Would foreign earned income tax break apply?

[Machine99]

Good morning all!

We are planning to retire early this coming January. I have a non qualified deferred compensation plan through my employer with a current balance of around $150k that is supposed to pay out lump sum a few months after separation from the company. When they pay out, they are supposed to withhold federal taxes.

So my questions are:
1. Does the NQDC payout just count as normal income for 2023?
2. If I have temporary residency in Mexico, and stayed in Mexico for 330+ days there next year, would I be able to use the Foreign Earned Income rule to deduct most of that from income? Or does the source of the income have to be from outside the US?

Many thanks!

 

[Sunset]

How much are Mexican Income taxes ?
Do they throw you in a Mexican jail for failing to file income taxes ?

 

[euro]

For the most part, it is "normal income". That said, there ARE restrictions. For example, you cannot fund any IRAs with it as it doesn't count as earned income in THAT sense.
I don't have firsthand knowledge on the foreign income question, but I would be pretty surprised if you had a loophole there. The income comes from a US source, right?

 

[Alan]

From the description the expected payout next year is not actual earned income nor is it income earned in a foreign country.

 

[Machine99]

For the most part, it is "normal income". That said, there ARE restrictions. For example, you cannot fund any IRAs with it as it doesn't count as earned income in THAT sense.
I don't have firsthand knowledge on the foreign income question, but I would be pretty surprised if you had a loophole there. The income comes from a US source, right?

Yes the source is from a company in the US. That is the part I could not understand. Does the foreign earned income tax break only apply if I were to earn income from a foreign source while living outside the US, or does it apply to income from a US company while living abroad?

 

[Alan]

Yes the source is from a company in the US. That is the part I could not understand. Does the foreign earned income tax break only apply if I were to earn income from a foreign source while living outside the US, or does it apply to income from a US company while living abroad?

It can be from a US company but should be paid to the recipient who is living in a foreign country at the time the money is earned.

 

[Alan]

Today I helped my son complete his tax return along with the FEIE and it was more of a challenge than usual. There is a place where you can enter both a US address and a foreign address for the company that paid the salary.

He had no other income so when he came to file his AGI was zero and TT said that the IRS won’t accept an efile return with zero AGI so he would have to print it out and mail it in. I suggested he invent some interest so he reported $5 from his UK bank where he only has a checking account with no interest. That worked a charm, zero tax on an AGI of $5 meant he was able to efile

 

[MichaelB]

It can be from a US company but should be paid to the recipient who is living in a foreign country at the time the money is earned.

This is what I would expect, the income has to be earned while living abroad.

 

[euro]

This is what I would expect, the income has to be earned while living abroad.

That's MY interpretation too and therefore, the OP is out of luck because he EARNED his income in the past while living in the US. The fact that the PAYOUT was delayed until he moved abroad is likely a moot point.

 

[Machine99]

That's MY interpretation too and therefore, the OP is out of luck because he EARNED his income in the past while living in the US. The fact that the PAYOUT was delayed until he moved abroad is likely a moot point.

Interesting. But does that apply even though it’s “deferred compensation” from a NQDC retirement plan.

Sorry for all the questions, just trying to see if there is any way of applying this rule to my situation.

 

[euro]

Interesting. But does that apply even though it’s “deferred compensation” from a NQDC retirement plan.

I would think so: "deferred compensation" implies/means that you earned it previously, but just waited with the actual payout (in order to delay taxes, of course).

You should consider consulting a tax attorney or the IRS directly for a definitive answer, but generally, it isn't THAT easy to game the system... You are not the first NQDC participant who isn't excited about paying the taxes on their deferred earnings. I feel your pain! Personally, I wish that I could at least fund an IRA or a SD-401k with the payouts, but alas, the IRS won't allow even that

 

[Alan]

Interesting. But does that apply even though it’s “deferred compensation” from a NQDC retirement plan.

Sorry for all the questions, just trying to see if there is any way of applying this rule to my situation.

Normally, if a US employer is paying a resident of another country as an employee they have to be registered and comply with that country’s tax and labor laws. Have you checked the US-Mexico tax treaty to see what the situation is? For example, I personally receive deferred compensation every year from a US employer which is reported on a W2 for which I pay UK taxes AND US taxes. I claim back all the US tax I would pay as foreign tax credits from my payments to the UK when I file my US return.

As a resident of Mexico, even for 1 year, what are/will be your tax obligations there?

 

[Alan]

You can try this IRS Q&A to see if you are eligible, rather than rely on SGOTI.

https://www.irs.gov/help/ita/am-i-eligible-to-claim-the-foreign-tax-credit

One of the first questions

Foreign Tax Imposed and Paid

Creditable foreign taxes include taxes legally imposed on you and taxes not in excess of what you owe. They don't include amounts that would likely be refunded or forgiven if you made a claim, or taxes that would be returned in the form of a subsidy to you or to a related person or another party to a related transaction.

In 2021, did you pay or accrue creditable foreign income taxes on income you actually or constructively received?
Yes No

Another critical question

Wages and Salaries
Were your services performed in a foreign country?

 

[rothlev]

I would think so: "deferred compensation" implies/means that you earned it previously, but just waited with the actual payout (in order to delay taxes, of course).

You should consider consulting a tax attorney or the IRS directly for a definitive answer, but generally, it isn't THAT easy to game the system... You are not the first NQDC participant who isn't excited about paying the taxes on their deferred earnings. I feel your pain! Personally, I wish that I could at least fund an IRA or a SD-401k with the payouts, but alas, the IRS won't allow even that

The other rule is about your abode , if you have an abode in the states that you plan to return to you do not qualify.

ABODE TRC

What are tax home and abode for purposes of the foreign earned income exclusion?
Tax Home

One of the requirements to claim the foreign earned income exclusion, foreign housing exclusion, or foreign housing deduction is that the taxpayer’s tax home be in a foreign country. See, “Who qualifies for the foreign earned income exclusion?”

A taxpayer’s tax home is the general area of his main place of business, employment, or post of duty, regardless of where he maintains his family home.

If your taxpayer does not have a regular or main place of business because of the nature of his or her work, the tax home for that taxpayer may be the place where he or she regularly lives. If the taxpayer has neither a regular or main place of business nor a place where he or she regularly lives, then he or she is considered an itinerant or transient, and the tax home is wherever he or she works.

A taxpayer is not considered to have a tax home in a foreign country for any period in which his abode is in the United States.

For more information about tax homes, see “How is a tax home determined?”

Abode

 

[rothlev]

Good morning all!

We are planning to retire early this coming January. I have a non qualified deferred compensation plan through my employer with a current balance of around $150k that is supposed to pay out lump sum a few months after separation from the company. When they pay out, they are supposed to withhold federal taxes.

So my questions are:
1. Does the NQDC payout just count as normal income for 2023?
2. If I have temporary residency in Mexico, and stayed in Mexico for 330+ days there next year, would I be able to use the Foreign Earned Income rule to deduct most of that from income? Or does the source of the income have to be from outside the US?

Many thanks!

ABODE TRC

What are tax home and abode for purposes of the foreign earned income exclusion?
Tax Home

One of the requirements to claim the foreign earned income exclusion, foreign housing exclusion, or foreign housing deduction is that the taxpayer’s tax home be in a foreign country. See, “Who qualifies for the foreign earned income exclusion?”

A taxpayer’s tax home is the general area of his main place of business, employment, or post of duty, regardless of where he maintains his family home.

If your taxpayer does not have a regular or main place of business because of the nature of his or her work, the tax home for that taxpayer may be the place where he or she regularly lives. If the taxpayer has neither a regular or main place of business nor a place where he or she regularly lives, then he or she is considered an itinerant or transient, and the tax home is wherever he or she works.

A taxpayer is not considered to have a tax home in a foreign country for any period in which his abode is in the United States.

For more information about tax homes, see “How is a tax home determined?”

Abode