Yang, James G. S.; Jeffers, Agatha E.
January 2007
International Journal of Business Research;2007, Vol. 7 Issue 1, p111
Academic Journal
This paper explains that a U.S. citizen working abroad can choose either the foreign tax credit or the foreign earned income exclusion when calculating his U.S. income tax liability. By using the former, the foreign tax paid can be used as a credit against the U.S. tax to the extent of the U.S. tax liability attributable to the foreign income; while the latter is limited to $85,700 plus foreign housing cost allowance in excess of $13,712 with a limitation depending on the location in the world where the income was generated. The tax rate bracket is determined as if no foreign earned income exclusion were taken. This paper further identifies what factors should be considered in determining an optimal decision between these two approaches. These factors include the foreign tax rate, the U.S. tax rate, the taxpayer's income and the statutory $85,700 foreign earned income exclusion. Our findings suggest that if the U.S. tax rate is lower than the foreign tax rate, coupled with the taxpayer's foreign earned income being much more than $85,700, it would be more beneficial to adopt the foreign tax credit approach. Otherwise, in all other situations, it would be more profitable to employ the foreign earned income exclusion approach. This paper presents numerous illustrations to demonstrate the tax implications associated with the two reporting choices under various scenarios. It further offers tax strategies for the situation where there are two foreign countries with two different tax rates. It also investigates the advantages and disadvantages of foreign active income and foreign passive income. In addition, this paper illustrates some tax planning techniques for high and low wage earners at different locations in the world.


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