This week, Republican lawmakers in the US published a proposed framework for tax reform. We spoke with our co-founder David McKeegan to get all the details on how these tax changes could affect US expats.
What are your impressions overall? How does the tax reform framework affect US expats?
There are still a lot of question marks. The nine-page framework doesn’t address the issues that affect expats the most, such as citizenship-based taxation versus residence-based taxation and the Foreign Account Tax Compliance Act (FATCA), but the plan will be fleshed out as it works its way through the legislative process.
There is no mention of the Foreign Earned Income Exclusion or the Foreign Tax Credit, the tax provisions that are most beneficial to expats. These are the provisions that allow expats to reduce their US taxable income as a result of residency in a foreign country or taxes already paid to foreign governments.
I do not believe that these provisions will be changed significantly, but since there is no mention of these at all, I wanted to point that out.
The plan states that it aims to simplify tax preparation for Americans. Do you think there will be any changes to the complex reporting and forms that US expats must file?
The framework does not mention how the information reporting elements are going to be addressed. Many expats have to file the following reports in addition to the Federal Tax Return:
- Report of Foreign Bank and Financial Accounts (FBAR)
- Statement of Foreign Financial Assets (Form 8938)
- Information Return of U.S. Persons with Respect to Certain Foreign Corporations (Form 5471)
- Return of U.S. Persons with Respect to Certain Foreign Partnerships (Form 8865)
There is also no mention of how Passive Foreign Investment Companies (PFICs) or Foreign Trusts will operate.
But, given the general tenor of the plans released so far, emphasizing simplification, reduction, and territorialization of the US tax system, if these reporting elements are addressed I’d be hopeful that it would be in a manner that is beneficial to expats. It is unclear at this stage if the plan will move corporations and/or individuals to a territorial-based tax system. That could be a major shift for expats if it applies to individuals.
Are there any areas in which expats stand to benefit from the tax reform plan?
On the surface, it looks like the plan would benefit higher-earning expats. Lowering of the highest marginal tax rate from 39.6% to 35% would be a boon for high-income expats. These folks by definition are earning above the Foreign Earned Income Exclusion amount, meaning that in 2016 a US expat taxpayer could only reduce their US taxable income by up to $101,300. Some of these folks are working in low or no tax jurisdictions in the Middle East, and would benefit from lower rates.
Second, the elimination of the Alternative Minimum Tax (AMT) would be beneficial for expats claiming Foreign Tax Credits whether they are high-earning or not. The AMT requires taxpayers to figure their taxes using two different formulas – the way they would normally calculate with deductions and so on, and the way that the AMT requires they calculate – and then pay the higher of the two amounts. The higher earners would escape having to pay the AMT as it arises.
For those who aren’t earning enough to trigger paying the AMT, this change would still save them the extra paperwork. Use of the Foreign Tax Credit usually requires you to at least calculate the AMT, even if in most cases it comes out to zero.
The Net Investment Income Tax (NIIT) was not explicitly mentioned in the plan, but has been targeted in the past for repeal by the president. If the NIIT were eliminated, how would it affect US expats?
The Net Investment Income Tax is a particularly burdensome tax for expats because it is a true double tax, and applies even in countries with tax treaties. It is a 3.8% tax on income from investments that applies to incomes above a certain threshold.
My expectation would be that they would want to eliminate this, and it may just be that it is too granular to include it in this initial framework summary. But I’d like to see whether this gets repealed as more details are released, as it would be great for expats.
It’s still too early to tell how the proposed framework will play out – the actual legislation still needs to be created. So, what do you think is the biggest wildcard for US expats in how the framework is interpreted?
From the framework, it’s not fully clear whether moving to a territorial model is just for multinational corporations or if it would apply to individuals as well. Would US citizens living abroad no longer be taxed by the IRS on their foreign earned income? What if those individuals establish themselves using foreign corporations? Would people who move abroad and want to work as independent professionals be able to set up shop and have the 100% dividend exemption apply to them? It’s unclear right now how this will work for regular individual expats absent more details, but it has the potential to be huge.
The next section of the framework partially contradicts this though, by stating that the US would tax “on a global basis the foreign profits of US multinational corporations.” This is the section on stopping offshoring. There is not nearly enough detail here to say what this would actually do. Assuming it has the desired effect and ends some offshoring, that might be bad for some expats. If you were shipped overseas by your company and you like your new location, you might not be in a rush to get sent back. Still, it’s too speculative at this point to really say much about.
Still have questions about how you might be impacted?
Our team of expert accountants are standing by to provide you with the tax expertise you need in order to make educated tax decisions. Contact us today to have your tax questions answered.