Mechanics of Calculating Section 911 Housing Exclusion Explained By Chief Counsel's Office (Parker's Federal Tax Bulletin: April 23, 2013)

Noting that the exclusion or deduction under Code Sec. 911 for foreign housing is calculated differently on Forms 1040 and 2555 than deductions are normally calculated, the Chief Counsel's Office explained how the exclusion/deduction should be calculated. CCA 201313023.

In CCA 201313023, the IRS Office of Chief Counsel responded to an inquiry for information on how the Code Sec. 911 housing deduction should be calculated on Forms 1040 and 2555. In general, the housing exclusion and the housing deduction under Code Sec. 911 are calculated in such a way that two similarly situated taxpayers will pay the same amount of tax regardless of whether they take the exclusion or deduction. To achieve this, the deduction is calculated differently on Form 1040 and Form 2555 than deductions are normally calculated.

The Code Sec. 911 housing exclusion is the amount provided by the taxpayer's employer for housing expenses incurred while living and working in the foreign country. In contrast, the housing deduction is generally taken by self-employed individuals working abroad. The deduction is taken by taxpayers who do not receive a housing stipend from an employer (or whose employer-provided housing stipend is less than the actual cost of housing, subject to limitations), and their housing expenses are instead paid for out of their own income (at least partially). For purposes of calculating the Code Sec. 911 housing exclusion and deduction, a qualifying taxpayer who is paid foreign earned income in the amount of $x and a housing stipend in the amount of $y from an employer will be treated the same as a qualifying self-employed taxpayer with income in the amount of $x+y, where y is spent on housing. Assuming they are otherwise identically situated, they will owe the exact same amount of tax.

According to the Chief Counsel's Office, the mechanics of how the forms work are as follows. First, the housing exclusion, housing deduction, and foreign earned income exclusion are all subtracted from total gross income on the Form 1040 at lines 21 and/or 36 to arrive at adjusted gross income (AGI) on Form 1040, line 37. Next, exemptions and the itemized or standard deduction are subtracted from AGI at lines 40 and 42 to arrive at taxable income. The tax on this taxable income is determined on the Foreign Earned Income Tax Worksheet for Form 1040, line 44. The housing exclusion, housing deduction, and foreign earned income exclusion are all added to the taxable income amount; this ensures that the taxpayer's income that exceeds the amounts allowed under Code Sec. 911 will be stacked on top of the Code Sec. 911 amounts and thereby be taxed at the appropriate rates. The worksheet then calculates a total hypothetical tax that would apply to this grossed-up amount in the absence of Code Sec. 911. Finally, the worksheet calculates a hypothetical amount of tax for the Code Sec. 911 amounts. The difference between this amount and the hypothetical tax on the grossed-up amount is the taxpayer's actual tax liability.

According to the Chief Counsel's Office, by making the Code Sec. 911 housing deduction an above-the-line deduction, adding it to taxable income to create a grossed-up amount, and then subtracting the tax attributable to that amount from the tax that would be owed on the grossed-up amount, Forms 2555 and 1040 work together to ensure that the housing deduction and housing exclusion are effectively treated the same.

PRACTICE TIP: If the housing deduction were instead simply deducted once when first calculating taxable income, a taxpayer taking the housing exclusion could end up paying more tax than a taxpayer taking the deduction because the taxpayers might otherwise fall in different tax brackets. That was not the intent of the statute, and the slightly more complicated approach taken above protects parity.

Staff Editor Parker Tax Publishing

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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