Us Income Taxes

[Old Man River]

OK, it is US tax time again. Time flies.

When coming up with the federal income tax rate to be used to pay US earned income (non excluded income) can I net my Thai income taxes I paid against my Thai earned income? Note, my question does not relate to the foreign earned income exclusion (USD 85,700 in 2007), but rather lowering my tax bracket in the US so that I pay less taxes on my US earned income (income not excluded).

Before last year, as I am sure you are all aware, the amount of Thai taxes paid was not that important since foreign income was excluded from US taxes up to the foreign earned income exclusion amount. Now, since we have to add our Thai earned income with our US earned income to come up with our federal income tax rate (for US earned income), the question arises as to whether we use the net after tax amount of foreign income to come up with the applicable US federal income tax rate, or the gross amount of Thai income earned. I would think we could net this amount out, lowering our US tax bracket, but so far I can't find any IRS publication that deals with this.

The above should be important to many of us. Has anyone found any IRS publications that deal with this?

Edited February 22, 2008 by Old Man River

[thaihome]

If I understand your question correctly, I think the answer is no. You must declare the gross amount of Foreign Earned Income. Of course, if you work for a fully Thai company and they do not give any sort of W-2 or income statement, the amount you declare is somewhat of an honor system anyway, if you know what I mean.

TH

[Old Man River]

If I understand your question correctly, I think the answer is no. You must declare the gross amount of Foreign Earned Income. Of course, if you work for a fully Thai company and they do not give any sort of W-2 or income statement, the amount you declare is somewhat of an honor system anyway, if you know what I mean.

TH

Thanks for the quick response. I imagine there are a number of us in the same boat and your summation of how we can possibly deal with it is pretty much on target. I just wanted to make sure I wasn't missing something that directly relates to this, which doesn't appear to be the case.

Thanks again,

OMR

[lanny]

You won't find a publication or regulation that addresses this question, as far as I know. But I can tell you that the general rule is that you DO NOT net an income and a related expense.

In this case, there are specific rules about foreign taxes on income that is also taxed by the US. You may have an option to deduct foreign taxes (on Schedule A, if you itemize) or take a credit against US taxes (using Form 1116.) In either case, you do not get any benefit for taxes paid on income which is excluded (on Form 2555.)

The new rules, which went into effect for 2006 returns, effectively calculate US tax on your total gross income and then reduce the amount you pay by the tax you would pay if the excluded foreign income were your only income.

[Old Man River]

You won't find a publication or regulation that addresses this question, as far as I know. But I can tell you that the general rule is that you DO NOT net an income and a related expense.

In this case, there are specific rules about foreign taxes on income that is also taxed by the US. You may have an option to deduct foreign taxes (on Schedule A, if you itemize) or take a credit against US taxes (using Form 1116.) In either case, you do not get any benefit for taxes paid on income which is excluded (on Form 2555.)

The new rules, which went into effect for 2006 returns, effectively calculate US tax on your total gross income and then reduce the amount you pay by the tax you would pay if the excluded foreign income were your only income.

Lanny, I know you are a CPA who does this for a living, so your advice is well heeded. However, for arguments sake, while I understand the reasoning for the 2006 tax change so that we are no longer being given free rides from income taxes because we have foreign sourced income (up to the exclusion), the only reasoning I can think of for not being able to deduct foreign paid tax against the foreign earned income for tax bracket purposes to be used for the tax rate on US earned income is that the powers that be, in their rush to change the law, didn't think about this. Otherwise, it doesn't make sense.

The credit against US taxes (form 1116) that you mention for foreign paid taxes is only effective if you earn above the foreign earned income exclusion. It has no impact if you don't earn more than the exclusion. On itemizing under Schedule A, from memory that would only come into play if your itemized deductions are above the standard deduction, which is hard to do if you are living in Thailand.

Hence, from your explanation, if the majority of your income is earned in Thailand and it is below the foreign earned income exclusion, then the income taxes you pay in Thailand have no value whatsoever in figuring your tax bracket in the US for US earned income. Correct?

[PeaceBlondie]

Lanny can and probably will answer for himself, better than I can, but it surely sounds as if you are mixing apples and durian. Employees cannot deduct their expenses against their earnings before computing tax, except on schedule A. Personal income taxes of the taxpayer are not an expense; they are taxes.

Trying to understand the mind of Congress is probably beyond your ability. Tax law is interpreted more literally than an Orthodox rabbi interprets the Law of Moses. Unless you have already served ten years as a U. S. Tax Court Judge, of course.

My guess is that the eagle eyes in Austin will catch such a mistake faster than you can say bpen rai. I know, I trained some of them.

[Dakhar]

As for me, I have Lanny do my taxes for me and wash my hands of all this language garbage.

[Old Man River]

Lanny can and probably will answer for himself, better than I can, but it surely sounds as if you are mixing apples and durian. Employees cannot deduct their expenses against their earnings before computing tax, except on schedule A. Personal income taxes of the taxpayer are not an expense; they are taxes.

Huh? Where did I ever mention that personal income taxes are an expense? I made my living too long knowing the difference, hence, can't see where I confused you on this.

The issue is simple, but seems to be answered. Although you pay foreign income taxes (Thai), you must still use the gross amount of your foreign earned income to derive your income tax rate that is used to get the amount of tax you pay on your US earned income.

[backflip]

I did it differently. Over three tax years, I worked and paid taxes in China. At the same time, I had income from the US. At no time did I add the two incomes together for any reason. My China income was taxed at the appropriate China rate, and the same was done for the US income.

[PeaceBlondie]

I apologize for not thinking that I might not have misunderstood what you think you meant when you wrote, "can I net my Thai income taxes I paid against my Thai earned income?" But if we all understand you cannot deduct Thai income taxes against Thai earned income, maybe it's all settled.

[thaihome]

I did it differently. Over three tax years, I worked and paid taxes in China. At the same time, I had income from the US. At no time did I add the two incomes together for any reason. My China income was taxed at the appropriate China rate, and the same was done for the US income.

If you did not declare the China income on your US return, you did it incorrectly. You must pay US income tax on any income above the 80k foreign income exclusion. You do get a tax credit for the China income tax you paid on the amount above the 80k. Also, all the China income must be included in calculating what tax rate you must pay on your US income and the amount above the 80k.

TH

[lanny]

I did it differently. Over three tax years, I worked and paid taxes in China. At the same time, I had income from the US. At no time did I add the two incomes together for any reason. My China income was taxed at the appropriate China rate, and the same was done for the US income.

Assuming that you are a US citizen, if you did it that way, you should not post on a public forum. Under normal circumstances, IRS has three years to assess additional tax for any given year. If you omit 25% of the income that should have been reported, they have 6 years. If they can prove you deliberately omitted income (of any amount) they have established fraud and there is no statute of limitations.

The correct way to report foreign income is to include it on the return and claim the foreign earned income exclusion and/or the foreign tax credit. But, once IRS begins asking about your return, you no longer have the option to take the exclusion.

On the face of things, you have filed fraudulent returns and the IRS can easily establish this fact. If they do, you would not only owe the tax, you would owe penalties for under-reporting, late payment, and fraud and, of course, interest. This could double or triple the amount owed.

Edited February 24, 2008 by lanny

[Old Man River]

I apologize for not thinking that I might not have misunderstood what you think you meant when you wrote, "can I net my Thai income taxes I paid against my Thai earned income?" But if we all understand you cannot deduct Thai income taxes against Thai earned income, maybe it's all settled.

OK. I think you now understand the question was only as it relates to coming up with the tax bracket for my US based income since the 2006 tax law is new. Lanny has explained that you must use your gross foreign income plus your US earned income to come up with the tax bracket (i.e. you get no credit for paying foreign taxes when coming up with your tax rate for US earned income). This is how I did it last year, but I was hoping I missed something. Unfortunately, I didn't.

[BigSnake]

Sound like a H&R Block question. Try there web site.

[Sam125]

Lanny has answered your question well.

I have seen similar situations and the good news is that you should simply refile and move on you are unlikely to get into trouble with a simple mistake for low dollars and I assume that it is low dollars or you would have had a tax advisor otherwise....

Do not got to H&R block or any of those types for tax advice beyond the simplest of returns.

Edited February 24, 2008 by Sam125

[Old Man River]

Lanny has answered your question well.

I have seen similar situations and the good news is that you should simply refile and move on you are unlikely to get into trouble with a simple mistake for low dollars and I assume that it is low dollars or you would have had a tax advisor otherwise....

Do not got to H&R block or any of those types for tax advice beyond the simplest of returns.

Sam, I am not sure who your comment relates to. I am the OP and I have no reason to refile. Actually, I was hoping I did need to refile, but Lanny's advice shows what I did last year was correct, unfortunately.

Note, I use H&R Block's Taxcut and find it very useful since my tax situation is straight forward. It is cheap and easy to use. However, you are correct that it does not replace a good tax adviser. For my purposes, having read Lanny's advice on other tax matters on TV in the past, his free advice here is more than sufficient (thank's Lanny).

[TerryLH]

"Although you pay foreign income taxes (Thai), you must still use the gross amount of your foreign earned income to derive your income tax rate that is used to get the amount of tax you pay on your US earned income."

I don't understand this stuff very well. It still gives me a headache.

Did they do away with the foreign earned income deduction that you could report on form 2555 or 2555EZ?

I thought you just added in the gross foreign income, but a couple of lines later you could minus it out. (up to the 80k+)

Am I not on the same page, talking about something completely different?

[Sam125]

Sam, I am not sure who your comment relates to. I am the OP and I have no reason to refile. Actually, I was hoping I did need to refile, but Lanny's advice shows what I did last year was correct, unfortunately.

Note, I use H&R Block's Taxcut and find it very useful since my tax situation is straight forward. It is cheap and easy to use. However, you are correct that it does not replace a good tax adviser. For my purposes, having read Lanny's advice on other tax matters on TV in the past, his free advice here is more than sufficient (thank's Lanny).

I was talking about the individual who seems to have not included his Chinese income on his US return. Note we may be not understanding him.... and perhaps all is well with his taxes.

My take on tax software is that it speeds things up and can be helpful but can also be less than perfect and sometimes dangerous lets say.

[lanny]

No, the exclusion for foreign earned income hasn't been taken away. Congress tried that, some 25 or so years ago but had to give it back. Too much protest from big, international companies.

What Congress did do was to change the way we calculate our taxes. Under the previous rules, you deducted the exclusion amount and figured your tax as though anything left was the only income. Now, however, we figure the tax BEFORE the exclusion and then reduce it by the tax that would apply if the exclusion were the only income. In effect, we lose the benefit of the lower tax brackets, thus paying a higher tax on any income above the exclusion.

If your income, from all sources, is less than the sum of your exclusion, your deductions, and your exemptions, the new rules don't affect you. Only those with very large salaries or with significant amounts of income not subject to exclusion are affected.

[Old Man River]

No, the exclusion for foreign earned income hasn't been taken away. Congress tried that, some 25 or so years ago but had to give it back. Too much protest from big, international companies.

What Congress did do was to change the way we calculate our taxes. Under the previous rules, you deducted the exclusion amount and figured your tax as though anything left was the only income. Now, however, we figure the tax BEFORE the exclusion and then reduce it by the tax that would apply if the exclusion were the only income. In effect, we lose the benefit of the lower tax brackets, thus paying a higher tax on any income above the exclusion.

If your income, from all sources, is less than the sum of your exclusion, your deductions, and your exemptions, the new rules don't affect you. Only those with very large salaries or with significant amounts of income not subject to exclusion are affected.

So, what we end up with is having to pay the full amount of foreign taxes on amounts under the exclusion (but not US taxes on amounts under the exclusion), but when figuring out the tax rate for US earned income, we have to add the gross amount of foreign earned income (not taking into account any foreign taxes paid) and add this to the US earned income to derive the tax rate on amounts not excluded.

[backflip]

"You must pay US income tax on any income above the 80k foreign income exclusion."

Yes, I know. What portion of my post seemed to indicate that I made more than the foreign income exclusion threshold?

[Old Man River]

I did it differently. Over three tax years, I worked and paid taxes in China. At the same time, I had income from the US. At no time did I add the two incomes together for any reason. My China income was taxed at the appropriate China rate, and the same was done for the US income.

Backflip, prior to 2006 you didn't need to add the two incomes together for any reason. That changed in 2006.

In 2006 your US earned income gets taxed at the income tax rate as if all your foreign earned income was not excluded (even if all of it is). This grosses up your tax bracket by this amount of foreign earned income, increasing the tax rate to be used to pay tax on your US earned income.

I would imagine there are thousands of people who were doing their own taxes that got this wrong. I would never have known if I wasn't using H&R Block's software which was updated for this new law.