Treating the nonresident spouse as a U.S. tax resident

How do I include my wife's income if she does not have a W-2 as she is income tax exempt? Her taxable income is 0.

If you are including her on a jointly filed US income tax return, she will be treated as a US resident and she would need to report any worldwide source income (in USD) on your jointly filed tax return (Just like a US citizen would need to.).  You can include any foreign-sourced income (in USD) as other taxable income under line 21.

1. Click on the “Federal Taxes” tab ("Personal" tab in TurboTax Home & Business)
2. Next click on “Wages and Income”
3. Next click on "jump to full list" or “I’ll choose what I work on”
4. Scroll down the screen until to come to the section “Less Common Income”
5. Choose "show more", then Miscellaneous Income
6. Choose "Other Reportable Income" and enter this information here under other taxable income 

Please refer to the links in the answer below if you have any additional questions.

Other question come up with regards to the child care deductions. Having my wife with 0 taxable income (her income is exempt), could we still deduct expenses related to child care?

why is her income exempt?

because she works in an international organization under a G-4 VISA. She decided to be treated as a un resident for tax purposes but her income is still tax exempt.

To qualify for child care credit, both you and the spouse need to have earned income, which is money earned from a job. What happens if the spouse has an exempt income? It means that we are not eligible for the child care credit?

Since her income is exempt, you cannot use the child care credit

Yes but you will only be able to file by mail and you will have some extra steps when completing your tax return.

If you are a US citizen or resident alien and you are considered married as of the end of the calendar year, you will only be able to file as either married filing separately or jointly.

Click here for more information about Claiming Non-Citizen Spouse and Children On Your Taxes.

To include your nonresident alien (NRA) spouse on your tax return, if your NRA spouse does not have a Social Security Number (SSN) or Individual Taxpayer Identification Number (ITIN), you will need to apply for one. To apply for an ITIN, you would use Form W-7 and would need to attached your tax return to this form (see below). Please note, you will not qualify for the Earned Income Credit (EIC) without a valid Social Security number (not an ITIN) for yourself, your spouse (if filing jointly), and any qualifying children.

If you are filing as Married Filing Jointly and you claim an exemption for your NRA spouse, your NRA spouse will be treated as a US resident alien for US tax purposes and all of your spouse's worldwide income in USD will be subject to being taxable as a US citizen or resident alien.

Additionally, if you file as married filing jointly and your NRA spouse lives outside the US and meets the Bona Fide Residence Test or the Physical Presence Test, your NRA spouse might be able to claim an IRS - Foreign Earned Income Exclusion that would exclude a portion of your NRA spouse's foreign source earned income (up to $101,300 for 2016).  TurboTax will guide you on taking the foreign earned income exclusion when you enter your NRA spouse's foreign source income under Federal Taxes> Wages and Income>I'll choose what I work on (or jump to full list)> Less Common Income (show more)> Foreign Earned Income and Exclusion.

The Internal Revenue Service has no official exchange rate. The IRS will normally accept any posted exchange rate that is used consistently. You can translate the foreign currency to U.S. dollars using the yearly average currency exchange rate for the tax year.  In general, use the exchange rate prevailing (i.e., the spot rate) when you receive, pay or accrue the item.

Please refer to the following IRS links for more information about Foreign Currency and Currency Exchange Rates and Yearly Average Currency Exchange Rates

Please note : If you have foreign bank accounts, you may be required to file a Report of Foreign Bank and Financial Accounts (FBAR) if are a US citizen or resident and:

1. you had a financial interest in or signature authority over at least one financial account located outside of the United States; and
2. the aggregate value of all foreign financial accounts exceeded $10,000 at any time during the calendar year reported.

To be directed to the US Treasury Government Website to prepare a Report of Foreign Bank and Financial Accounts, click FBAR (TurboTax does not support this form)

Here are some additional steps for filing married filing jointly if spouse needs an ITIN. 

• leave NRA spouse's SSN blank and print a paper copy of your tax return.
• skip error check section if only error is missing SSN for spouse.
• under the file tab, you will need to select "file by mail" and print a copy of your federal income tax return.
• attach a statement, signed by both spouses, to your joint return for the first tax year for which the choice applies (Nonresident Spouse Treated as a Resident). It should contain the following information:
•  A declaration that one spouse was a non-resident alien and the other spouse a U.S. citizen or resident alien on the last day of your tax year, and that you choose to be treated as U.S. residents for the entire tax year.
• The name, address, and identification number of each spouse.
• apply for NRA spouse’s Individual Taxpayer Identification Number (ITIN) using Form W-7 (Click ITIN). (You will need to apply for a ITIN if filing married filing separately and taking an exemption for NRA spouse and that NRA spouse does not have a SSN. (see option 3 below))
• attach a copy of your Form W-7 (along with the necessary supporting documents) to your tax return (For the supporting documents, one option is for your NRA spouse to get a certified copy of his/her passport which will need to be included with your tax return filing.) Click here for IRS website  ITIN - Frequently Asked Questions .
• mail your tax return along with your declaration statement, Form W-7 and supporting documents to the IRS. According to the IRS, because you are filing your tax return as an attachment to your (ITIN) application, you should not mail your return to the address listed in the Form 1040, 1040A or 1040EZ instructions. Instead, send your return, Form W-7 and proof of identity and foreign status documents to:
  
       Internal Revenue Service
       Austin Service Center
       ITIN Operation
       P.O. Box 149342
       Austin, TX 78714-9342 
  
  You may also apply for an ITIN using the services of an IRS-authorized Acceptance Agent or visit some key IRS Taxpayer Assistance Center in lieu of mailing your information to the IRS in Austin.

• State filing - You will want to file an extension for your state until you receive your ITIN. This is because the application for your ITIN is a federal filing. Most state will not process your return without either a SSN or an ITIN. (However some states will accept state filings with W-7 attachments. Please contact your state for more information using the State Department of Revenue Contacts and ask if your state will accept a state tax return with a Form W-7 attached).  
  When the IRS assigns you an ITIN, update your returns (both federal and state) in TurboTax with this new information and then you should be able to e-file your state return.
  Because many states give an automatic extension when you file the federal extension Form 4868, just file a federal extension even if you don't think you will need it for your federal tax return.  But check with your state's Department of Revenue to make sure that your state doesn't have a separate state extension filing.