A U.S. citizen accepts a permanent assignment in France on January 1, Year 1. They are present in France for all 365 days of Year 1. They earn $140,000 in salary. Assume the maximum Foreign Earned Income Exclusion for Year 1 is $126,500. Which statement correctly describes the tax planning implication of electing the exclusion?

Answer options:

The taxpayer must elect the exclusion because it is mandatory for eligible individuals.

If the exclusion is elected, the taxpayer can also claim a Foreign Tax Credit for taxes paid on the excluded $126,500.

Electing the exclusion may result in a higher marginal tax rate on the non-excluded income due to the stacking rule.

The taxpayer cannot elect the exclusion because they did not meet the physical presence test.

How to approach this question

Understand the 'stacking rule' for the Foreign Earned Income Exclusion. The excluded income pushes the remaining taxable income into higher tax brackets.

Full Answer

C.Electing the exclusion may result in a higher marginal tax rate on the non-excluded income due to the stacking rule.✓ Correct

Under IRC §911, the Foreign Earned Income Exclusion is elective. If elected, the 'stacking rule' applies, meaning the tax on the non-excluded income ($140,000 - $126,500 = $13,500) is calculated using the tax rates that would have applied to that income had the exclusion not been taken (i.e., the rates applicable to income between $126,500 and $140,000). Also, no Foreign Tax Credit is allowed for taxes allocable to excluded income (IRC §911(d)(6)).

Common mistakes

Assuming the remaining income is taxed at the lowest bracket rates or thinking the Foreign Tax Credit applies to the full income.

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