Not sure if foreign tax credit is applicable

[Greenbriar]

New one on me. New client teaches at a US university in China, gets a W2 from the NJ based university, does not owe nor pay any taxes to China, and lives on campus at no cost. Aside from being a very nice arrangement, I don't see where a foreign tax credit or deduction is applicable. Keeps a minimal amount in China bank account and for all his expenses, he uses a debit card from TD Bank here in NJ. Am I missing something? Looks like a straight forward 1040. Thanks.

[mastertaxguy]

Foreign Earned Income Exclusion?

Are you missing something?

Maybe. Maybe not.

Seems like the foreign earned income exclusion may apply if other requirements are met. There is that physical presence test which may apply.

See TTB 14-16.

[Greenbriar]

Even if he doesn't pay any foreign income tax?

Thanks for the reply but he does not pay any foreign income tax so doesn't that negate the need for a foreign tax deduction or credit?

[mastertaxguy]

Foreign earned income exclusion: Does the tp have to have paid foreign tax?

Nope.

This is somewhat of an rtfm issue.

Separate foreign earned income exclusion, which is limited to $97,600.00 for 2013 tax year, from foreign tax credit which is available for all kinds of foreign taxes paid on all kinds of US taxed income.

The FEIE and FTC (or foreign tax deduction) are two separate things.

SEE TTB p.14-15, right column, bottom of the page and all of TTB Pp. 15. (Does anyone really look at TTB anymore???)

Foreign tax credit or foreign tax deduction on schedule A are alternative which the taxpayer may elect to use as to income not elected to be excluded under the Foreign Earned
My experience (and I am in a locale where many taxpayers have foreign earned income and/or foreign taxes paid on investments) is that as to earned income, for taxpayers with less than $120,000 of E.I., the foreign earned icnome exclusion works best, but each case is fact specific. I have prepared returns where the foreign earned income exlusion is taken, and a credit or dedcution is taken for foreign taxes on the amount of foreign earned income in excess of the applicable exclusion amount.

Another issue may be lack of withholding for US Social Security.

There may be a tax treaty involved which you might want to look at.

IRS Publication 54 is worth reading as well and, of course, if you take the foreign earned income exclusion, review form 2555 and related obfuscations (opps: I ment instructions).

Some may assert that a TP cannot claim both the FIE and the foreign tax credit or deduction. However, as noted on the IRS web site (not substantial authority):

"Once you choose to exclude either foreign earned income or foreign housing costs, you cannot take a foreign tax credit for taxes on income you exclude. If you do take the foreign tax credit, one or both of the choices may be considered revoked. However, you can choose to take the foreign tax credit on any amount of foreign income which has not been excluded under the foreign earned income exclusion or the foreign housing exclusion."


Have fun!

[Greenbriar]

I read TTB all the time

As a sole practitioner I find this forum very helpful but I'm not following your responses. While I understand and agree with you, the bottom line is he does not pay any tax to the Chinese so why would there be a tax credit or deduction??? He gets a W2 like any other U.S. based employee. See TTB 11-11 "Credit can be claimed for tax paid to a foreign country on income that is also taxed by the United States." My guy did not pay tax to the Chinese government, therefore, no double taxation, therefore, no need for a foreign tax credit or deduction, right?

[David1980]

As a sole practitioner I find this forum very helpful but I'm not following your responses. While I understand and agree with you, the bottom line is he does not pay any tax to the Chinese so why would there be a tax credit or deduction??? He gets a W2 like any other U.S. based employee. See TTB 11-11 "Credit can be claimed for tax paid to a foreign country on income that is also taxed by the United States." My guy did not pay tax to the Chinese government, therefore, no double taxation, therefore, no need for a foreign tax credit or deduction, right?

If taxes were based on an idea of fairness and there were no exceptions then yes. The foreign earned income exclusion when the taxpayer pays no foreign tax does feel "unfair" to those of us that don't receive the same benefit. Why should someone get to exclude their income from tax when they're not paying any foreign taxes!? And yet, it's there and the payment of foreign taxes is not a requirement. Assuming he meets all the qualifications he can exclude $97,600 of foreign earned income from tax for 2013.

[Lion]

You are still confusing two tax benefits.

No. He cannot take a foreign tax credit when he had no foreign tax.

Yes. He can exclude foreign income and housing allowance if he meets the requirements in his overseas work, resident, substantial presence, etc.

[Greenbriar]

I have more homework to do

Thanks all for your help.

[mastertaxguy]

As a sole practitioner I find this forum very helpful but I'm not following your responses. While I understand and agree with you, the bottom line is he does not pay any tax to the Chinese so why would there be a tax credit or deduction??? He gets a W2 like any other U.S. based employee. See TTB 11-11 "Credit can be claimed for tax paid to a foreign country on income that is also taxed by the United States." My guy did not pay tax to the Chinese government, therefore, no double taxation, therefore, no need for a foreign tax credit or deduction, right?

Yep.

Been AFK.

[Burke]

I am not sure what the rationale behind the FIE is any more, except for the fact that if he lives in another country for the preponderance of the year (or permanently), he is not availing himself of any of the tax-supported benefits of living in the US. However, remaining a US citizen is certainly worth something. This was enacted in 1926 and signed into law by Calvin Coolidge on the theory that persons living abroad had higher costs of living than in the US. Also, at the time, the United States was the only country that taxed income that was earned in another country. And he had a big budget surplus ($250M) that he wanted to reduce , based on his economic theory that less taxation was good for the marketplace. The rules have been amended many times, but it is still in the Code. Congress is again taking a good look at it.

[Greenbriar]

Physical presence test question

This is where I am hung up. For tax purposes he started on 9/1/13 so he is in China for only four of the 12 month presence test. Does that mean that unless your start on 1/1 in the foreign country, you don't qualify in the first year for the foreign earned income (FEI) exclusion? Doesn't sound right and somewhere I thought I read that extensions count toward qualifying for the physical presence test and unfortunately I can't find that reference now. His 2013 extension runs to 10/15/14 which is beyond the 330 day physical presence requirement. Appreciate your comments.

[David1980]

This is where I am hung up. For tax purposes he started on 9/1/13 so he is in China for only four of the 12 month presence test. Does that mean that unless your start on 1/1 in the foreign country, you don't qualify in the first year for the foreign earned income (FEI) exclusion? Doesn't sound right and somewhere I thought I read that extensions count toward qualifying for the physical presence test and unfortunately I can't find that reference now. His 2013 extension runs to 10/15/14 which is beyond the 330 day physical presence requirement. Appreciate your comments.

For the physical presence test you can choose the 12-month period. For example, you could choose 8/1/13 - 8/1/14. Pick whatever dates maximize the exclusion. (Since you only need 330 days out of 365, you can start the 12-month period before they are physically present and the exclusion for 2013 will be based on the number of days in your 12-month period that fall in 2013.)

[Burke]

His 2013 extension runs to 10/15/14 which is beyond the 330 day physical presence requirement. Appreciate your comments.

Did you file Form 2350? That is a special extension for persons living abroad to take advantage of such tax benefits.

[Greenbriar]

Re extension form 2350

Not yet. Started but the physical presence test (PPT) question 4b is unclear to me. He arrived in China on 9/15/13, so first full day of PPT is 9/16/13. I can get him an extension until 10/15/14. He is still working there in 2014 and intends to continue at least thru the end of 2014. On Form 2555, if I enter 9/15/14 as end date, ProSeries tells me to file the return after that date. I'd like to file asap and get him is refund, just don't understand the concept of any 12 month PPT. Thanks.

[David1980]

There's an illustration in Publication 54 top of page 15 that might help with the 12-month period concept. http://www.irs.gov/pub/irs-pdf/p54.pdf

Also see "How to figure the 12-month period" on the right column same page. So with his first full day in China 9/16/13, he will have his 330th day on 8/12/14 (but you should check that I calculated that right) assuming he spent 0 days since then in the US after moving to China. In which case you could use the 12-month period of 8/12/13 - 8/11/14. You would have to wait until after 8/11/14 to file the tax return. That's why the 2350 exists - you could not meet the physical presence test until after 10/15 and a regular extension wouldn't give you enough time. Unfortunately when claiming the foreign earned income exclusion you can't file early based on the expectation he will meet the physical presence test. He actually has to meet the physical presence test first.