exclusion under the rules.

I entered all my data into Turbo Tax except for the foreign earned income. Without foreign income, the tax liability was around 7K. Then I entered the foreign earned income (in the Less Common Situations section) and answered all the related questions. Adjusted gross income and taxable income remained the same as before (as they should), but the tax liability increased to 14K! I have gone through the forms in Forms mode several times but I cannot see why this is happening and it makes no sense. Any guidance is much appreciated.

Best answer by pk12_2

@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 ?

pk12_2

Employee

@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 ?

TaxsmithAuthor

@pk12_2, 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?