Tax Reform 2.0 has officially been passed by the House. Now, what exactly does that mean? These three bills have gained momentum and will now advance to the Senate. Get in the know on how the proposed tax reform may impact US expats around the world with this comprehensive overview helping to answer your Tax Reform 2.0 questions!
Protecting Family and Small Business Tax Cut Act of 2018
The provisions of this bill expand upon the significant tax reform bill of 2017, the Tax Cuts and Jobs Act (TCJA). The primary objective of the bill was to eliminate the expiration of benefits provided to taxpayers under the TCJA. The provisions for individuals were set to expire in 2025, and the tax code would then revert to pre-2017 tax law. Let’s quickly examine the provisions of the act.
This deduction was nearly doubled for each filing status. The standard deduction is nothing more than the annual limit that a taxpayer can earn before they are subject to income tax. However, the expansion of the standard has permanently removed the exemption deduction from the table that once allowed a deduction for each person listed on the return. In 2018, a married couple can earn $24,000 tax-free. A person filing singly could earn $12,000 tax-free.
The standard deduction is allowed after the Foreign Earned Income Exclusion. So for example, a single person could make a salary of $110,000, and if they are eligible for exclusion, then they could exempt $103,900 from tax and then yet another $12,000 using the standard deduction. Combining the standard deduction and FEIE would result in no income tax; this is extremely important for those expats in low to no tax countries. Note that the ability to itemize is limited since many deductions – such as work-related expenses and investment-related deductions – are no longer available. The deduction for state and local taxes was significantly limited. It will now be much harder to itemize; while you might assume this would result in a tax increase, it doesn’t since the tax rates have all been lowered. However, some taxpayers will experience tax increases, so careful considerations must be made for your unique situation.
The seven rates introduced by the TCJA would be made permanent, so now the new lower tax rates would be 10, 12, 22, 24, 35, and 37. This is good news for expats in low and no tax country since their income subject to taxation will be subject to lower rates.
One itemized deduction that was left intact was medical expenses, though under the proposal you could count these expenses that exceed 7.5% of your adjusted gross income, as opposed to 10% today. The lower threshold is in effect until 2020. After that, it will revert to 10% of AGI if no future tax law changes are made.
Child Tax Credit
The child credit tax has been increased from $1,000 to $2,000 per qualifying child under age 17 at the close of the year. This change is significant for many expats in low to no tax countries since they can use this refundable credit to pay the tax that they owe. The act ensures that more expats are eligible by raising the phase-out (gradual reduction of the credit to zero) for married couples up to $400,000 and all others to $200,000. Previously the limits were $110,000 for joint couples and $200,000. If you are an expat with children, you must carefully examine this because the FEIE doesn’t allow for the refundable portion of the credit to be claimed. The refund portion is limited $1,400 per child. For families with more than three children, limitations will begin to apply.
20% Business Deduction
Owners of small businesses could qualify for a 20% deduction of business income that flows through. Owners of LLCs that report income on schedule C or received passthrough income from a partnership and/or S-corporations are allowed this deduction as well. For expats, this is important if they own a foreign company since the tax treatment of foreign entities is complex. This provision would be made permanent. Entity selection for an expat is critical since this determines the overall taxation of the entity abroad. However, we’ll save that topic for another day.
Family Saving Act of 2018
These provisions would be geared toward encouraging people to save for retirement by making it easier for American companies to offer retirement plans and move money from one plan to another plan. It would also create a special savings account that allows wages earner and self-employed person to invest $2,500 that could be accessible in the future and not generate a tax bill. The plans are designed to be similar to Roth plans, minus the return plan feature. Since these plans are new, it’s hard to say how they will be treated abroad. Expats should consider this before establishing an account since it could result in taxation in your home country!
The act also removed the 70 ½ age limitation from traditional IRAs so that you could contribute a traditional IRA at any age. The required minimum distribution provision has been removed for savers with less than $50,000 saved to allow their investments more time to grow.
Families can access their retirement accounts upon birth of a child, free from the burden of the 10% early withdrawal penalty. However, they are capped $7,500 dollars of qualified expenses, and they allow replenishing funds in the future if desired.
529 education saving plans would be expanded to cover the cost of homeschooling, paying off student loan debt, and covering apprenticeship fees. But overall, this section doesn’t do much to expat taxation.
American Innovation Act of 2018
This portion of the bill is quite small and doesn’t offer much excitement for expats. The most notable piece would allow a qualified small business owner to deduct $20,000 of startup cost right away against their income. This deduction was previously limited to $5,000 of start-up cost. The amount that exceeds this threshold could be deducted over the number of years. One of the other provisions eases the requirements to claim certain small business tax credits and reduced restrictions would apply during transfer events.
The majority of these changes strengthen the TCJA and include additional provisions designed to support the startup of businesses and motivate people to grow their savings. The provisions do not have a direct impact on expats, and unfortunately, do not curtail the difficulties of filing an annual income tax return. We’ll continue to share updates as Tax Reform 2.0 moves ahead.