Stacking with 2555, joint filing foreign rules and NI

Hi all,

Have a few unclear questions would appreciate thoughts on:

1) Lets say you have some income not earned so cannot apply the FEIE (2555) to. Let's suppose after the standard/dependants deductions you have a taxable amount. For example let's say it is $20k. And let's say you excluded $60k on the 2555. Would you stack the income to determine the tax e.g. tax due on ($20k + $60k) - tax on ($60k)? Or would you take the tax on the $20k?

2) If you file jointly, and decide that one of you is better off using FTCs but you want to use 2555 for the other filer, can you do this?!

3) I assume NI that comes off of gross pay cannot be excluded anywhere or accounted for anyhow? Or can it?? It is something like 12% (on earnings over £8k or so) so is significant. Just wondering how you can deal with this.

Many thanks!
J

Start with 3):

3) I assume NI that comes off of gross pay........

NI contributions are part of gross salary. Period.

1) Lets say you have some income not earned so cannot apply the FEIE (2555) to. Let's suppose after the standard/dependants deductions you have a taxable amount. For example let's say it is $20k. And let's say you excluded $60k on the 2555. Would you stack the income to determine the tax e.g. tax due on ($20k + $60k) - tax on ($60k)? Or would you take the tax on the $20k?

I'm afraid I don't understand this. Was UK tax (or other country) paid on the unearned income? What type of income was the unearned income? Interest? Benefits? If interest, use FTC (from 1116) (likely passive basket) to declare tax paid on unearned income only. Follow the rules for 'excluded (FEIE - 2555) income' on form 1116 and 1040. So, $60,000 earned income excluded on 2555 and $20,000 unearned interest income calculated via form 1116.

2) If you file jointly, and decide that one of you is better off using FTCs but you want to use 2555 for the other filer, can you do this?!

Again, don't understand given 2). Is one individual over the $100,000+ limit of 2555?

IMHO, when filing a joint return and both individuals qualify, I believe both persons are entitled to a separate 2555 - FEIE exclusion. I could be wrong so research on your part is needed.

Since $20,000 is a lot of interest for one year (by today's standards) a better explanation of the type of unearned income would help.

Start with 3):

NI contributions are part of gross salary. Period.

I'm afraid I don't understand this. Was UK tax (or other country) paid on the unearned income? What type of income was the unearned income? Interest? Benefits? If interest, use FTC (from 1116) (likely passive basket) to declare tax paid on unearned income only. Follow the rules for 'excluded (FEIE - 2555) income' on form 1116 and 1040. So, $60,000 earned income excluded on 2555 and $20,000 unearned interest income calculated via form 1116.

Again, don't understand given 2). Is one individual over the $100,000+ limit of 2555?

IMHO, when filing a joint return and both individuals qualify, I believe both persons are entitled to a separate 2555 - FEIE exclusion. I could be wrong so research on your part is needed.

Since $20,000 is a lot of interest for one year (by today's standards) a better explanation of the type of unearned income would help.

Hi OAP,

Thanks for your comments. I will try to clarify better!

I realise NI is part of gross salary. I certainly include it in gross salary. I am just wondering if there is a way to deduct it from any tax calculations when filing otherwise (ignoring any 2555 considerations) it will be subject to US tax. I suspect not, but want to be sure.
 
OK let me put it another way. The tax on $20,000 is different to the (tax on $80,000) – (tax on $60,000). The reason being as you will well know, is the fact that different amounts are taxed at different rates and it is a sliding scale of tax %. So, for example if you look at tax tables, $20k from a married filed jointly gives tax of $2,081 (forget exclusions and the rest for now). However, tax at $80k is $11,594 and tax at $60k is $8,081. Thus the tax at ($80k-$60k) is $11,594 - $8,081 = $3,513. As you can see, this is considerably more than the $2,081 (about 70% more!!) as it is a different % being applied. This is income stacking and is why especially in the past it could have been unfavourable for married couples to file jointly in some cases.
 
Now in my scenario, I have this past year had the opportunity to exercise and sell Employee Incentive Stock Options (ISO in US terms) and made some money on those given the very low option cost when I joined, and the perceived value of the private company now being ~70-fold higher than the exercise cost. This has been a big help and I did it as we are on one salary at the moment as my wife is off looking after our young kids. However, as it is not earned income, I cannot apportion this to the 2555 (and I did not realise at the time I had to file US taxes!!). Therefore, I can take off my standard and dependents deductions but I am still left with a small taxable amount.
 
So what I have done is to fill out a 1116 for the tax due to be paid (accrued) on the gains as they are subject to UK CGT. This worked out fine and exceeded the amount in the tax tables I thought the US would expect me to pay. HOWEVER, now I am thinking that I should have used the above income stacking approach (i.e. added this taxable amount to the amount excluded on the FEIE and worked out the tax of that minus the tax that would have been on the FEIE amount) rather than use the tax tables based on the lower amount.
 
The problem here is that would push the tax above what I paid in the UK on the gains alone (for a few reasons, 1) being the £11.1k CG tax-free UK allowance and 2) these are EMI shares subject to favourable 10% CGT rates, not the usual 28% on anything above £11.1k).
 
However, I suppose I could completely forget the 2555 form and actually put my whole salary and the share gains onto 2 x 1116 forms. When I do it this way, I think I would be in credit and owe nothing.
 
The further problem is I already have submitted my forms for 2015 (!!) and I am not 100% clear if stacking rules apply to this income or not.
 
I’m not sure if this makes sense? I think, that actually as I have more ISO shares that my company might allow us to sell back to the board again in the future, perhaps if the above is true that I would be better off going down the 1116 route, also building up tax credits, rather than the FEIE/2555 even though my earned income won’t exceed $100k (and my wife is currently unable to work). But I’m just not clear!
 
Many thanks,
J

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I'll start this with a warning. I have no good news for you, so you may want to look away now.

As always, I could well be wrong. My opinion only, and I know nothing.

Start with NI contributions. They are part of your gross salary and they are UK taxed pre contribution. You may include them in salary for a FEIE - 2555 amount and thereby they become not US taxed (excluded), or, you may offset the tax paid on them by using FTC's (1116) for the entire salary which includes the NICs (and not using FEIE at all). There is no other special treatment for them.

I do understand your quandary with the tax on unearned items not included in FEIE. According to the rules, any income excluded for FEIE uses the basic part of the tax rates. Unfortunately, if there is any additional income, it is taxed at a tax rate as though the FEIE income were included, and the additional income will be taxed at a rate starting where the FEIE income left off. In other words, above the rates that would have been applied to the FEIE income. The actual taxed amount will only be on the $20,000, not on $80,000, but it is at the higher rate.

So, for example, total income is $95,000 (including salary and $35,000 unearned income). $60,000 is earned and is excluded using FEIE. That leaves £35,000. A further ~$15,000 is exempt due to standard deduction and personal allowance. That leaves $20,000 to be taxed. The tax rate for the $20,000 ($35,000 on 1116) will be as if it were the tax rate for $80,000 ($95,000). Note: if a 1116 were filed, it would be for the $35,000 amount of unearned income, not a $20,000 amount. The stacking rule only applies if FEIE was taken, and then a 1116 is filed to offset tax for additional income on which UK tax was paid.

I'll leave it to others to comment on how the ISO is taxed and what forms are required, but I do have some additional bad news. Often, when stock options are either exercised or sold, there may be additional tax due thanks to AMT (Alternative Minimum Tax - form 6251). Did you explore AMT? I'm unsure *of the forms required when selling ISO's or the implications of UK tax paid and its availability for form 1116 given any additional required forms. Also be aware of any tax treatment of, and any tax due on ISOs once they are vested, and they are exercised (you now own the shares, but haven't sold them yet).

(* Wait for someone to comment who knows what they're talking about!)

Since you've already sent 2015 you have two options: Do nothing and see if the IRS has a problem with your return. If so, you'll hear but it may be 24 to 36 months. If there is additional tax due, calculation of the penalties and interest will have started on 15 April, 2016. The second option is to carefully re-evaluate your return and if it is incorrect, file a 1040X (give it at least 3 months before filing the 1040X) and pay any additional tax due plus penalties/interest now.

     

Hi again OAP,

Thanks again for your reply. This makes sense – and is what I feared. Unfortunately I had the reassurance as I met with a family friend who was a CTA and seemed to agree with my approach, and had not heard of/realised the stacking rule, so I pressed ahead and got this return in, along with the previous 3 years. Fortunately, this only applies to the current year.

Is there a good reason to wait 3 months for the 1040X and not do it now, before June 15th? Is this the only way to file an amended form? Do I reattach all the other forms with the 1040X?

The thing is, when I apply ALL my income to the 1116 (FTCs) rather than just the share options and avoid the 2555 completely, I actually end up in credit for tax, so I could resubmit an amended return and still owe no tax. However, if I exclude my earned income on a 2555 and only apply the tax from the share options to a 1116, I end up owing maybe around $1000 or so. So I personally think I should just avoid using the FEIE and put earned income on one 1116 and capital gains on another, and between them I actually end up in credit by about $1000. But this would mean I would have to file using 1116 for the next 6 years (I played catch-up using the FEIE 2555 for the last 3 years), but that is probably fine given in the UK I will always pay more tax so can build up credits. Does that make sense and seem sensible?

As for the AMT and ISO’s – I have researched into this and I do not believe I qualify for AMT and also tax own on exercise etc. It seemed pretty clear to me the type of shares and also the transaction, from what I read, meant that no additional tax was needed. These were exercised and sold on the same day (by my company on my behalf to board members) and I have recorded this on an 8949 and Schedule D.

See https://turbotax.intuit.com/tax-tools/tax-tips/Investments-and-Taxes/Incentive-Stock-Options/INF12049.html (in particular category 2) – this is why I am treating this as disqualifying stock and ordinary income tax. But that should be fine, if I apply all my income to the 1116 rather than the original way I did it, as outlined above, unless anyone can point out a flaw here?

By the way – I am of course including NI in all of these examples as part of gross income and not deducting it in any way to come up with these figures.

Many thanks,

J

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Is there a good reason to wait 3 months for the 1040X and not do it now, before June 15th?

There is no hard and fast rule that I am aware of, but the logic is based on the IRS not having two unscored returns simultaneously. Give them time to get the first into the system and avoid confusion. In the end, it's your choice as to when you file the 1040X, and I am aware you're trying to avoid penalties/interest.

Is this the only way to file an amended form?

Yes. (1040X)

Do I reattach all the other forms with the 1040X?

The instructions as to how to prepare a 1040X for your particular circumstances are usually clear.

The thing is, when I apply ALL my income to the 1116 (FTCs) rather than just the share options and avoid the 2555 completely, I actually end up in credit for tax, so I could resubmit an amended return and still owe no tax. However, if I exclude my earned income on a 2555 and only apply the tax from the share options to a 1116, I end up owing maybe around $1000 or so. So I personally think I should just avoid using the FEIE and put earned income on one 1116 and capital gains on another, and between them I actually end up in credit by about $1000. But this would mean I would have to file using 1116 for the next 6 years (I played catch-up using the FEIE 2555 for the last 3 years), but that is probably fine given in the UK I will always pay more tax so can build up credits. Does that make sense and seem sensible?

If you're saying the UK tax rate was 10%, then yes, it does make sense. If the US tax rate is in the 15% bracket due to the higher rate of 'stacking' with the FEIE income, the result is not surprising. Depending on circumstances many find using FTCs give a more satisfactory result. Overall, your situation is somewhat exceptional, and using FTCs may certainly be more favourable. Although, with the increase in UK tax free income, interest, and dividends, FTCs may be harder to come by in the future.

As for the AMT and ISO’s – I have researched into this and I do not believe I qualify for AMT and also tax own on exercise etc. It seemed pretty clear to me the type of shares and also the transaction, from what I read, meant that no additional tax was needed. These were exercised and sold on the same day (by my company on my behalf to board members) and I have recorded this on an 8949 and Schedule D.
See https://turbotax.intuit.com/tax-tools/tax-tips/Investments-and-Taxes/Incentive-Stock-Options/INF12049.html (in particular category 2) – this is why I am treating this as disqualifying stock and ordinary income tax. But that should be fine, if I apply all my income to the 1116 rather than the original way I did it, as outlined above, unless anyone can point out a flaw here?

I'm much relieved to hear you've done your research. I'm uncomfortable commenting on ISOs (although I am familiar with them), so I'll leave this for others to comment on. From your previous comments, I was afraid you had not completed Schedule D. Contemplating that unpleasantness, you've put my mind to rest. ISOs can be tricky.

One last comment - read all instructions carefully and be sure you can change from 2555 to 1116 on a 1040X. It shouldn't be a problem, but there are surprises at every turn. The instructions for dealing with excluded income and the 'stacking' are pretty prominent on most forms, and I'm surprised you missed them on 1116.

And, don't let anyone frighten you with scaremongering. You are making a reasonable 'best effort' to file the return.

This has been bothering me as the more I think about it I'm still not sure I understand what you did on the return you have submitted.

$95,000 total income, $60,000 earned, 35,000 unearned.

IF you declared $95,000; then excluded $60,000 via FEIE; subtracted ~$15,000 for personal exemptions and standard deduction; arrived at a taxable amount of $20,000; and then paid tax on that $20,000 at MFJ using the tax tables (and ignoring all/any tax paid to the UK) which you say earlier is around $2,081 from the tables; and then sent a cheque for $2,081 to the IRS, then you are fine. You've overpaid by not using FTCs for the $20,000 (using the stacking rule on 1116), but the IRS will not argue with this and gladly cash your cheque, thank you.

Is this what you did?

If you did something else (using 1116 without the stacking rule for example), then the return is likely incorrect. By following the instructions for 1116, the process for calculating tax credits should include calculations dealing with the 2555 excluded income and the stacking rule. Did you file a 1116 (in this case for the $35,000 amount of unearned income) and did you do this element of 1116? if yes, then the return would automatically be correct (in process). Again, if you filed a 1116 but did not do the calculations for the stacking rule, then the return will likely raise an alert flag.

One other thought, if you file a 1040X and are able to use FTC only for all income (in both passive and general baskets), and thereby end up owing no tax, there will be no penalties or interest on $0 tax due. If you did as per the IF scenario above and have paid $2,081, you would receive a refund for the $2,081.

So what I have done is to fill out a 1116 for the tax due to be paid (accrued) on the gains as they are subject to UK CGT.

Electing to accrue taxes can create problems in the UK.  The taxes don't accrue until the end of the U.K. year.  If the income was earned in the prior calendar year but the taxes accrue in the next calendar year, you can end up with taxable income and no foreign tax credits to offset the U.S. tax.  You may be able to wait until the next year and have excess foreign tax credits (if any) that can then be carried back one year on an amended tax return.  Also, once you elect to claim taxes on an accrual basis, it is a permanent election and you can never go back to the cash method.

There is no hard and fast rule that I am aware of, but the logic is based on the IRS not having two unscored returns simultaneously. Give them time to get the first into the system and avoid confusion. In the end, it's your choice as to when you file the 1040X, and I am aware you're trying to avoid penalties/interest.
Yes. (1040X)
The instructions as to how to prepare a 1040X for your particular circumstances are usually clear.
If you're saying the UK tax rate was 10%, then yes, it does make sense. If the US tax rate is in the 15% bracket due to the higher rate of 'stacking' with the FEIE income, the result is not surprising. Depending on circumstances many find using FTCs give a more satisfactory result. Overall, your situation is somewhat exceptional, and using FTCs may certainly be more favourable. Although, with the increase in UK tax free income, interest, and dividends, FTCs may be harder to come by in the future.
I'm much relieved to hear you've done your research. I'm uncomfortable commenting on ISOs (although I am familiar with them), so I'll leave this for others to comment on. From your previous comments, I was afraid you had not completed Schedule D. Contemplating that unpleasantness, you've put my mind to rest. ISOs can be tricky.

One last comment - read all instructions carefully and be sure you can change from 2555 to 1116 on a 1040X. It shouldn't be a problem, but there are surprises at every turn. The instructions for dealing with excluded income and the 'stacking' are pretty prominent on most forms, and I'm surprised you missed them on 1116.

And, don't let anyone frighten you with scaremongering. You are making a reasonable 'best effort' to file the return.

Hi OAP,

Here is perhaps a simpler attempt to explain what I did (not using precise numbers and removing small amounts of bank interest, for ease)!

- Gross Income (joint) = $80,000
- Income from sale of employee shares = $45,000
- Therefore total income = $125,000
- FEIE (2555) exclusion of ($80,000)
- Adjusted income = $45,000
- Standard deduction = ($12,600)
- Deduction for dependents (4) = ($16,000)
- Adjusted gross income to tax: $16,400
- Filled out form 1116 for the employee shares ($45,000) stating that $3000 tax is (to be) paid on this in the UK
- Determined from tax tables that $16,400 = $1643
- FTC = $3000 which is > $1643, so nullified any owed tax – tax owed = $0

I think I should have worked out the tax by adding the $16,400 onto the FEIE amount ($80,000), worked out the tax on that, and subtracted the tax on $80,000 to come to the actual tax due. The problem for me would be that would result in the UK tax paid on the gains ($3000) being less than the actual tax owed by around $1000, thus if I went with this approach correctly I would owe US tax.

However after realising this (too late!), if I had NOT used the 2555/FEIE but rather put my gross income on a 1116, as well as my shares on a 1116, I would have enough FTCs to be in excess of any tax amount I would owe, thus meaning I owe no tax and also would have about $1000 credit to take forward.

Now this change would result in an additional 1116, removing the 2555’s (one for me, one for wife), and applying a different strategy for my AGI etc by cancelling out any tax with my FTCs only. Which is why when looking at the 1040X I wonder how this will be viewed, as this is not a simple amendment.

The definitive fact is that I have paid more foreign tax in total this year than what I would owe on all my income to the US. So I shouldn’t have to owe anything, but if I go down the FEIE I perversely will. I did not realise this and a US family friend CTA had helped me so I was in a false sense of security that I thought I had done this correctly. Also this is my first time doing this and doing it on my own (I am a UK citizen only with US citizenship through birth), having spent 2 months of every evening after long days at work researching and trying to understand and fill out 4 years of tax and 7 years of FBAR whilst also trying to have some type of family life with my two very young boys!! Hence, this mistake has come in…no excuses I know but this is all new to me – from my perspective I am only a US citizen through having American parents. (Rant over!)

However I have also read that if the filing deadline date has not passed, you can send in another form with “superseding return” written on it and you should not need to file 1040X, as long as the superseding form is filed before the deadline date. I have read this on multiple tax sites (including TurboTax) so I am thinking that is how I should go about it, and avoid the 2555/FEIE altogether.

Thanks again for your help!

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Electing to accrue taxes can create problems in the UK.  The taxes don't accrue until the end of the U.K. year.  If the income was earned in the prior calendar year but the taxes accrue in the next calendar year, you can end up with taxable income and no foreign tax credits to offset the U.S. tax.  You may be able to wait until the next year and have excess foreign tax credits (if any) that can then be carried back one year on an amended tax return.  Also, once you elect to claim taxes on an accrual basis, it is a permanent election and you can never go back to the cash method.

Hi discly,

For the share options  which I originally put on a 1116, these were exercised and sold on 1 day in Dec, 2015. Thus I am filing UK taxes now for CGT for the 2015-16 April - April UK tax year. That tax is owed by whenever due date is (Oct for efiling??) But I have already filled out my UK HMRC self-assessment form online so I know how much tax I will be paying.

I cannot afford to not claim the FTC on these options if they are down as income as that would be significant and it's money we now dont have at the moment. Also I shouldn't have to pay double tax when I'm already paying more UK tax - that's partly the point of the treaty right?!

So on 1116 part II what box would you tick for this tax I will be paying on the gain of the share options? Would you not tick accrued? Why would I always have to tick accrued in the future if that wasn't the case for a different transaction / income?

Confused!

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For the share options  which I originally put on a 1116, these were exercised and sold on 1 day in Dec, 2015. Thus I am filing UK taxes now for CGT for the 2015-16 April - April UK tax year. That tax is owed by whenever due date is (Oct for efiling??) But I have already filled out my UK HMRC self-assessment form online so I know how much tax I will be paying.

I cannot afford to not claim the FTC on these options if they are down as income as that would be significant and it's money we now dont have at the moment. Also I shouldn't have to pay double tax when I'm already paying more UK tax - that's partly the point of the treaty right?!

So on 1116 part II what box would you tick for this tax I will be paying on the gain of the share options? Would you not tick accrued? Why would I always have to tick accrued in the future if that wasn't the case for a different transaction / income?

The taxes for the UK 2015-2016 tax year accrued on the last day of that year (April 5, 2016).  So for your U.S. tax return in the calendar year 2016, you will be able to claim the taxes that accrue on April 5, 2016. 

Since the income from the options was recognized in the calendar year 2015, the income will be in that year.  You did not pay the UK taxes on the share option income in the 2015 calendar year and the UK taxes on this income did not accrue in the 2015 calendar year.  Therefore, you cannot claim the UK taxes related to this income in the calendar year 2015.

I am not saying that this is fair.  Just explaining the rules.

So you are saying I will have to pay tax this year then try and get a refund next year? Surely that qualifies as burdensome which is what the US - UK tax treaty has as it's main point!!

What does accrued mean then and how do you use it?

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What does accrued mean then and how do you use it?

See:
https://www.irs.gov/pub/irs-utl/am2008005.pdf

https://www.irs.gov/pub/irs-wd/201438027.pdf

I would file 2 x form 1116 - one for the shares (passive income??) and one for my general income (ie. Salary). Can I select accrued for the passive income and cash basis for the other?! And then for all passive income I would be accrued but general income would be cash basis??

I'm basically screwed if this is all true. I don't have a spare $2k to pay this year and get a refund next year.

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- Adjusted gross income to tax: $16,400
- Filled out form 1116 for the employee shares ($45,000) stating that $3000 tax is (to be) paid on this in the UK
- Determined from tax tables that $16,400 = $1643
- FTC = $3000 which is > $1643, so nullified any owed tax – tax owed = $0

An interruption concerning your method of filing from 1116:

If line 1a of 1116 was for ~$45,000, and
If you adjusted line 3e of 1116 for excluded income on 2555, and
If line 18 of 1116 reflected line 41 of 1040, the amount prior to exemptions, and
If line 19 of 1116 = 1, and
If line 20 of 1116 reflects line 44 of 1040 ($1,643 ?), and
If line 22 of 1116 is also ($1,643 ?), and
If line 47 of 1040 = ($1,643 ?), and
If line 48 of 1040 = ($1,643 ?), and
If line 55 of 1040 = ($1,643 ?), and
If line 56 of 1040 = $0, then

the method of calculating tax due is correct. The return should be acceptable from this standpoint.

Any additional adjustment for stacking is not required (it's unearned income, and not earned income which was the type of income excluded, hence no further stacking rule applies). Hands up, I believe, now, I may have mislead you on this issue when unearned income is concerned. The stacking rule seems only to apply when filing a 1116 'general limitation' basket for additional earned income in excess to the amount excluded by the FEIE.

Now, you only have to be concerned by the good catch discly made concerning the accrued $3,000 tax. (Well spotted.)

If discly is right, then your 1116 would be incorrect (there would be no $3,000 UK tax paid), and would not allow for any FTC to be claimed. I'll leave that to you two.