From: wales@kona.cs.ucla.edu (Rich Wales)
Subject: Re: Income Earned Abroad/Foreign Income Exclusion
Reply-To: wales@CS.UCLA.EDU (Rich Wales)
Organization: UCLA, Computer Science Department
Distribution: usa
Date: Sat, 12 Dec 92 05:33:54 GMT

Gerard Horan asked about deductions available for taxes paid in another
country.  Since I'm about to find myself in this kind of situation, I've
been doing some reading on the subject, and here's a summary of what I
found out.

First of all, be aware that US law requires all US citizens and green
card holders to pay US income tax based on their worldwide income --
whether the person in question was living in the US and/or the money was
earned in the US.  (Some may see this as arrogance on the part of the
US, but that's the way the law is.)

Since someone living and working in another country will generally be
expected by that country to pay its taxes, the possibility of double
taxation exists.  However, in practice this generally won't happen
because of various provisions in both countries' laws.

The two biggest things to be aware of in this regard in US tax law are
(1) the foreign earned income exclusion and (2) the foreign tax credit.

The foreign earned income exclusion allows you to subtract your foreign
income from your taxable income.  If you spend all year abroad, the
limit on this exclusion is US$70,000.  If you spend part of the year
outside the US, the limit is pro-rated.  (The rules are actually more
complex than this; see the relevant IRS publication for the details.)

The foreign tax credit allows you to subtract income tax paid to a for-
eign country from your US income tax liability.  There is a very complex
formula by which your foreign income is split into several different
categories and a certain amount of foreign tax is allocation proportion-
ately to each category; this hair-pulling exercise becomes important if
you use your right to carry "excess" foreign tax forward or back to off-
set US tax in different years.

These two tax benefits interact:  if you exclude all of your foreign
income, you can't take any foreign tax credit; and if you exclude only
part of your foreign income, you can take only a reduced tax credit.
Also, you can't switch arbitrarily back and forth between these two
techniques:  if you take the foreign income exclusion in one year, but
not in the next, you have to wait five years before you can take the
income exclusion again (though you can keep taking the tax credit).
This provision probably means you're usually better off taking the for-
eign tax credit if the other country's taxes are higher than in the US.

Ask the IRS for publications 54 (tax guide for US citizens and resident
aliens abroad); 519 (tax guide for aliens); and 514 (foreign tax credit
for individuals).  Also, forms 2555 (foreign earned income) and 1116
(foreign tax credit).

Also, you need to check to see if there is a "tax treaty" in effect
between the US and the other country in question.  If so, ask the IRS
for info on said tax treaty.  The tax treaty contains additional provis-
ions which may permit or ban certain kinds of deductions (e.g., the two
countries may recognize donations to charities in each other's country),
affect the way you have to compute taxes (e.g., you may be required to
start with the US tax form, then compute the other country's taxes on
the basis of the initial US tax computation, then go back and refigure
US taxes -- or maybe vice versa), treat issues relating to Social Secur-
ity and retirement programs in the two countries, etc., etc.

-- 
Rich Wales <wales@CS.UCLA.EDU> // UCLA Computer Science Department
3531 Boelter Hall // Los Angeles, CA 90024-1596 // +1 (310) 825-5683