# Foreign Earned Income Exclusion



## dacfer

I have hopefully a simple question on this. I moved from the US to the UK earlier this year. I have just bought Turbotax to help fill in my 2013 tax forms. I earned a salaried income in the US before I came here. I am now working in the UK.

I obviously don't have my W2 yet, so I entered an estimate for my US earnings. Turbotax shows a federal refund of $X and a NJ state refund of $Y. All well and good.

Now I start on the UK income. I'm not sure where to put it as I don't have a W2, so started in the Foreign Earned Income and Exclusion section, where I can enter the foreign amount earned. I entered my UK salary from 2013. Wham! Down goes the federal refund by 50% and the state refund turns red into something I owe. As expected so far.

However, as I understand, I can exclude this income as it is under the threshold. So I start to enter this information into TurboTax and as I satisfy the requirements, TurboTax finally tells me I can exclude all this UK income. Great! However the federal and state tax refunds stay at their new figures and don't go back up to $X and $Y. Why?

If I can exclude this income, why I still being taxed on it?


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## Bevdeforges

I've moved you over here to the Expat Tax section, since this is exactly what we set up this section for.

It sounds like you're probably doing something wrong with the data entry on your tax program. But, it can depend on your income level (among other things).

You enter your UK income - usually on either a "dummy" W-2, or possibly on a special income form for foreign earned income (so that it goes to the form 2555, which is the FEIE form). You will have to calculate your UK income for yourself (usually from adding your payslips) because the UK is on a tax year that runs from April to April rather than a calendar year like the US.

But, depending on your income level, the exclusion may work a bit differently than what you would expect. In essence, you wind up adding your US and UK income together, then figure the tax on that combined figure, as if you were getting no FEIE at all. You then take the tax on just the "excluded" part (i.e. your UK income) and subtract that from the total figure. It means that your US income is being taxed at the higher marginal rates, and if your UK income is significant, it can make quite a difference.

But, you should take a good read-through of Publication 54, because you can't file your 2013 return until you have spent a full year (i.e. 12 months) outside the US if you are planning on taking the FEIE. It's explained in Pub 54. Normally, you file for extensions until you hit your one year anniversary of UK residency, and then you file your 2013 return.

On the state side of things, check the state tax website, but the usual procedure is that you file a NR (non-resident) return for the year in which you moved out of the state (and out of the country) and you apportion your taxes according to your in-state vs. out-of-state earnings. Of course individual states may have their own (completely unique) procedures for handling your move out of the state.
Cheers,
Bev


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## dacfer

Thanks Bev. I understand the calculations will be affected by salary levels, etc, however this does not explain why the tax refunds did not change at all before and after I entered the Exclusion qualification. If I did not qualify, then yes, refunds would not change, however if I do qualify, the refunds should increase surely.


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## Bevdeforges

In the instructions for form 1040, under the instructions for line 44, if you are taking the FEIE you must calculate your taxes based on the "Foreign Earned Income Worksheet" in the instructions. Take a look at that worksheet and it should show you why your refund will, if anything, decrease when you add in your UK income and then "exclude" it using form 2555.
Cheers,
Bev


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## dacfer

I'd hoped TurboTax would do this for me... that's why I bought the program! Maybe there are some others out there that use TurboTax who can comment? I wouldn't try filling in these forms without a program to help.


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## BBCWatcher

...And also run your taxes without the FEIE but with the Foreign Tax Credit. That's also why you bought TurboTax, to figure out which path is more advantageous for you.


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## Bevdeforges

Just one small reminder about doing your first year abroad's US taxes using the Foreign Tax Credit. Normally, you'll only be able to claim credit for the UK taxes you have already paid (i.e. the PAYE withheld from your pay), not on what you expect your tax bill to be for the year. This may also be a bit more complicated, thanks to the April to April UK tax year, as you have to tally up the taxes paid based on the US calendar year.

But to try to explain the "discrepancy" between your refunds with and without the exclusion, let me just say that you're paying your top tax rate on your US income when the UK income exclusion is taken into account - and a portion of your exemption and standard deduction are counted as part of your exclusion. When you figure your taxes based solely on your US income, you're paying the bottom rate, and you get full benefit of your exemption and standard deduction. That's what is making the difference.
Cheers,
Bev


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## dacfer

Bevdeforges said:


> Just one small reminder about doing your first year abroad's US taxes using the Foreign Tax Credit. Normally, you'll only be able to claim credit for the UK taxes you have already paid (i.e. the PAYE withheld from your pay), not on what you expect your tax bill to be for the year. This may also be a bit more complicated, thanks to the April to April UK tax year, as you have to tally up the taxes paid based on the US calendar year.
> 
> But to try to explain the "discrepancy" between your refunds with and without the exclusion, let me just say that you're paying your top tax rate on your US income when the UK income exclusion is taken into account - and a portion of your exemption and standard deduction are counted as part of your exclusion. When you figure your taxes based solely on your US income, you're paying the bottom rate, and you get full benefit of your exemption and standard deduction. That's what is making the difference.
> Cheers,
> Bev


hmm... I'm not convinced. The chances of getting exactly the same refund to the closest cent is about zero with and without the exclusion. The only way this can happen is if the exclusion is not allowed. But Turbotax is telling me that it is allowed. Either there is a bug in Turbotax or I'm missing something in the program.


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## dacfer

BBCWatcher said:


> ...And also run your taxes without the FEIE but with the Foreign Tax Credit. That's also why you bought TurboTax, to figure out which path is more advantageous for you.


Yes of course. But that does mean I have to firstly make sure it's right in both scenarios. I'm still battling to work out what's going on in the FEIE route.


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## Bevdeforges

dacfer said:


> hmm... I'm not convinced. The chances of getting exactly the same refund to the closest cent is about zero with and without the exclusion. The only way this can happen is if the exclusion is not allowed. But Turbotax is telling me that it is allowed. Either there is a bug in Turbotax or I'm missing something in the program.


I think you are misunderstanding how the FEIE affects your taxes. One more attempt to explain (simply - or as simply as possible):

Say you made $75,000 in the US, then moved to the UK and made $25,000 to the end of December.

Let's say, just for round numbers that your personal exemption is $3000 and your standard deduction is $5000. 

OK, when you put in just your US salary, your final taxable income is $67,000 ($75,000 - $3000 - $5000). Look up in the tax tables what the tax is (I'm assuming single filer, no dependents). I'm using old tax tables, but the figure I get is $12,944

Now, if you add your UK salary to that, and take the FEIE, your tax is calculated a little differently, thanks to that FEI worksheet I mentioned. You take your taxable income from the first calculation ($67,000) and you add back your FEIE ($25,000) for a total of $92,000. Look up the tax on that amount in the tax tables. That's basically what you'd be paying on the whole income if there were no FEIE. From my old tax tables, I get $19,487.

OK, the way the FEIE worksheet does things, it then tells you to look up the tax on the amount you took as your FEIE, that is, on $25,000 and subtract that from the tax on the combined total. In my old tax tables, the tax on $25,000 is $3,336.

So, before you add in your excluded UK income, you were looking at a tax of $12,944. However, using the worksheet, your tax comes to (19,487 - 3,336) or $16,151. So your refund will be $3207 less.

This is a VERY simplified version of the calculation, however.
Cheers,
Bev


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## dacfer

Bevdeforges said:


> I think you are misunderstanding how the FEIE affects your taxes. One more attempt to explain (simply - or as simply as possible):
> 
> Say you made $75,000 in the US, then moved to the UK and made $25,000 to the end of December.
> 
> Let's say, just for round numbers that your personal exemption is $3000 and your standard deduction is $5000.
> 
> OK, when you put in just your US salary, your final taxable income is $67,000 ($75,000 - $3000 - $5000). Look up in the tax tables what the tax is (I'm assuming single filer, no dependents). I'm using old tax tables, but the figure I get is $12,944
> 
> Now, if you add your UK salary to that, and take the FEIE, your tax is calculated a little differently, thanks to that FEI worksheet I mentioned. You take your taxable income from the first calculation ($67,000) and you add back your FEIE ($25,000) for a total of $92,000. Look up the tax on that amount in the tax tables. That's basically what you'd be paying on the whole income if there were no FEIE. From my old tax tables, I get $19,487.
> 
> OK, the way the FEIE worksheet does things, it then tells you to look up the tax on the amount you took as your FEIE, that is, on $25,000 and subtract that from the tax on the combined total. In my old tax tables, the tax on $25,000 is $3,336.
> 
> So, before you add in your excluded UK income, you were looking at a tax of $12,944. However, using the worksheet, your tax comes to (19,487 - 3,336) or $16,151. So your refund will be $3207 less.
> 
> This is a VERY simplified version of the calculation, however.
> Cheers,
> Bev


Thanks Bev, OK I follow the logic of all that. My point is:
1. I enter my US income. TT tells me tax due is $12,944.
2. I enter my UK income. TT then tells me my tax due is $19,487
3. I enter my FEIE. TT still tells me my tax bill is $19,487.
Even though it told me my FEIE is allowed.
It never gets to even trying to calculate the lower figure (in the example above $16,151)

This is my question.


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## Bevdeforges

OK - sorry, I misunderstood your question. 

Check to see that you have filled in all the necessary stuff for the FEIE. Sometimes there are one or two other questions you have to still fill in. The other issue is that if you have given the software the date on which you moved out of the US, it may not allow you to calculate the FEIE adjusted amount until you reach your 1st anniversary of arriving in the UK. (Officially, you can't file for the FEIE until you have fulfilled either the physical presence test or the bona fide resident test.)
Cheers,
Bev


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## dacfer

Bevdeforges said:


> OK - sorry, I misunderstood your question.
> 
> Check to see that you have filled in all the necessary stuff for the FEIE. Sometimes there are one or two other questions you have to still fill in. The other issue is that if you have given the software the date on which you moved out of the US, it may not allow you to calculate the FEIE adjusted amount until you reach your 1st anniversary of arriving in the UK. (Officially, you can't file for the FEIE until you have fulfilled either the physical presence test or the bona fide resident test.)
> Cheers,
> Bev


Thanks Bev,
I'm pretty sure I have answered all the questions correctly and that I do qualify, as Turbotax specifically tells me that the exclusion is allowed. I assumed most expats use TT, and would readily have the answer. Am I incorrect? If so, what other packages are out there?


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## Bevdeforges

It really may be a question of the date, as you can't file claiming the FEIE until you have spent a full 12 continuous months outside the US. But try TaxAct if you want to check that. (Again, the forms aren't final until sometime in January - and there was talk that things might be delayed a bit due to the government shutdown in October.)
Cheers,
Bev


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## wenglish

Out of curiosity, what governs the exchange rate to be applied to the calculations?

Thanks ... Mike


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## Bevdeforges

It simply has to be a credible exchange rate. The IRS publishes lists of average exchange rates for the various currencies for each year, but you don't necessarily have to use theirs. Just about any published rate will do as long as it applies to the proper period of time.
Cheers,
Bev


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## FFMralph

Simply said, if you Claim the FEIE, your tax is figured using the "stacking rule" which causes your deductions to be less beneficial. The rule figures the tax on your taxable income without taking the FEIE and housing cost exclusion into account.

I forgot to use the worksheet, so the IRS refigured my tax for me and dropped my FTC on passive income. I had to amend my return to avoid paying tax.


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## dacfer

Bevdeforges said:


> I think you are misunderstanding how the FEIE affects your taxes. One more attempt to explain (simply - or as simply as possible):
> 
> Say you made $75,000 in the US, then moved to the UK and made $25,000 to the end of December.
> 
> Let's say, just for round numbers that your personal exemption is $3000 and your standard deduction is $5000.
> 
> OK, when you put in just your US salary, your final taxable income is $67,000 ($75,000 - $3000 - $5000). Look up in the tax tables what the tax is (I'm assuming single filer, no dependents). I'm using old tax tables, but the figure I get is $12,944
> 
> Now, if you add your UK salary to that, and take the FEIE, your tax is calculated a little differently, thanks to that FEI worksheet I mentioned. You take your taxable income from the first calculation ($67,000) and you add back your FEIE ($25,000) for a total of $92,000. Look up the tax on that amount in the tax tables. That's basically what you'd be paying on the whole income if there were no FEIE. From my old tax tables, I get $19,487.
> 
> OK, the way the FEIE worksheet does things, it then tells you to look up the tax on the amount you took as your FEIE, that is, on $25,000 and subtract that from the tax on the combined total. In my old tax tables, the tax on $25,000 is $3,336.
> 
> So, before you add in your excluded UK income, you were looking at a tax of $12,944. However, using the worksheet, your tax comes to (19,487 - 3,336) or $16,151. So your refund will be $3207 less.
> 
> This is a VERY simplified version of the calculation, however.
> Cheers,
> Bev


OK I got TurboTax to behave, and it basically performs the same calculations as you've detailed above. So this means I am being taxed twice on my UK income, once by HMRC (by whatever the tax is on $25,000) and then again by the IRS ($3,207). I understood that US and UK have a dual taxation agreement to prevent this.


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## BBCWatcher

No, you're not being double taxed. You're just missing how tax brackets work.

The FEIE shields your first dollars of foreign earned income, not your final dollars. That $25K from the U.K. becomes (in your U.S. tax return) your $0 to $25K of income. Your $75K of U.S. income then gets pushed up to include your earned income from dollar #25,001 up to dollar #100,000. The U.S. tax is higher on $75K above $25K than it is on $75K above $0. That's because the U.S. (and many other countries) have graduated progressive income tax brackets.

I may be oversimplifying slightly in order to illustrate the core principle, which is correct.

Make sense? In short, the FEIE shields your first (lower U.S. tax brackets) income, not the income in the higher tax brackets. That foreign income is shielded, but it also pushes your U.S. income into higher tax brackets. Neither portion of your income is double taxed.

This is also why you need to check whether taking the FEIE makes sense, or whether you should rely on the FTC alone. I'll take a guess that taking the FEIE will be the better choice in this situation, but I'm not 100% certain of that. Note that you cannot partially take the FEIE. You either take the FEIE on all foreign earned income (up to the FEIE maximum) or none. You can't take the FEIE on, say, $5,368 of that $25,000 of U.K. earned income. It's $25K or $0. (I'm of course assuming you qualify to take the FEIE on that income.)


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## Bevdeforges

OTOH, while you can't take a partial FEIE, you can combine the FEIE with the FTC - though there is a mechanism somewhere in there (haven't done FTC in a good, long time now) to associate what part of your UK taxes apply to the excluded income and what part of them are on the "exposed" income.

Check the instructions for the FTC form (1116) for precisely how this works. But you can, indeed, take both if you have both earned and "unearned" income.
Cheers,
Bev


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## dacfer

Yes it makes sense, however it doesn't take into account the fact that I pay more UK tax on that $25,000 than I get credit for in the US. But I guess that's the rules.


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## BBCWatcher

No, the Foreign Tax Credit (FTC) takes account of that. Which is why you ought to run the numbers taking the FEIE (with allowed/reduced FTC, as Bev astutely pointed out) and without taking the FEIE (with a usually bigger FTC).

Also, the U.S. has to decide _where_ to place that foreign income within your total dollars, and the U.S. places that income in the only place it makes sense: starting from dollar number 1. If the U.S. is going to give you a break (and it does), it'll give you the break on dollar 1 through X. Any place else is not consistent with the whole principle of graduated income tax brackets.


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## FFMralph

Remember though, you can not switch back and forth. If you take the FEIE for any tax year. and then in a later tax year revoke it, the revoktion is for 5 tax years otherwise, you must apply for IRS approval.


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## dacfer

FFMralph said:


> Remember though, you can not switch back and forth. If you take the FEIE for any tax year. and then in a later tax year revoke it, the revoktion is for 5 tax years otherwise, you must apply for IRS approval.


I understand revoke to mean change your mind about a previous return (ie. <= 2012). I can use the FEIE for 2013, use the foreign tax credit in 2014, the use the FEIE in 2015 if I so wish.


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## FFMralph

If you take the FEIE in 2013 and not in 2014 then you cannot take it again until 2019 unless you apply for and are granted permission to do so.


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## dacfer

From IRS website: 
You can revoke your choice for any tax year. You do this by attaching a statement that you are revoking one or more previously made choices to the return or amended return for the first year that you do not wish to claim the exclusion(s).

ie. a previous choice you are changing for that tax year.


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## FFMralph

From the IRS Website:
Revocation of the Foreign Earned Income Exclusion 

*Revocation of the Foreign Earned Income Exclusion*


> If you revoked a choice and within 5 tax years again wish to choose the same exclusion, you must apply for IRS approval.


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## BBCWatcher

Exactly, and that's yet another reason you ought to run the numbers both ways and do some thinking about taking the FEIE.


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## DavidMcKeegan

I also want to mention that unfortunately, most tax software programs (TurboTax, etc) were not created with the expat in mind. As such, they often have trouble "walking" you through an expat return. I have seen so many people come to me with errors on their return because of the software they were using.

My advice would be to take everything the software says with a grain of salt. Always double check everything, and possibly have your return reviewed by an expat accountant before sending it off.

Best of luck!


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