# Credit or Deduction and for 2555-T



## KristenJune (Oct 8, 2016)

Help.

Using Turbo Tax. Moved to the UK mid tax year and have just over $7k foreign earned income to report.

It gave me the option of either taking this as a Credit or a deduction. If I decided to take it as a credit, form 2555 popped up but it started to get very confusing to complete. So I went back and decided to take my foreign income as a Deduction. It meant paying just a small amount more tax but the form 2555 didn't need filling ( I don't mind paying the small amount extra rather than make an error on the 2555).

Turbo Tax added my foreign earned income to line 7 of my 1040 but of course I do not have a W2 to attach for the foreign income. It shows as a deduction on my Schedule A.
So am I correct that if I take my foreign earnings as a deduction I don't need to complete a form 2555, or do I need to file form 2555 in both cases or am I still missing something ? Confused.


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## Bevdeforges (Nov 16, 2007)

Where are you taking your foreign income as a "deduction?" Normally the choice is to exclude the income using the 2555 (which is actually the easier way to go - especially if you can use the 2555EZ form) or to take a tax credit (using form 1116) for the foreign (in your case, UK) income tax you paid on the income. 

It's also possible to deduct the UK income tax you paid on your earned income from the gross amount and just report the net amount - but be very careful here. You can only deduct income taxes, not social insurances or anything else that may have been deducted from your income in arriving at "taxable income" for UK purposes. The tax rules are very different between the two countries.

With only $7K of foreign earned income to report, simply excluding using the 2555(EZ) form will eliminate all income tax due to the US. If you're paying even "a small amount more tax" then you're doing something wrong.

And no, you don't need a W-2 for foreign income. A foreign employer can't and won't issue one. The IRS basically just has to take your word for it.
Cheers,
Bev


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## KristenJune (Oct 8, 2016)

Bevdeforges said:


> Where are you taking your foreign income as a "deduction?"
> Bev


My error, I mean I am taking the foreign income TAX PAID as a deduction.


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## KristenJune (Oct 8, 2016)

Bevdeforges said:


> With only $7K of foreign earned income to report, simply excluding using the 2555(EZ) form will eliminate all income tax due to the US.
> Bev


I thought I could only exclude income if I had been in foreign country for an entire tax year.


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## Bevdeforges (Nov 16, 2007)

KristenJune said:


> I thought I could only exclude income if I had been in foreign country for an entire tax year.


There are two "tests" for this. The one is the bona fide residence test, where you have to have been outside the US for an entire calendar year. The other is the physical presence test, where you have to have been outside the US for 12 consecutive months. With the physical presence test, you have to wait until the anniversary of your move to file your taxes if you're claiming the physical presence test.

In any event, if you file from outside the US, you have an automatic extension to June 15th. If you moved to the UK after June last year, you file the form for an extension to October - it's supposed to be automatically granted. You file your return any time after you have reached your 12 month anniversary of living abroad. So, say you moved in July last year. File for the extension to October. You file your return for 2016 sometime after July, 2017, excluding all your earned income under the physical presence test.

Depending on your status (visa, etc.) you can then file next year as usual for 2017 (i.e. by June 15th 2018). 
Cheers,
Bev


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## KristenJune (Oct 8, 2016)

Thanks Bev.

I think I understand. I will file an extension delaying filing my taxes until I get the 12 months in the UK then file a 2555 to exclude my (net) foreign income. 

If I show my foreign taxes that has been paid as a deduction rather than a credit then it should show on a Schedule A but I need to separate any other contributions to show the true tax paid.

At this stage looks like I have a $454 federal refund due.


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## Bevdeforges (Nov 16, 2007)

KristenJune said:


> Thanks Bev.
> 
> I think I understand. I will file an extension delaying filing my taxes until I get the 12 months in the UK then file a 2555 to exclude my (net) foreign income.


Actually, you declare and exclude your gross foreign earned income.

If you deduct the foreign income tax paid, you need to itemize your deductions rather than taking the standard deduction. 
Cheers,
Bev


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## Moulard (Feb 3, 2017)

It is almost always better to take a credit for foreign taxes paid rather than taking a deduction.

Consider that a deduction will only reduce your taxable income, which means you are only getting the marginal tax rate value out of it. 

Consider the following simplified example which illustrates the idea...

if you had a gross taxable income of 10,000... and paid foreign taxes of 1,000. For the sake of simplicity lets say the US tax rate is a flat 10%.

If you take a deduction for your foreign taxes you now have a taxable income of $9,000 and you have to pay tax on that amount. -- in this example $900.

If instead you take a tax credit, your taxable income is $10,000, and the amount of tax due would be zero... The tax payable is $1,000 but you can offset that with the tax credit of $1,000 and so owe no tax. 

If you live in a country that has a higher tax rate than the US this can be an effective way of minimizing your US tax obligations.

You just have to remember that you you can't take a credit or a deduction on the portion of your income that you excluded on the 2555.


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## Bevdeforges (Nov 16, 2007)

The other caveat about taking the foreign tax credit is that it can be a bit complicated in practice. There is a tendency to say that you get credit for the income tax you paid in the foreign country - but take a look at the instructions. You have to separate earned income from "passive" income (like bank interest). Then, you apportion the tax you paid between the categories based on the relative amounts of income you show on your US tax forms.

It can be way less advantageous if, for example, you have "tax free" bank accounts in your country of residence and thus $0 tax on "passive" income. Or if you're filing married, filing separately and your NRA spouse has a much higher income than you do because in that case, most of the taxes you pay are attributed to your spouse. 

The other consideration is that, once you give up using the FEIE, it can be difficult to switch back to it. In some cases, you need to get "permission" from the IRS to do so.

If your primary source of income is salary, and that salary is below the FEIE limit, the FEIE usually winds up being the quickest way to bring your tax liability down to $0. You can also take both the FEIE and the FTC (only on income not already excluded) if necessary. In any event, it can pay to run the numbers for your particular case to see which approach works best for you. (And there may be considerations other than just which way yields the lowest tax bill.)
Cheers,
Bev


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## Moulard (Feb 3, 2017)

Sorry, Yes. Agree. I fixated on the taking foreign taxes as a deduction or as a credit part of the question and overlooked the 2555 part of it.... 

Agree that the preference would be to go with the FEIE particularly if this is the first return with foreign earned income. 

Truth to tell, I can't think of any scenario off hand where it would actually be advantageous to revoke the foreign earned income exclusion for anyone who gets the bulk of their income from wages.


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## KristenJune (Oct 8, 2016)

Thank you so much for your input and comments. I am sure this is easy but its causing me some stress.

In my case, my income is almost entirely employment with a small amount bank interest ($127).

I have started to fill out form 2555 (thats the FEIE right?) as its my first year (applying for filing extension to accommodate this).
I was only going to exclude (report) my employment income but unsure if this should be Gross or Net (gross is $7318 and net is $5853) in my situation. 

I have entered my UK bank interest of $127 on Schedule B (Interest and Ordinary Dividends) as its also shown as interest on my 8938 (not reporting this on 2555). This interest was not taxed at source.

The UK tax I have paid is showing on Schedule A Itemized Deductions (I have been able to separate tax paid from other contributions as its clearly shown on my payslips). Is this ok?

FYI, my spouse and I are married filing separately and taking the itemized deduction option if that makes any difference. 

I am not so concerned about saving myself a few tax dollars at this stage but just completing everything so its acceptable for filing without screwing it up for this and future years and it not being accepted and the need to file an amended return. I have lost count the number of times I have had to go through TurboTax making changes and even starting afresh again!


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## iota2014 (Jul 30, 2015)

If your circumstances are quite straightforward, might it be worth having a go at filling in the forms without using TurboTax?

I tried using a similar tax software package (Taxact) when I was trying to get my head around filing for the first time. I found it hellishly confusing.


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## Bevdeforges (Nov 16, 2007)

KristenJune said:


> Thank you so much for your input and comments. I am sure this is easy but its causing me some stress.
> 
> In my case, my income is almost entirely employment with a small amount bank interest ($127).
> 
> ...


If you can, use the 2555EZ. It's shorter and a bit easier to get through. For US taxes, you always report your income gross. (And thus, you exclude the gross amount.) 



> I have entered my UK bank interest of $127 on Schedule B (Interest and Ordinary Dividends) as its also shown as interest on my 8938 (not reporting this on 2555). This interest was not taxed at source.


You don't actually need to enter your bank interest on the Schedule B. Unless your interest income is > $1500 you can leave the top part of the form blank and just fill out the section at the bottom that asks if you have any foreign accounts. Unless you have at least $200,000 in foreign assets that are reportable, there's no need to file an 8938 at all.



> The UK tax I have paid is showing on Schedule A Itemized Deductions (I have been able to separate tax paid from other contributions as its clearly shown on my payslips). Is this ok?
> 
> FYI, my spouse and I are married filing separately and taking the itemized deduction option if that makes any difference.


Is your spouse a US citizen, too, and subject to US taxation? If not, he has no need of filing. If he is a US citizen and has to file, you'd probably do better to file jointly. You can each take your own FEIE, and if that wipes out your tax liability, you may not need to take the itemized deduction. But if he has to file anyone, easier to add your income to his, file jointly and be done with it.



> I am not so concerned about saving myself a few tax dollars at this stage but just completing everything so its acceptable for filing without screwing it up for this and future years and it not being accepted and the need to file an amended return. I have lost count the number of times I have had to go through TurboTax making changes and even starting afresh again!


First of all, make sure hubby actually has to file. But if you're filing separately, it may be easier, as iota says, to simply fill out the forms manually. They really and truly don't have to be "perfect" - as there is no one, single "correct" way to report your taxes no matter what your situation. Give it a good faith effort.

I take it you had no taxable income from the US last year. If you did, you should combine that with your UK income and file a single return for the whole year. Only your UK earned income (i.e. from the date you moved to the UK) will be eligible for the FEIE. Any salary or bank interest you received before your moving date still winds up being taxed at regular rates.
Cheers,
Bev


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## KristenJune (Oct 8, 2016)

Thanks everyone.


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