Expat, foreign earned salary and IRA
I am an expat living in Europe and have been receiving the foreign earned tax relief. My wife and I would jointly (I am the bread winner in the family) in the 15% tax bracket (about 45,000/year).
I had been under the impression that because I was taking advantage of the foreign earned tax break that I couldn’t contribute to an IRA.
However, a tax accountant told me that it was possible to expose up to 16,000 USD of my salary that would not fall under the foreign earned bracket. Because of the moneys exposed to normal salaried taxes I could then contribute to an IRA. However, because the amount that wasn’t considered foreign earned then was under 16,000 USD the taxes would be zero.
Now when I first heard this I was skeptical. But I brought this possibility up in another forum and no one seemed to argue with it. I also checked it out with another accountant, and he agreed that it was possible.
So I went ahead and invested the max for both my wife and I in a Roth IRA for the year of 2008.
However, in another forum (http://www.diehards.org) someone said that they had tried this a few years back and found out that this wasn’t allowed. They suggested that I ask the experts on this forum.
So…is this allowed by the IRS? If not, what can I do now? Is there anyway to reverse this?
Thank you for your help!
Permalink Submitted by Alan Spross on Wed, 2008-04-16 21:38
I am not sure what they meant by “exposing up to 16,000” of your salary, but this suggests possibly a limited use of the foreign earned income exclusion. While you may opt out of using the exclusion altogether, you cannot use only part of your available exclusion in order to leave yourself with enough earned income to generate an IRA contribution. In your case, you apparently do not have enough earned income to be in excess of the excluded amount.
Permalink Submitted by [email protected] on Thu, 2008-04-17 03:53
So I guess the next question is what to do since I have already invested in a Roth IRA for 2008. What are my options?
Permalink Submitted by Alan Spross on Thu, 2008-04-17 05:47
You have several options:
1) Wait longer if there is any chance your earned income will exceed the exclusion, or worse case drops low enough for you to not apply the exclusion.
2) Correct the excess contribution by telling the IRA custodian you have an excess contribution to be corrected. The custodian must do an earnings allocation on your contribution and return to you with earnings or loss adjustment. If you have earnings, the earnings will be taxable and you will owe a 10% early withdrawal penalty on the earnings amount only. If the earnings are negative, there is no tax impact. You have until 10/15/09 to correct the contribution in this manner.
3) You could also leave the contribution in the Roth if you expect to be in a different situation next year or if you otherwise do not correct the excess by 10/15/09. You can apply the excess to your 2009 contribution if you are eligible for 2009. You would owe a 6% excise tax on the contribution for 2008, but any earnings would stay in the Roth. This only works if you have excellent earnings on your contribution.
4) If you just leave the excess contribution there and do not become eligible for several years, you would owe the 6% excise tax for each year and the IRS would charge interest if you paid the 6% late.
You would probably decide based on whether you just want to put this behind you now (ie correct it ASAP) or wait longer to see what develops. The IRS would know about this due to Form 5498 which you and the IRS receive next January.
Permalink Submitted by [email protected] on Thu, 2008-04-17 09:54
Thank you alanoniras! I will probably go with 2nd option though I am also considering number three.
It looks like I would be able to contribute in 2009 as I will be in the States for 3 months (10,000 USD will not be foreign earned but US earned and therefore taxable). So then if I keep the money in the IRA I would pay %6 on the 10,000 that both my wife and I contributed which would amount to 600 USD. And then the following year 2009 and on I wouldn’t need to pay any kind of tax on this. Is that correct?
Someone mentioned to me that I might be able to recharacterize it to a non-deductible IRA. Is this possible?
Thanks again.
Permalink Submitted by Alan Spross on Thu, 2008-04-17 16:04
Yes, your second paragraph is correct. In 2009 you would need to file Form 5329 to show the applied contribution to 2009, but there would be no tax or penalty for 2009, just the 6% for 2008.
However, the earned income requirement applies to both traditional and Roth IRAs, so you cannot recharacterize the current contribution. The recharacterization option would apply to those who have earned income but their modified AGI is too high to qualify for a Roth contribution. That’s not the case with you.
Permalink Submitted by [email protected] on Thu, 2008-04-17 18:24
Thanks for all your help! I will go with option 2 and call Vanguard today.