Foreign Tax Credit & FEIE Examples (IRS Expatriation Procedures) (Golding & Golding)

Foreign Tax Credit & FEIE Examples (IRS Expatriation Procedures) (Golding & Golding)

Foreign Tax Credit & FEIE Examples (IRS Expatriation Procedures)

In order to qualify for the IRS new expatriation program, the taxpayer must have less than $25,000 in total tax liability for the total combined current and prior years.

Luckily, the applicant is able to apply foreign tax credits and the foreign earned income exclusion, if applicable — to reduce U.S. tax liability.

FTC is the Foreign Tax Credit (IRS Form 1116 and 1118) and FEIE is the Foreign Earned Income Exclusion (FEIE).

Foreign Tax Credit & FEIE Examples

The IRS provided some examples of how the foreign tax credit is applied, and we will summarize these examples in plain English for you.

Preliminary Cutoff 877A

No matter how much Foreign Tax Credit you have available, the total average tax liability must be less than those set forth in 877A.

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Example 1: Sufficient Foreign Tax Credit (35% Foreign Tax Rate in Treaty Country)

“Jane is a dual citizen of the United States and Country T and is a resident of Country T.  The United States has a tax treaty with Country T.  Jane has a net worth under $2,000,000 and has an average income tax liability for the past five years under the threshold of IRC 877(a)(2)(A). “


(For 2014 through 2018 this is $168,000 of average annual net income tax).  Jane’s only income over the past 5 years has been $200,000 of wage income that she earned from performing services in Country T for a Country T employer. 


For the last 5 years Jane has been filing tax returns in Country T as a Country T resident reporting all her wage income. Jane was subject to an income tax rate of 35% in Country T in each year. 


Assume the U.S. income tax rate for 2014-2019 is 25%. Assume further that Jane does not qualify to make an election under IRC 911.”

Plain English: Jane DOES Qualify

Jane resides overseas in a tax treaty country. Jane’s tax liability is below the 877A guidelines, but her tax liability would otherwise put her above the $25,000 total tax liability requirement when she files U.S. taxes.

But, since Jane pays tax overseas, and in a high-tax jurisdiction — she should have a sufficient foreign tax credit to reduce her total tax liability to less than $25,000 for the compliance period.

Example 2:  Insufficient Foreign Tax Credit (20% Foreign Tax Rate in Treaty Country)

“Assume the same facts as in Hypothetical 6, except that Jane paid income taxes in Country T at a tax rate of 20%.  Assume the U.S. income tax rate for 2014-2019 is 25%.


As in Hypothetical 6, under the U.S.-Country T tax treaty, Country T would have the primary right to tax Jane’s wage income and the United States would have a secondary right to tax the income based on her citizenship, after providing a credit for the income tax paid to Country T. 


Because Jane’s Country T tax liability is lower than Jane’s U.S. tax liability, and even though Jane is not limited in the amount of the Country T tax she may claim as a credit, Jane still owes additional residual tax to the United States.


Jane paid the equivalent of $40,000 of tax in Country T in each year.  After applying the U.S. foreign tax credit, Jane still owes $10,000 of additional tax in the United States in each year. Considering six years from 2014-2019, Jane owes an aggregate of $60,000 of tax to the United States, which would be greater than $25,000. Jane is not eligible to use these procedures.


Plain English: Jane does Not Qualify for the Procedures 

Jane resides overseas in a tax treaty country. Jane’s tax liability  is below the 877A guidelines, but her tax liability would otherwise put her above the $25,000 total tax liability requirement when she files U.S. taxes.

Unfortunately, the amount of taxes that Janes pays overseas is less than she would owe in the U.S. Therefore, even after the credit is applied, her tax liability is above $25,000 — and she does not qualify for the procedures

But, since Jane pays tax overseas, and in a high-tax jurisdiction — she should have a sufficient foreign tax credit to reduce her total tax liability to less than $25,000 for the compliance period.

Example 3: Hybrid FEIE and FTC 25% Rate in Tax Country)

When a person pay significant taxes overseas in another country, and qualifies for the Foreign Earned Income Exclusion, they can use a hybrid FTC/FEIE analysis. This allows the person to both take the FEIE, and apply foreign tax credits to the remaining liability — as long as there is no double-dipping.


“Assume the same facts in Hypothetical 6, except here is no applicable treaty, Jane may be eligible to make an election under IRC 911, and Jane was subject to a 25% income tax rate in Country T. Assume the U.S. income tax rate for 2014-2019 is 25%.


Because Jane is a U.S. citizen residing in a foreign country and working in that foreign country, Jane may be entitled to claim the foreign earned income exclusion (FEIE) under IRC 911, which would reduce Jane’s U.S. taxable income. Although Jane can claim a foreign tax credit (FTC), assume Jane chooses to first use the FEIE. “


If Jane meets the requirements under IRC 911, Jane can claim the FEIE on IRS Form 2555/2555-EZ and exclude a portion of her earned income in each year. 


To the extent that the FEIE does not cover all the income earned, Jane can claim a foreign tax credit with respect to the excess foreign source income (but cannot credit foreign taxes against amounts excluded under FEIE). Due to the FEIE and foreign tax credits, Jane would not owe any U.S. tax.  Thus, Jane would have an aggregate U.S. income tax liability for 2014 through 2019 under the $25,000 aggregate income tax threshold. Jane is eligible to use these procedures.


Plain English: Jane does Qualify for the Procedures

Jane resides overseas in a tax treaty country. Jane’s tax liability is below the 877A guidelines, and she qualifies for the Foreign Earned Income Exclusion. In addition, Jane has remaining foreign tax credits she can apply to bring her overall tax liability below $25,000 for the compliance period.

Therefore, Jane qualifies for the procedures.

Golding & Golding (Board Ceritfied Specialist in Tax Law)

Golding & Golding (Board Certified Specialist in Tax Law)

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Golding and Golding, Board-Certified Tax Law Specialist

Golding and Golding, Board-Certified Tax Law Specialist

Golding & Golding: Our international tax lawyers practice exclusively in the area of IRS Offshore & Voluntary Disclosure. We represent clients in 70+ different countries. Managing Partner Sean M. Golding is a Board-Certified Tax Law Specialist Attorney (a designation earned by < 1% of attorneys nationwide.). He leads a full-service offshore disclosure & tax law firm. Sean and his team have represented thousands of clients nationwide & worldwide in all aspects of IRS offshore & voluntary disclosure and compliance during his 20-year career as an Attorney.

Sean holds a Master's in Tax Law from one of the top Tax LL.M. programs in the country at the University of Denver. He has also earned the prestigious IRS Enrolled Agent credential. Mr. Golding's articles have been referenced in such publications as the Washington Post, Forbes, Nolo, and various Law Journals nationwide.
Golding and Golding, Board-Certified Tax Law Specialist