What's Tax Reform Ever Done For US Expats?

Expat Briefing Editorial Team, 06 February, 2018

The short answer is not a lot.

While the United States tax code is subject to frequent legislative and regulatory change, the plight of the estimated 8 million Americans living and working overseas, who generally remain in the US tax net, has largely been ignored.

Indeed, even the sweeping pro-growth tax reform bill signed by President Trump in December 2017 – reputedly the largest shake-up of the US tax regime for 30 years – was a huge disappointment for US expats, dashing their hopes that Congress would at long last provide long called-for tax relief for doubly-taxed Americans.

Corporations, on the other hand, got a great deal. For not only was corporate tax slashed from 35 percent (previously the highest corporate tax in the OECD grouping) to 21 percent, but multinationals companies effectively got a tax exemption on their foreign income.

Ultimately, it seemed, when the corporate tax cuts were combined with more moderate tax cuts for individuals and small business income, there just wasn't room for more favourable rules for Americans overseas, given the budgetary constraints Congress set itself.

So are expats forever doomed to play the Cinderella of tax reform?

Tax By Citizenship

The United States is one of the few countries on earth (Eritrea is reportedly the other) which taxes its citizens on the basis of nationality rather than residence. In other words, if you were born in the US, or have sufficiently strong ties to be considered an American, the Internal Revenue Service (IRS) has the legal right tax you, no matter where you live, or how long you've lived there. And this tax liability will of course be in addition to tax paid in an expat's country of residence.

Therefore, all US citizens and green card holders must file a tax return (Form 1040) regardless of whether they live abroad. And expats who do owe taxes may have to make estimated tax payments on a quarterly basis.

Fortunately, there are ways in which US expats can mitigate the impact of America's tax claim on their foreign income and assets.

US taxpayers in higher tax countries can eliminate their US tax liability using the foreign tax credit, which is intended to prevent double taxation when foreign income is taxed by both the US and a foreign country.

US expats also may be able to take advantage of the Foreign Earned Income Exclusion (FEIE). This exclusion entitles US expats to exclude for US income tax purposes a certain amount of foreign earnings that is adjusted annually for inflation. The FEIE thereby reduces the tax liability of US taxpayers working abroad even if they paid no foreign income taxes to another country.In 2017, the FEIE limit was USD102,100, and it will rise to USD104,100 for 2018.

In addition, US expats can exclude or deduct certain foreign housing amounts. This entitles US citizens who work and live abroad to exclude some or all of the amounts paid for their foreign housing costs when calculating their worldwide income subject to US tax.The housing amount excludable under the US tax code is the total of an individual's housing expenses for the year less the base housing amount, which is 16 percent of the maximum FEIE amount. However, housing expenses that are eligible to be used in determining the exclusion cannot exceed 30 percent of the maximum FEIE amount, and also cannot exceed an individual's amount of foreign earned income for the tax year. Furthermore, excludable housing expenses include only reasonable expenses that were actually incurred for housing in a foreign country.

Additional legislation has placed comprehensive reporting requirements on US citizens with income from foreign bank accounts, as well as the financial institutions with which they hold investments, under FBAR (report of Foreign Bank Account) and FATCA (Foreign Account Tax Compliance Act).

What's the Alternative?

According to expat advocacy groups, it's something called residence-based taxation (RBT).

Under RBT proposals released by American Citizens Abroad (ACA) last year, only US residents – whether Americans or foreigners – would be subject to US income, estate, and gift taxation, while Americans resident abroad would be taxed under essentially the same rules applicable to nonresident aliens.

ACA proposed that, as part of a general tax reform package, an election should be provided to citizens who are long-term nonresident citizens to be taxed as nonresident aliens if they meet certain conditions – for example, a minimum three-year period of residence abroad. The plan also included proposals to alter the treatment of Social Security income, distributions from individual retirement plans, and other deferred compensation arrangements, and several special transition rules.

The ACA also said that it had even considered ways to prevent the RBT system from being exploited by tax avoiders and evaders.

"An area that will be a key concern of the tax-writing committees is 'leakage' or the potential for abuse of an RBT system purely for the purpose of tax avoidance. ACA has done its homework on this issue, considering how to tighten up rules for those qualifying for RBT, while acknowledging the needs of short-term and contract workers who need RBT to get a foothold in new markets and compete overseas," the group said.

The release of these proposals turned out to be well timed. Momentum towards tax reform was growing, and the Republicans were desperate for a major legislative victory by the end of 2017.

However, as we know now, Republicans did indeed get their tax reform bill passed, but expats are stuck with CBT.

What's Next?

So, should all ye who have gone abroad abandon all hope of positive change? Given that there are unlikely to be any more major tax reform bills introduced in Congress any time soon, the outlook does appear somewhat bleak.

On the other hand, expat lobbyists in Washington say that many members of Congress are sympathetic to their plight. And the Republican Party platform agreed at the while also appearing to call for RBT.

"Americans overseas should enjoy the same rights as Americans residing in the United States," the platform declared.

"FATCA not only allows 'unreasonable search and seizures' but also threatens the ability of overseas Americans to lead normal lives. We call for its repeal and for a change to residency-based taxation for US citizens overseas."

So there is still hope yet.

However, until RBT does become a reality, we could continue to witness record numbers of people renouncing their citizenship to escape the tax net.

Tags: small business | business | multinationals | Tax | inflation | budget | FATCA | Compliance | Citizenship | individuals | retirement | investment | United States | Eritrea | legislation | Internal Revenue Service (IRS) | mining | tax | tax avoidance | tax reform | gift tax |


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