America’s new Making Work Pay credit: Are the IRS and TurboTax getting it right for overseas Americans?

Ho ho!

Finished my Japanese taxes earlier this month, and decided to go back to my American ones.

When I’d last left off, TurboTax was showing me as having a $400 refund. This is the amount of the new Making Work Pay credit. Available for two years, 2009 and 2010, and an unsung part of the stimulus package passed by Congress and signed into law by President Obama last February.

I felt the software was right, because all of my income from work was excluded by the Foreign Earned Income Exclusion. The parts that weren’t excluded were under the amount where income tax would hit. And so I should get the refundable credit when I file.

Or so I thought.

Someone at the IRS decided that people who take the Foreign Earned Income Exclusion should not get the Making Work Pay Credit! Oh no! How did this happen?

So I did a Google search, and in fact TurboTax updated their software during February to reflect what the IRS is saying.

Except—as far as I can tell—it’s not what Congress had said!

In the stimulus (or the American Recovery and Reinvestment Act) that created Make Work Pay Credit, (codified as Internal Revenue Code Section 36A), Congress specifically adopts the definition of “earned income” that is found in another credit, called the Earned Income Credit (Section 32 of the Internal Revenue Code). You cannot choose the earned income credit if you use the Foreign Earned Income Exclusion because the Section 32 specifically prohibits it. (26 U.S.C. section 32(c)(1)(C).) Not because foreign earned income suddenly is no longer “earned income” if you take the exclusion. It is earned income! And it is includible as part of gross income.

That’s why Section 32 specifically excludes taking both FEIE and EIC, because otherwise you’d be able to take and exclusion and then say you don’t earn big money, so give me the earned income credit, too! (That would be double-dipping.)

It is a subtle difference, but important: earned income in the EIC is defined to include foreign earned income. (Sec. 32(c)(2).) Then, elsewhere in the section, (that is, outside of the definition), Congress simply prohibited Foreign Earned Income Exclusion takers from double-dipping.

So now we come back to this new Making Work Pay Credit.

What looks to have happened is that someone at the IRS has confused earned income with taxable compensation. Taxable compensation is a term used to define the kind of income that is eligible for Individual Retirement Accounts (IRA). And with IRA’s, yes, it’s well settled that amounts excluded under FEIE were not eligible for an IRA. But not because FEIE is not earned income, it’s because it isn’t taxable compensation.

These are two different, unique categories, and have been for at least 35 years. They are generally the same, “earned income” and “taxable compensation”, but they are not interchangeable.

And all I can give is one man’s opinion. But if you check out more authoritative commentary, like what Commerce Clearing House (CCH) put out last year, they seem to agree with me! See? No where does it say to adjust out FEIE as not being earned income. The only adjustment is the typical one where you must add back foreign income that was excluded, in case you are hitting one of those caps where you are cut out of the benefit.

(Say, you would get the benefit unless you earned over $100,000 modified adjusted gross income. The modification is to put your excluded foreign earned income back in, to make the calculation.)

So if I’m wrong, I think Commerce Clearing House is wrong too. And that would be something, because CCH are the experts and they study these enactments with a religious fervor.

I spent too much time on this today, like I don’t have other projects. Man, I thought taxes were going to be easy this year.

[Update: Getting back to the Section 32 definition of “earned income”, this is what it says:

“(2) Earned income

(A) The term “earned income” means—

(i) wages, salaries, tips, and other employee compensation, but only if such amounts are includible in gross income for the taxable year, plus

(ii) the amount of the taxpayer’s net earnings from self-employment for the taxable year (within the meaning of section 1402 (a)), but such net earnings shall be determined with regard to the deduction allowed to the taxpayer by section 164 (f). ”

Now, if somebody is going to tell me that, no, foreign earned income is out because it’s not includbile in gross income, that’s just plain wrong. It is Section 61 income and it is includible in gross income. What happens is that, next, Congress permits an exclusion of these amounts in order to determine adjusted gross income, and, following that, taxable income.

Foreign earned income is not included, up to the $91,400 limit, in your adjusted gross income. But it is part of your gross income.

I still think that’s why Section 32 has the other section, defining eligible individuals, to exclude those who take the “Section 911” or FEIE. The Foreign Earned Income that relates to Section 901 creditable taxes seems just fine as “earned income” in Section 32.]