When it comes to the Foreign Earned Income Exclusion versus the Foreign Tax Credit, sometimes individuals get confused about the application of both the exclusion and the credit for the same type of income – as opposed to the same actual income.
- 1 Foreign Earned Income Exclusion (FEIE – Form 2555)
- 2 Foreign Tax Credit (FTC Forms 1116 or 1118)
- 3 Not applied to the Same Earned Income
- 4 May be Applied to the Same Category of Income
- 5 Unreported Foreign Income or Accounts
- 6 IRS Voluntary Disclosure of Offshore Accounts
- 7 When Do I Need to Use Voluntary Disclosure?
- 8 Golding & Golding, A PLC
Foreign Earned Income Exclusion (FEIE – Form 2555)
Under the Foreign Earned Income Exclusion individuals who reside overseas and meet either the Physical Presence Test or Bona-Fide Resident test may be qualified to exclude upwards of $100,000 of their earned income such as employment salary each year.
Even if a couple is married filed jointly, each spouse is entitled to their own ~$100,00 worth of exclusion.
Example: David resides in China and earns $95,000 a year. David made no trips back to the United States and even though he is a U.S. citizen, because he qualified for the Physical Presence Test — the first $100,000 of his earnings are not taxed by the United States.
Foreign Tax Credit (FTC Forms 1116 or 1118)
Generally, a foreign tax credit applies when individual pays any type of qualifying tax overseas to avoid “double taxation” (income tax for earned income or passive income such as dividends, interest, or capital gains). For example, David earns $20,000 in interest income from money he has in foreign bank accounts. He also pays 25% tax on those earnings; therefore, when he reports the income in the United States, David can also claim a foreign tax credit of $5000 for the taxes he paid on the passive income.
Not applied to the Same Earned Income
If David had $150,000 worth of salary, he cannot first apply the exclusion to the first $100,000 of income as well as apply the foreign tax credit to the first $100,000 dollars worth of income — that is considered “double-dipping.”
May be Applied to the Same Category of Income
What David can do, is apply both the Foreign Earned Income Exclusion and the Foreign Tax Credit to the same $150,000 worth of salary – only he has to stagger the applications of the Exclusion and Credit.
For example: David can apply the Foreign Earned Income Exclusion to the first $100,000 worth of income. Thereafter, a specific formula is used (see IRS publication 54) in which a representative portion of the Foreign Tax Credit is applied towards the remaining income so that he can still use the remaining portion of his Foreign Tax Credit toward the additional income above and beyond the $100,000 exclusion.
Unreported Foreign Income or Accounts
At Golding and Golding, we limit our entire law practice to offshore disclosure. Many times, clients come to us when they realize that improperly utilized the income exclusion/foreign tax credit and have not reported or disclose foreign accounts, investments, etc.
This is the case, we can safely get you back into compliance by utilizing one of the approved voluntary offshore disclosure methods.
IRS Voluntary Disclosure of Offshore Accounts
Offshore Voluntary Disclosure Tax law is very complex. There are many aspects that go into any particular tax calculation, including the legal status, marital status, business status and residence status of the taxpayer.
When Do I Need to Use Voluntary Disclosure?
Voluntary Disclosure is for individuals, estates, and businesses who are out of compliance with the IRS and the Department of Treasury. What does that mean? It means
If the IRS discovers that you are out of compliance, you may become subject to extensive fines and penalties – ranging from a warning letter all the way up to tax liens, tax levies, seizures, and criminal investigations. To combat this, you can take the proactive approach and submit to Voluntary Disclosure. that if you are required to file a U.S. tax return and you don’t do so timely, then you are out of compliance.
Golding & Golding, A PLC
We have successfully represented clients in more than 1,000 streamlined and voluntary disclosure submissions nationwide and in over 70-different countries.
We are the “go-to” firm for other Attorneys, CPAs, Enrolled Agents, Accountants, and Financial Professionals across the globe.