Q: The new foreign earned income exclusion rules require that any income remaining on my return be taxed in the same bracket as if my foreign income had never been excluded. I work overseas, and my wife is in the U.S. Our taxes just went way up as a result. Any advice?
Wayne
A: I would say you have three options available to you (and you would need to run the numbers all three ways to see which one works best for you each year): take the foreign earned income exclusion anyway, claim the foreign tax credit, and file as "married filing separately"...
Those needing more background information should first read my posts on the foreign earned income exclusion, the foreign tax credit, and married filing separately status.
Wayne is in a bit of a conundrum. His wife has signficant earnings, as does he. He can exclude his, since they face international taxation. They still have to pay taxes on his wife's income, but now in a higher tax bracket than before. What are the options?
1. Deal with it. This would involve excluding the foreign earned income as much as possible, then paying whatever U.S. tax is owed on the remaining income.
2. Take the foreign tax credit. This would involve including the foreign income, and taking a tax credit for foreign income tax paid. The benefits of this will vary depending on the amount of the wife's income, as well as the amount of foreign tax paid.
3. File as "married filing separately." While this rarely makes sense, it might in this case. Wayne would file as married filing separately, maybe exclude all his income, and have no tax owed. His wife would file separately, claim all the itemized deductions, and pay tax on whatever is left. She would, of course, face all the remaining downsides of filing separately that I describe in my article.
The worst news is that Wayne or his tax pro will have to run the numbers on all three arrangements. My guess is that number three will be the best bet, but that's just a guess without all the facts and circumstances in front of me.
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