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Area 1: Individual TaxTCPIndividual TaxInternational Tax

CPA · Question 10 · Area 1: Individual Tax

A US citizen working abroad qualifies for the Foreign Earned Income Exclusion (FEIE). In Year 1, they earned $140,000 in salary and had $15,000 in foreign taxes withheld. The FEIE limit for Year 1 is $120,000. The taxpayer also has $10,000 of U.S. source interest income. If the taxpayer elects the FEIE, how is the tax on the remaining income calculated?

Answer options:

A.

The remaining $20,000 of salary is taxed at the lowest tax bracket rates.

B.

The taxpayer cannot claim a Foreign Tax Credit on the excluded income, but can on the excess.

C.

The tax is calculated using the rates that would apply if the excluded income were present (stacking rule).

D.

The $10,000 interest income is excluded because it is less than the standard deduction.

How to approach this question

1. Understand FEIE Stacking Rule: Income excluded under FEIE is included for determining the marginal tax rate on the non-excluded income.<br/>2. Tax Calculation: Calculate tax on (Excluded + Non-excluded). Calculate tax on (Excluded). Difference is the tax on Non-excluded.<br/>3. Result: Remaining income is taxed at the highest marginal rates applicable to the total income.

Full Answer

C.The tax is calculated using the rates that would apply if the excluded income were present (stacking rule).✓ Correct
C
Under the 'stacking rule', the tax on the non-excluded income is determined by calculating the tax on the total income (including the excluded amount) and subtracting the tax calculated on just the excluded amount. This ensures the remaining income is taxed at the higher marginal rates.

Common mistakes

Assuming the remaining income starts at the 10% bracket.
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