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I'm a U.S. citizen living abroad claiming the Foreign Earned Income Exclusion (FEIE). According to https://www.americansabroad.org/us-taxes-abroad-for-dummies-update/,

The exclusion applies only to earned income. Other income, such as pensions, interest, dividends, capital gains, etc., cannot be excluded with the FEIE. You are liable for full US tax on this type of income.

However as I understand it, the FEIE is entered as a negative number on Line 21 ("Other income") of form 1040, and then combined with all other sources of income (including dividends (line 9a) and capital gains (line 13)) to obtain the total income (line 22), in which case it would seem to effectively 'apply' to these types of income.

Can someone explain this apparent discrepancy?

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    What country do you live in? Do they have a tax treaty with the US? – Joe Aug 10 '17 at 18:20
  • Part of the year (January till September) I lived in the Netherlands, the rest in Italy. – Kurt Peek Aug 11 '17 at 9:15
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If you read a bit further down, you'd see the explanation, as well as one alternative.

FEIE can only reduce your taxes by the amount of your foreign earned income, up to a cap (a bit over $100k). So if you have earned income of $109k in the example, that would be taxed at around $11k; $100k would be taxed at around $9k, leaving $2k tax bill remaining.

If you have capital gains, that is just in addition, so the tax from that and the tax from dividends would be in addition to that $2k.

  • Earned Income - $109k
  • Capital Gains - $10k
  • Tax on Earned Income - $11k
  • Tax on Capital Gains - $2.5k
  • FEIE exlusion - $9k

  • Total tax = $11k - $9k + $2.5k = $4.5k

However, the way you avoid double taxation on capital gains, if you owe it, is with the Foreign Tax Credit. Any tax you paid on those capital gains to the other country would also be a credit towards your taxes here. So if you paid $2k in capital gains overseas, you would only owe $500 here from the capital gains, for a total of $2.5k total owed.

There also may be a tax treaty between your country of residence and the US that may apply.

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    You might want to mention that if the Foreign Tax Credit is chosen, then the FEIE cannot be used. – Dilip Sarwate Aug 11 '17 at 2:55
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    Dilip Sarwate, I understand from irs.gov/individuals/international-taxpayers/… that the Foreign Tax Credit cannot be used on income you exclude using the FEIE. But for income not excluded (i.e. from dividends and capital gains) you could still use the Foreign Tax Credit while simultaneously using the FEIE for your earned income, no? – Kurt Peek Aug 11 '17 at 8:42
  • Joe, your high-level explanation is consistent with my understanding the the FEIE is for earned income only, but I'm trying to understand the nitty-gritty details of how to fill this out on forms 1040 and 2555. Because if it is correct that I have to fill in "Form 2555" on line 21 and enter the negative FEIE, and then combine lines 7 through 21 to obtain the total income, then the resulting sum would not make any distinction between income from dividends or capital gains. Or is there a separate form for taxes on dividends and capital gains? – Kurt Peek Aug 11 '17 at 9:21
  • @KurtPeek: there is a separate copy of form 1116 (the foreign tax credit) for each 'category' of taxed income; dividends, interest and investment capital gains are in the passive category. Current year instructions online and all years downloadable from the Forms&Pubs tab. This form is a PITA to do manually; if possible use software or a (professional) preparer. – dave_thompson_085 Aug 11 '17 at 14:41
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What discrepancy? You enter all the earned income on Line 7 and get to reduce it by the FEIE which you enter as a negative number on Line 21. So your AGI is the total of earned income less the FEIE amount plus the dividends, capital gains etc. Thus, dividends, capital gains etc are subject to US tax and only the foreign earned income is excluded from US tax (up to the maximum allowable exclusion for income earned abroad).

  • Let me try to illustrate with an example where my doubts arise. The instructions on line 22 are "Combine the amounts in the far right column for lines 7 through 21. This is your total income". Suppose I earn $70k in wages (line 7) and $5k in dividends (line 9a) and my FEIE is $100k (so -$100k in line 21). Then after combining them I get a total income of -$25k, which would mean I don't have to pay any tax, right? So in this example the FEIE would have eliminated both the earned income and the income from dividends. – Kurt Peek Aug 11 '17 at 8:38

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