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We are US citizens. We live overseas and make our income from a business here. We pay taxes here on the income and thus don't pay US taxes on it. Let's say we make $50,000 and all of it is excluded on our US taxes (using form 2555) so that our AGI (line 38 of the 1040) is $0. Then we can't make contributions to a Roth IRA because you have to have taxable income to contribute to a Roth IRA. I read one website where someone recommended this:

As I understand it, you can contribute to a Roth IRA with foreign earned income, but the contribution amount is limited to the amount of TAXABLE income you have earned. Therefore, you would claim a foreign earned income exclusion on the income you made abroad minus the amount you contributed to the IRA. In other words, if you earned $50,000 abroad, claim $44,500 as excluded income under the foreign income exclusion, leaving $5500 taxable by the US. Since this $5500 is under the amount for the standard deduction, you won't be taxed on it either and your contributions should be fine.

Is this correct? Can I only exclude a portion of my foreign income, considering some of it as taxable US income, enough to contribute $ to a Roth IRA, but I wouldn't owe US taxes because it's below the standard deduction? If yes, then what form would I use to report the income that is not excluded? I don't have a W-2 to report it.

thanks

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    You'd be well advised to consult with a tax attorney versed in the tax relationships between the USA and your expatriate country. Even if you can't do what you propose per se, it's conceivable that there is something you can do to alter your tax situation in the other country in a way that might help. That's just speculation though, so you'd want to talk to someone who knows the ins and outs. – BrenBarn Dec 11 '15 at 19:48
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No, this is incorrect. You cannot exclude a portion of your income, that would be false reporting.

What you can do is not use the FEIE at all, and instead use the foreign tax credit. If the foreign tax is higher than the US tax - there's a chance that you will have the US tax liability reduced to zero by the credit, while still keeping all of your earned income in the AGI, and thus eligible for the IRA contributions.

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    Be aware that electing to not take the FEIE means you have to go through some extra hoops if you change your mind and want to use it in future years. – Eric Dec 11 '15 at 12:03
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    As discussed in this question, there's room for debate on this issue, so I believe your answer is an oversimplification. The article I cited there (from a law professor) suggests that you're not always required to claim every deduction you're entitled to. Of course, this question is slightly different, since it is an exclusion rather than a deduction, and since they still want to claim it, but just not the full amount they could claim. The questioner should of course consult a tax attorney for a real answer. – BrenBarn Dec 11 '15 at 19:46
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    @BrenBarn you may not claim a deduction, although you do sign a jurat. But you can't claim an amount that is plain incorrect. You either use FEIE, and then you fill all the amounts correctly, or you don't use it at all. – littleadv Dec 12 '15 at 5:43
  • @eric the choice is every year. If in year X you chose not to use FEIE - it doesn't preclude you from using it in year Y, and doesn't add any hoops whatsoever. You can even change your mind for year X. irs.gov/Individuals/International-Taxpayers/… – littleadv Dec 12 '15 at 5:44
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    @littleadv If you revoke the FEIE and want to use it again within 5 years, you need to apply for permission to do so. See here: irs.gov/Individuals/International-Taxpayers/… – Eric Dec 12 '15 at 8:09
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You don't want to do that. DON'T LIE TO THE IRS!!! We live overseas as well and have researched this extensively. You cannot make $50k overseas and then say you only made $45k to put $5k into retirement.

I have heard from some accountants and tax attorneys who interpret the law as saying that the IRS considers Foreign Earned Income as NOT being compensation when computing IRA contribution limits, regardless of whether or not you exclude it. Publication 590-A What is Compensation (scroll down a little to the "What Is Not Compensation" section). Those professionals say that any amounts you CAN exclude, not just ones you actually do exclude. Then there are others that say the 'can' is not implied. So be careful trying to use any foreign-earned income to qualify for retirement contributions. I haven't ran across anyone yet who has gotten caught doing it and paid the price, but that doesn't mean they aren't out there.

AN ALTERNATIVE IN CERTAIN CASES: There are two things you can do that we have found to have some sort of taxable income that is preferably not foreign so that you can contribute to a retirement account. We do this by using capital gains from investments as income. Since our AGI is always zero, we pay no short or long term capital gains taxes (as long as we keep short term capital gains lower than $45k)

How to get money 100% income tax free

Another way to contribute to a Roth IRA when you have no income is to do an IRA Rollover. Of course, you need money in a tax-deferred account to do this, but this is how it works:

  1. Take $5,000 (or whatever amount you want to that is below the maximum) from your IRA and roll it over into a Roth IRA. You will be "taxed" on that and it will be considered income.
  2. Since your real income is $0 because of the FEIE, you won't really pay any taxes on the $5k because your standard deductions will cover it.
  3. Repeat this until every year until all of your money is in Roth IRA and it will be tax free when you retire, not taxed like with a regular IRA.

I always recommend those who have tax-deferred IRA's and no AGI due to the FEIE to roll over as much as they can every year to a Roth IRA. That really is tax free money. The only tax you'll pay on that money is sales tax when you SPEND IT!! =)

  • The link you posted says that excluded foreign earned income is not considered compensation. In your answer you make it sound like any foreign earned income is not considered as compensation, which is incorrect. – littleadv Aug 3 '16 at 16:39
  • Please note that short term capital gains are taxed as income. However, this does not mean they count as earned income, which is the requirement for RIRA/TIRA contributions. Therefore, swimex is making years of unallowable contributions that will bite them if and when the IRS checks up on them. – Boogieman Mar 11 at 16:21

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