American expats: your taxes just went up

[ThaiHome]

Neo said:

The other disadvantage of claiming the foreign exemption is you can't use the money for retirement plans. If you claim it as regular US income, you can put about 25% of it tax free into retirement plans and it will grow tax free every year. Seems a better way to go to me.

 

Iam not sure what you mean. Are you referring to 401K's or IRA or what?

I put 15% of my income (excluding housing and education allowances and up to some maxium amount I can't recall) in a 401K (company then matches first 3%). This can be either before or after taxes. I choose to take it after tax, since between the 80k deduction and the foreign tax credits, I pay very little US income tax I might as well have it taxable income now rather then later when I won?t have the deductions and credit when I stop working. Keep in mind that these retirement accounts are only tax free now; when you withdraw the money later you will owe tax on the original income and interest. The theory being you will be in a lower tax bracket later. In my case, I am in a lower tax bracket now, so I choose to declare the income now. I will have to pay tax on the interest when I withdraw.

TH

[Neo]

In order to fund your 401k, IRA, or other types of retirement plans including self employment plans, you need income. If you earn nothing, you can put away nothing. About the best case you can do is put 25% of your income away. So if someone claims the foreign exemption it could reduce or eliminate their ability to invest in retirement plans because it eliminates this income.

 

As far as going tax deductable or not, you are not factoring in the part that when you put money in tax deductable, you get a 30-50% return immediately on how ever many $'s you put into your retirement plan that in turn can be invested and grows year after year. I've never heard someone say tax on the way in is an advantage over tax on the way out years down the road, though I don't rule out the possibility there are some corner cases where it could work out.

[ThaiHome]

From your comment it appears you never filled out and submitted a Form 1040 for Federal Income Tax.

 

The Foreign Income Deduction does not eliminate any income. All income is reported and then a series of deductions are taken to arrive at taxable income upon which your tax is calculated. After the tax is calculated, you are allowed to take a series of tax credits (if eligible) which reduce that tax amount. One of the allowable credits is a dollar for dollar credit (in most cases) for any foreign income tax paid (up to a calculated limit, based on your income). I have plenty of income on which to contribute to a tax defered retirment plan.

 

It also appears you missed my point on whether it is best to make the contribution before or after tax. In my case, and the case of most US expats, we pay very little tax now, so making the retirement contribution after tax makes sense as we are paying less tax now then we will be when withdrawing after retirement. Declaring the contribution as taxable income now does not materially affect the amount of tax I pay as I have excess foreign tax credits that lower my tax amount to almost nothing. This means that when I withdraw I will not have to declare it as income again. Income on the contribution is, of course, deferred until you withdraw it. This is a very common scenario, which is one of the reasons you are allowed to contribute before or after tax.

 

If you have not been involved in the US Federal Income Tax system, none this will make a lot sense, but then it doesn?t to a lot of people who file every year

TH

[YimSiam]

There's another expat way around all this - international organizations. Work abroad for the UN and - after a bunch of bureacratic nonsense, of course - they pay back every dollar paid in US tax on your earnings. It's a lot of paperwork (and with low UN salaries, the tax-free vs. decent-salary tradeoff is hardly worth it), but if you want to sleep at night knowing that you've kept every dollar you earned, get a UN job... The US gets their tax money, but you get paid back. Where does the money come from? An internal 'assessment' on UN salaries, largely those who don't have to pay national taxes on their UN income.

[Neo]

The Foreign Income Deduction does not eliminate any income.

 

I am 100% sure that it does eliminate income for my case. I ran the numbers on Turbo Tax and verified this aspect face to face with the IRS. In my case, I am referring to Schedule C income and SEP IRA contributions.

 

It also appears you missed my point on whether it is best to make the contribution before or after tax. In my case, and the case of most US expats, we pay very little tax now

 

You are right, your method makes complete sense to me after you highlight the fact you aren't paying much tax.

[ThaiHome]

In my case, I am referring to Schedule C income and SEP

IRA contributions.

 

Are you referring to income you are claiming the extraterritorial income exclusion? If so, I can see how this would affect your ability to make a contribution to a SEP-IRA

This is different the Foreign Earned Income Deduction I have been discussing.

Maybe you could declare yourself a statutory employee and issue yourself a W-2 then it would not be excluded from your Schedule C calculation.

TH

[Neo]

Are you referring to income you are claiming the extraterritorial income exclusion?

 

No, I am referring to the foreign earned income exemption all along.

 

I am probably stupid for paying US taxes on this especially since I don't live there and receive no benefits, but I don't see a better way. I'm a bit skeptical that there exists a way to claim the foreign income exemption and at the same time fund tax deferred retirement instruments based on that same income.

[gummigut]

Whoever would have thought nanacpa.com might have a future?

 

<<burp>>

[ThaiHome]

Neo said:

Are you referring to income you are claiming the extraterritorial income exclusion?

 

No, I am referring to the foreign earned income exemption all along.

 

I am probably stupid for paying US taxes on this especially since I don't live there and receive no benefits, but I don't see a better way. I'm a bit skeptical that there exists a way to claim the foreign income exemption and at the same time fund tax deferred retirement instruments based on that same income.

 

From what I have read, it is only the various IRA?s that are affected by the Foreign Earned Income deduction. 401(k)?s do not seem to be affected. Perhaps instead of a SEP-IRA you could setup a Self-Employed 401(k)s ?

I know for fact that you can contribute up to the limit with a 401(k) and still take the Foreign Earned Income deduction.

 

Enough of this as we seem to be boring some people....

TH