I'm an American who's been living in Norway this year and who is getting paid in Norwegian kroners. I have some old 401ks that I want to merge into a Roth IRA I have. I've learned recently, though, that I may be able to roll them only into a traditional IRA.
Either way, how do I determine my tax bracket for this purpose? As I understand it, the foreign income exclusion is $85k (yes?), and so if I earn the equivalent of $100k, then I'll have to pay U.S. taxes on the remaining $15k. If that's correct, then would my tax bracket be based on the $100k I earned, or on the $15k on which I paid taxes?
The foreign earned income exclusion is indexed, and by now is slightly above the 85,000 figure.
You will soon be able to directly transfer 401ks to a Roth IRA if you wish, recognizing the income.
Under the Foreign Earned Income Exclusion rules, the foreign earned income is the lowest taxed income, so excluding it cuts out taxes at the low tax rates, and other income, such as conversion income from a 401k to an IRA, is taxed at the higher rates.
Does that mean if you have 100k of foreign earned income and an 85k foreign earned income credit, then the remaining 15k is taxed at the higher rate of 28% (for single filers: 10% rate at 0 to 8,025; 15% rate at 8,025 to 32,550; 28% rate at 28% rate is from 78,850 to
164,550)? Since you would just enter the 85k as negative other income, it seems it that the net income would be 15k and would be taxed at 10% and 15%.
I did some research and saw that there is a tax worksheet "Foreign Earned Income Tax Worksheet?Line 44". It looks like it computes tax on 100k, tax on 85k, and subtracts the results. The result is probably 0.28*15k=4.2k.
And what are the tax rates for the foreign tax credit?
Suppose the foreign country currency is F and that 1 F = 1 USD. Suppose the foreign country has brackets of 0% (0 to 5,000F), 10% (5,000F to 10,000F), 20% (10,000F to 15,000F), 60% (15,000F to infinity). If your income was 100F, then the foreign country withheld 5000*0 +
5000*0.1 + 5000*0.2 + 85000*0.6 = 52,500F.
Suppose the foreign exemption is 85k, then only 15k of income is taxable. The taxon it looks to be 28%, or 4.2k, as shown above.
What is the foreign tax credit? Is should be the smaller of the US tax on your foreign income or the actual foreign tax paid. But which
15,000F is it? The lowest 15,000F has a tax of 5000*0 + 5000*0.1 +
5000*0.2 = 1500F. But the highest 15,000F of income had a tax of
0.6*15,000 = 9,000F. I would imagine that as the US taxes the highest
15k of earnings, then the foreign tax credit should be on 9,000F. So the foreign tax credit would I think be min(0.28*15k, 0.6*15k)=4.2k.
Without doing the calculations, the way the foreign tax credit calculations work is to compare the foreign tax rate on the foreign income vs the US tax rate on that same income, and limit the credit to the lower of the two.
And of course, no foreign tax credit is allowed on foreign earned income excluded on form 2555. You will have to allocate foreign tax paid to the amount of foreign earned income excluded and not excluded, and calculate foreign source income using the nonexcluded portion.
It sounds as if the OP wants to know his tax bracket to determine whether he is eligible for a roth conversion. To the OP, is this the underlying concern? If so, I think you asked the wrong question. Your focus should be on your modified adjusted gross income, not your tax bracket. I do not know how the foreign tax credits affect MAGI, though. I'm sure someone here more knowledgable than me can assist with that.
Of course, it my assumptions are way off-base, I apologize and I'll go back to standing in the corner:-)
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