What amount to report from foreign income: gross or "taxable"?

[puravidapto]

The United States resident needs to report worldwide income from
United States and from foreign sources. The wage from United States
is reported in W-2, and we take the box 1 amount. The wage from
foreign countries are not reported in the format, can we take some
pretax deductions and derive the box 1 amount? Let us take a Chinese
paycheck stub as an example to make the question more clear.

Monthly salary: 24,000
Food allowance: 220
Retirement ("401K"): 2,000
Medical fund ("HSA"): 500
Provident housing fund: 3,000
Taxable income: 13,720

The taxable income per Chinese law is calculated as:

24,000 + 220 - 2,000 - 500 - 3,000 - 5,000 ("monthly standard deduction") = 13,720

When we report the foreign income in US tax return, do we report:

[a] Gross income: 24,200
[b] Taxable income per Chinese law: 13,720
[c] "Box 1 amount" computer per US law: 24,000 + 2,000 - 2,000 - 500
[d] Other

On one hand, the US law does not apply to China, and the pretax
items in China are not mapped exactly to the ones in the US. For
example, the 401K in the US is elective and in China is mandatory,
and there is no "High Deductible Health Plan". On one
hand, it would not be fair to report the gross income ("box 5
amount"). How to solve this dilemma?

Also the exchange rate used should be at the time of the income,
at the end of year, or at the reporting time?

[itonewbie]

You have a number of concepts confused.

For US tax purposes, worldwide income is reportable and taxable based on US tax law (regardless of how an income or benefit, including pension, is or is not subject to tax in a foreign jurisdiction) unless otherwise excepted or exempted by domestic statutes or modified by an income tax treaty provision.

Instead of looking at how Chinese IIT is computed, which is based on a standard formula, you need to determine whether he is a domicile or non-domicile tax resident because the scope of taxation is different and that determines how his foreign tax credit should be computed.

Exchange rate for income and expenses would generally be spot rates unless it is ratably earned or incurred.  QBU is handled with functional currency being the foreign currency and §988 will apply.  Exchange rates for foreign tax credit gets a bit more complicated - you can refer to F.1116 filing instruction as well as §§905 and 986 for details.

In case you are not familiar with international taxation, you may be well-advised to farm out this type of work to a specialist, especially one who understands both US tax and the taxation system of the country in which your client is based.

[puravidapto]

There are pretax items similar to "401K" and "HSA" which will be excluded based on US law, that is basically what I am asking.

[itonewbie]

You mentioned in your question that "The wage ***from*** foreign countries are not reported in the format, can we take some pretax deductions and derive the box 1 amount?"

The word "from" implies that it is compensation administered in China based on local tax law.  If the compensation was paid from China but shadow payroll is managed from the US (by competent international tax/payroll specialists), the W-2 should be correct and you wouldn't be asking the question.

Although similarly natured benefits may be provided outside the US, those plans more often than not do not conform to US tax law and regulations, which means they generally are subject to US tax in full.

[minor edits]

[itonewbie]

If you do not understand, you can ask more questions cordially.  Giving a "no" vote for a correct answer will not help you or others who have similar questions.

[puravidapto]

If you apply the US law literally to the foreign income, there will be no any items exempted from the tax because you cannot find an item named "401K" in a foreign payroll system. Just as in translation, I am wondering if the US law could be applied in spirit, otherwise there would be a disparity between US income and foreign income.

As an analogy, marriage in a foreign country is recognized in the US even the registration processes are different. A university degree in a foreign country is recognized even the courses taken are not exactly the same. The local law could be recognized in certain areas.

I provided 4 choices for discussion and the 4th one is open ended. I do not insist that it has to be one way or the other. I do not know and that is why I ask questions. I prefer that technical questions be addressed technically. I was excited to see that you answered my question, however the first and last paragraphs of your answer deviate from what I expect from a technical forum and I became disheartened.

[itonewbie]

I have no doubt you could be very competent in your area of practice but expatriate taxation is probably not your cup of tea.  I certainly wouldn't take offense if someone provides me this level of details on something I do not fully understand and advises that I should consider farming the work to a competent specialist.

US tax law cannot be applied in spirit when the letter of the law is clear.  That is especially so when it comes to ***statutory*** plans where the code clearly lays out the conditions for concessions and authorizes the IRS to issue regulations that govern its applications.

Furthermore, some of the line items your example refer to appear to be a combination of Chinese social security contributions and deductible benefits available only to expatriates under Chinese tax law.  That is why you should consider referring your client to someone who is familiar with both US and China IIT.

There are issues that are just too broad for all the details to be covered on a forum like this.  I have covered the high-level considerations but it is evident that there are a number of technical issues and practical matters relevant to foreign and US tax as well as compensation structure, which you do not seem to have experience in or fully comprehend.

It would be against the spirit of participation in the forum to deprive others of the opportunity to learn from one another by voting down a correct answer just because you do not like it.  Again, for that reason, you should consider retracting your no vote.

[abctax55]

What would this place do without you?

[itonewbie]

I'll be sticking around still. :smile:

[abctax55]

Thank goodness for that.  I even have a question for you, but it's for 2020 taxes.

[itonewbie]

Feel free to ping me.  Will definitely help if I have or can find the answer.

[abctax55]

Thx & I will. There's no hurry.

[itonewbie]

@puravidapto Two last comments as I overlooked your analogies, just to reiterate how complicated international issues could be.

First, your analogy about recognition of foreign marriage is not valid because that recognition is rested in the long-standing position of the IRS, published as a Rev. Rul. and well tested in case law.

Second, foreign degrees are not recognized automatically in all cases - many a time, that depends on treaties and conventions.  Furthermore, accreditation bodies, especially for professional degrees, in different countries often have different standards and requirements.

[sjrcpa]

OP is asking this on another forum, too and not liking the same answer.

[itonewbie]

I see that too.  Seriously, I would really think twice about preparing expat returns if I were the OP.

The foreign pension question Is a whole different ballgame.  Before even getting to that, the OP needs to understand how compensation is structured in China and how its social security scheme works.

[Akinofe67]

Am glad you are sticking around sir. I've been following the thread but am not sure am clear about the conclusion. So let me ask the question for my benefit, if you dont mind that it is becoming redundant. My client earns foreign income and foreign pension is only item deducted before foreign income tax rate is applied.

I also was considering what to report, Gross Wages or Taxable Wages (Gross less pensions). I have searched instructions and publications and I have not found anything that gives me the explicit instruction to report anything such as Taxable Wages. 

So, do I understand that I must report Gross Wages, without regard to employee contribution to pension plan which is deducted before tax?

Thanks for your response, and am sorry that I am repeating what you probably already have answered. I appreciate what you do.