Any US Expats out there? Need help with 401k and Foreign Earned Income Exclusio

[CongoKid]

I am a US citizen working in Africa.  I'm having some trouble managing my 401k in light of the unique tax issues facing expatriates.  I'm hoping someone can help me with the question below about my tax liability and the potential to reduce this via my 401k.

Here's the background:

Income:
Salary: $105,000
Housing Allowance: $27,000
Total Income: $132,000

Deductions:
Foreign Earned Income  Exclusion: $99,200
Housing Exclusion: $13,888
Standard Deduction: $6,200
Standard Exemption: $3,950
Total Deductions: $123,238

So the above leaves me with a Taxable Income of ($132,000 - $123,238), or $8,762.  Figuring that my MAGI would be in the 28% tax bracket, I would owe taxes of $2,453.

My question is, if I put into my 401K account the total taxable income ($8,762), would that completely eliminate my tax liability for the year?

Thanks in advance for any help you might have!  CongoKid

[MDM]

So the above leaves me with a Taxable Income of ($132,000 - $123,238), or $8,762.  Figuring that my MAGI would be in the 28% tax bracket, I would owe taxes of $2,453.

My question is, if I put into my 401K account the total taxable income ($8,762), would that completely eliminate my tax liability for the year?

Thanks in advance for any help you might have!  CongoKid

You get taxed on taxable income, not MAGI.  Tax on $8762 would be $876.

So yes, if a 401k deduction brings your taxable income to zero, you will pay zero tax.

Can you voluntarily take less FEIE so you can have a higher MAGI, put more into the 401k, and still pay zero tax?

Or, if you are only paying 10-15%, it may be better to pay that rate now and go into a Roth.  Particularly if you will repatriate and be in a much higher bracket later....

[CongoKid]

Thanks a ton MDM....that's really helpful and I appreciate you taking the time to reply.  I never thought about reducing the FEIE voluntarily....though it could be a possibility.  Unfortunately though with the TIPRA act (2005, 2006?), they changed the way the tax rate is applied, so I am actually taxed at the 28% rate on any income that's not excluded.  In any case, this year I'll save roughly $2500 in taxes that without this site I would have paid!

[genselecus]

Unfortunately though with the TIPRA act (2005, 2006?), they changed the way the tax rate is applied, so I am actually taxed at the 28% rate on any income that's not excluded.

Is this true? When I looked at all the forms (I'm not an accountant, and haven't spoken to one yet), it seems like they take your AGI (after exclusions) and you pay taxes on that as you normally would. In other words, what MDM said. Your interpretation has a very large impact on how much I may pay in taxes next year (may be an expat in the UAE).

[MDM]

I think he's right -- it used to work the way you describe, but around 05/06 they changed the way you calculate things so that you have to fill out different forms and if you owe tax, you pay at the rate you would on your entire income.  Kind of sucks big time.  Took me totally by surprise in 2007, when I had a grant that was not tax deductible because I was not enrolled in a degree program.  Ended up having to pay about 1/3 of the grant amount in taxes that year.

Ouch.

lhamo, does that mean the tax calculations in the Reader Case Study spreadsheet are incorrect when foreign income exclusion is non-zero?  Don't know if I want to go down that rabbit hole to fix it if so, but would at least like to know if the rabbit hole exists.

From http://www.bankrate.com/finance/money-guides/taxpayers-abroad-can-limit-u-s-taxes-1.aspx (appears the link is a few years old but if the information is still correct...):
Before TIPRA, after an overseas worker subtracted the exclusion amount, the worker was then able to figure U.S. taxes based on the remaining income. Now, however, regardless of the final taxable dollar amount, it is taxed as if it were still in the bracket it would have been in before the exclusion was allowed.
This means that expatriate workers will lose the tax-reducing value of the lower brackets in our progressive tax system. For example, if you make $100,000 overseas, your tax bracket is based on that amount, not just on the $8,600 you have after subtracting the $91,400 exclusion from your overall $100,000 income. So instead of figuring taxes on the $8,600 by beginning at the 10 percent bracket and working up through the progressive tax scale, the foreign-based worker would calculate his or her tax bill by starting at the 28 percent bracket into which the pre-exclusion income amount falls.

[Left]

i didnt think foreign income could be tax sheltered in 401k since they get tax exempted already for $90k

[genselecus]

Thanks for the link. Very helpful.

[nonsequitur]

I'm also under the impression that you pay at the marginal rate implied by your MAGI.

You cannot reduce the FEIE.  You must take it all.   Do you owe income taxes in your country of residence?  The foreign tax credit may be a better idea for your situation.

My impression is that you could only contribute your residual earned income to the 401k, so in your case $5,800.  But how/where is your 401k administered?  Can you take salary from your foreign employer and contribute it to your 401k?  I was not aware that this was possible, unless it is actually your employer administering the 401k, in which case I'd imagine they are sophisticated enough to have some in HR who could advise you on these issues.

[MDM]

Good comments by nonsequitur.

Interesting segment of the IRS tax code....

Regarding marginal rate, it's actually the rate in effect at "taxable income plus amount excluded for FEIE."  See the Foreign Earned Income Tax Worksheet (Form 1040 instructions for Line 44).

Reader Case Study spreadsheet has been updated to include the above worksheet.  Should be accurate for "simple" FEIE situations.   

[Americans Abroad]

For Americans living abroad it is often very complicated , costly and a hassle with all the reporting that is required due to FATCA.

[expatartist]

Yes, anything financial overseas for US citizens has gotten complicated in the past few years.  Even opening a new acct the other day in Beijing I had to fill out a W-9 for the first time. This was a bank I've used for 3 years, just adding a HK$ acct so I could do a small transfer to HK.