American citizen abroad and under FEIE- IRA contribution possible?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
canrun
Posts: 8
Joined: Sun Oct 20, 2019 9:32 am

American citizen abroad and under FEIE- IRA contribution possible?

Post by canrun »

Hi all,

I'm a long-term resident of China and make below the $108,700 FEIE. I have no US-earned income. I am under the impression that it is not possible to contribute to an IRA of any kind (Roth or Traditional) if all income is excluded. However, several colleagues have said they have successfully funded a Traditional IRA while well under the FEIE. So, I'm not sure what the correct answer is in terms of overseas residents funding an IRA. Any help is much appreciated. Thanks. :happy
crre
Posts: 69
Joined: Fri Apr 12, 2019 8:07 pm

Re: American citizen abroad and under FEIE- IRA contribution possible?

Post by crre »

i believe if you take the foreign tax credit instead of the foreign earned income exclusion you can fund an ira. whether or not this is a good idea is another story. depends how much you are taxed in china, whether or not you plan to still be in china when you retire, etc. etc.
Topic Author
canrun
Posts: 8
Joined: Sun Oct 20, 2019 9:32 am

Re: American citizen abroad and under FEIE- IRA contribution possible?

Post by canrun »

I'd like to follow up with what a fellow American citizen here in China told me today.

He said: "I’ve researched this in depth before. Excluding all income via FEIE means you don’t have earned wages and thus cannot contribute to a Roth. However, if you use the physical presence test by which to claim FEIE, then you get to choose *which* 12-month in which you were gone the required number of days. You can thus claim less than a full 12 months fiscal year (like Dec 2019 to Nov 2020) and still meet the physical presence test to claim FEIE, but you would not claim it for that one month (Dec 2020). Since you wages are lower than the tax threshold, you’d not pay tax on it, but since you did have wages you can that month’s wages to a Roth IRA. You don’t have to claim the FEIE when you’re gone. So if you claim part but not all of a tax year, it’s fine. You can claim as much or as little as you like."

Does this advice seem to be accurate? Any caveats? Thanks.
crre
Posts: 69
Joined: Fri Apr 12, 2019 8:07 pm

Re: American citizen abroad and under FEIE- IRA contribution possible?

Post by crre »

sounds.... creative. i am not an accountant and i have absolutely no idea if this is a legit thing to do or not.
Karamatsu
Posts: 1365
Joined: Mon Oct 27, 2008 2:42 am

Re: American citizen abroad and under FEIE- IRA contribution possible?

Post by Karamatsu »

I am under the impression that it is not possible to contribute to an IRA of any kind (Roth or Traditional) if all income is excluded.
That's correct. If you exclude all of your foreign-earned income, then you have no earned income to contribute to an IRA. The only way to have some US-earned income is to make more than the FEIE, or to earn some income while you are in the US (say, while attending a conference, meeting, etc). Since you're a long-term resident I assume you've used the exclusion every year, so it's hard to change now, but if you'd just arrived you would have the option of computing your 2020 taxes twice, once with the FEIE and then again without the FEIE (using the foreign tax credit to avoid double taxation of your salary), then see which gives you the best end result. Usually the FEIE is the best choice. Certainly it's the simplest. Form 1116 can be incredibly complex and you really have to know what you're doing, even if you use software like TurboTax.

I may just not understand what your colleague is suggesting, but it does not seem correct. In fact it looks to me like a horrible idea that will result in the IRA contributions being designated as excess contributions. When the IRS finally catches on, which may not be until you retire, you'll have to remove any excess contributions made, along with all gains attributable to them, pay penalties, excise taxes, and interest (compounded daily) on those unpaid taxes and penalties going back to the day that the contributions were made. There is no limitation on how far back the IRS can go to penalize excess contributions to an IRA, so this can easily wipe out your entire IRA balance. The power of compound interest works both ways...

Before trying anything clever, make an appointment with the IRS office in Beijing to discuss your plan with someone there, or to see if there is any other kind of alternative. Be sure to wear flame-proof clothes!
James1
Posts: 54
Joined: Tue Jun 23, 2015 5:59 pm

Re: American citizen abroad and under FEIE- IRA contribution possible?

Post by James1 »

While you can't contribute to an IRA, you can do Roth conversions. When we lived overseas, our income was less than the FEIE cap. Since we could still use the standard deduction, we converted the equivalent of our standard deduction (there's 4 of us) from a traditional IRA to a Roth every year. It's a huge tax savings!
typical.investor
Posts: 2611
Joined: Mon Jun 11, 2018 3:17 am

Re: American citizen abroad and under FEIE- IRA contribution possible?

Post by typical.investor »

canrun wrote: Mon May 03, 2021 8:51 am I'd like to follow up with what a fellow American citizen here in China told me today.

He said: "I’ve researched this in depth before.
Me too. I've researched this in-depth before as I am an expat concerned about the same thing.

canrun wrote: Mon May 03, 2021 8:51 am Excluding all income via FEIE means you don’t have earned wages and thus cannot contribute to a Roth.
True.
canrun wrote: Mon May 03, 2021 8:51 am However, if you use the physical presence test by which to claim FEIE, then you get to choose *which* 12-month in which you were gone the required number of days.
That is not correct. Anyone who has had to prove residency will know that where you physically were will be used in the determination. If you can't prove you'd left the country, your claim won't be accepted. You simply can't choose to not be a resident for periods that you are actually there.

canrun wrote: Mon May 03, 2021 8:51 amYou can thus claim less than a full 12 months fiscal year (like Dec 2019 to Nov 2020) and still meet the physical presence test to claim FEIE, but you would not claim it for that one month (Dec 2020).
Regardless of where you claim to be, income earned in China is foreign sourced income. There is simply no choice to declare some foreign source income as excluded and some as taxed.
canrun wrote: Mon May 03, 2021 8:51 amSince you wages are lower than the tax threshold, you’d not pay tax on it, but since you did have wages you can that month’s wages to a Roth IRA.
This is a not correct. At least that's what the IRS said when I made a mistake. Amounts excluded under the FEIE are used to calculate your tax bracket. So if you exclude $85,526 (beginning of 24% bracket) under FEIE for instance and have $9,875 in US income (end of 15% bracket), that US income is taxed in the 24% bracket. (ignoring exclusions here for a second)

As for exclusions, your claimed foreign income may be under the $12,400 standard deduction (so untaxed), but you'd have to watch out for dividends and capital gains. Once you exceed the exclusion (for US income +dividends + capital gains), you aren't starting in the 10% bracket with 0% qualified dividends and capital gains. Your FEIE excluded income has pushed you into the 15% bracket.
canrun wrote: Mon May 03, 2021 8:51 am You don’t have to claim the FEIE when you’re gone. So if you claim part but not all of a tax year, it’s fine. You can claim as much or as little as you like.".
The IRS is very clear. You can claim the FEIE or not. But what you can't do is claim the FEIE for only part of your foreign income.

Think about it, if you did claim only part of your foreign income, the part that you didn't claim would be eligible for a tax credit. This is because you'd have paid taxes in China and taxes in the US and there is no double taxation. The IRS is crystal clear that doing a tax credit on unexcluded foreign income when you have excluded other income under the FEIE will revoke your FEIE.

Now in the case of if you exclude some under the FEIE, don't exclude some under the FEIE and don't claim the credit ...
canrun wrote: Mon May 03, 2021 8:51 am Does this advice seem to be accurate? Any caveats? Thanks.
I will add rules on claiming the FEIE are very restrictive. You can't even choose it in one year and not the next and then choose it in the third year. If you qualify for the FEIE but decide not to take it, that's referred to as revoking your exclusion. If you have revoked an exclusion in the last five years, you are not eligible to take the FEIE without explicit permission from the IRS.

If you do as your friend says and not take the FEIE for a month (despite being eligible for the year, taking it on other income in the year and the income being foreign income), that seems to a revocation of the FEIE. I think the IRS can rule that your are not eligible for the FEIE for five years from that point.

Your friends advice is firmly in the "I am going to do what I want", "they can catch me in an audit if they want", "I will plead ignorance if they do" category of tax planning.

If you hear differently from a qualified tax planner and that advice is truly correct (highly doubtful), then expats everywhere will be doing ROTH contributions in a way that was previously thought impossible.
User avatar
asset_chaos
Posts: 1968
Joined: Tue Feb 27, 2007 6:13 pm
Location: Melbourne

Re: American citizen abroad and under FEIE- IRA contribution possible?

Post by asset_chaos »

I never tried this because until retirement my living abroad income was always above the limit, but, if you elect to exclude, are you required to exclude all income up to the limit? Can you exclude, say, all but $5k of overseas income, then use the unexcluded income to legitimately fund an IRA? As I haven't heard of this being done, there's probbly something that precludes the strategy, apart from perhaps owing a little tax on the unexcluded income.
Regards, | | Guy
plats
Posts: 428
Joined: Mon Dec 31, 2007 9:46 pm

Re: American citizen abroad and under FEIE- IRA contribution possible?

Post by plats »

asset_chaos wrote: Mon May 03, 2021 9:34 pm Can you exclude, say, all but $5k of overseas income, then use the unexcluded income to legitimately fund an IRA?
That's an easy one--absolutely not.

I agree with Karamatsu. It's probably not a good idea to play footsies with the IRS. Decades from now they may realize that you were a bona fide resident of China that whole time and wonder why you didn't report that way. I don't think a business trip to the USA would work either, unless there was some verifiable money earned, such as direct sales at a trade show. My advice would be to invest in a total market stock fund which throws off minimal distributions and let it ride.
typical.investor
Posts: 2611
Joined: Mon Jun 11, 2018 3:17 am

Re: American citizen abroad and under FEIE- IRA contribution possible?

Post by typical.investor »

asset_chaos wrote: Mon May 03, 2021 9:34 pm I never tried this because until retirement my living abroad income was always above the limit, but, if you elect to exclude, are you required to exclude all income up to the limit? Can you exclude, say, all but $5k of overseas income, then use the unexcluded income to legitimately fund an IRA? As I haven't heard of this being done, there's probbly something that precludes the strategy, apart from perhaps owing a little tax on the unexcluded income.
No, you can't.

Once you choose the FEIE, you must continue to take it unless you declare a revocation. If you have revoked your FEIE in the previous 5 years, you are not eligible for the FEIE without explicit IRS permission (Private Letter Ruling rumored to be at a cost of $2,000).

Per IRS documentation:
Effect of Choosing the Exclusion
Once you choose to exclude your foreign earned income, that choice remains in effect for that year and all later years unless you revoke it.

Revoking the Exclusion
You can revoke your choice for any year. You do this by attaching a statement that you are revoking one or more previously made choices to the return or amended return for the first year that you do not wish to claim the exclusion(s).

If you revoked a choice and within 5 years again wish to choose the same exclusion, you must apply for IRS approval. You do this by requesting a ruling from the IRS.
See https://www.irs.gov/publications/p54#en ... k100047514
assyadh
Posts: 335
Joined: Tue Sep 18, 2018 12:44 pm

Re: American citizen abroad and under FEIE- IRA contribution possible?

Post by assyadh »

Any reason why you don't use the foreign tax credit? If you live in a high tax country it could be better.
User avatar
asset_chaos
Posts: 1968
Joined: Tue Feb 27, 2007 6:13 pm
Location: Melbourne

Re: American citizen abroad and under FEIE- IRA contribution possible?

Post by asset_chaos »

plats wrote: Mon May 03, 2021 9:44 pm
asset_chaos wrote: Mon May 03, 2021 9:34 pm Can you exclude, say, all but $5k of overseas income, then use the unexcluded income to legitimately fund an IRA?
That's an easy one--absolutely not.
Ok, that is an easy one; it's just prohibited. Knew there'd be a simple reason somewhere, thanks.
Regards, | | Guy
TedSwippet
Posts: 3627
Joined: Mon Jun 04, 2007 4:19 pm
Location: UK

Re: American citizen abroad and under FEIE- IRA contribution possible?

Post by TedSwippet »

Karamatsu wrote: Mon May 03, 2021 8:05 pm Before trying anything clever, make an appointment with the IRS office in Beijing to discuss your plan with someone there, or to see if there is any other kind of alternative. Be sure to wear flame-proof clothes!
The IRS closed its Beijing office in 2013, and all of its offices outside the US in 2015. For your increased customer convenience and satisfaction.
Topic Author
canrun
Posts: 8
Joined: Sun Oct 20, 2019 9:32 am

Re: American citizen abroad and under FEIE- IRA contribution possible?

Post by canrun »

Thank you for the replies.

Yes, I am uneasy with my colleague's recommendation, and I'll be returning to the States in the next few years, so it's not something I can't live without doing for now.

Always good advice here. :sharebeer
Karamatsu
Posts: 1365
Joined: Mon Oct 27, 2008 2:42 am

Re: American citizen abroad and under FEIE- IRA contribution possible?

Post by Karamatsu »

The IRS closed its Beijing office in 2013...
Wow. Hard to believe it's been that long since I talked to them. But perhaps that's for the best!
jsprag
Posts: 229
Joined: Sun Nov 26, 2017 11:25 am

Re: American citizen abroad and under FEIE- IRA contribution possible?

Post by jsprag »

Excluded income is not "compensation" for purposes of determining IRA contribution limits; if all income is excluded then you cannot make a contribution. From IRS Publication 54:
Contributions to your individual retirement arrangements (IRAs) that are traditional IRAs or Roth IRAs are generally limited to the lesser of $6,000 ($7,000 if 50 or older) or your compensation that is includible in your gross income for the tax year. In determining compensation for this purpose, don’t take into account amounts you exclude under either the foreign earned income exclusion or the foreign housing exclusion.
As far as your friend's suggestion, my recommendation is to read Pub 54 and the instructions for Form 2555, and then work through some scenarios using forms 1040 and 2555. I think it will help you make a better assessment of his advice.
Post Reply