On the 20th of December, President Trump hosted an array of Republican Congressmen and Congresswomen at the White House to celebrate the successful passage of the Tax Reform Bill “HR1”, the most sweeping reform of the U.S. tax system in over 30 years. Supporters say that it puts America first just as the U.S. is disproportionately impacted by the OECD’s BEPS initiative, that it will boost jobs and economic growth, and that it reduces and simplifies individual taxation. Critics counter that it cuts taxes for the rich at the expense of adding USD 1.5trillion to the already USD 20trillion national debt, and annual USD 666billion deficit (2017), over the next 10 years.
In this post, we consider how the new law impacts expat Americans.
What do Expatriate Americans need to know?
Rates: The top rate of tax becomes 37% from 2018 with the threshold rising to USD 600,000 for married couples (39.6% and USD 470,700 currently). It is hard to make sweeping statements about tax rates coming down but it’s reasonable that this might generally be the case. However, for Americans with mostly foreign earned income, lower effective tax rates will only benefit those with US sourced earnings (i.e. U.S. ‘trailing income’ or U.S. work days) or those in ‘lower tax’ countries with insufficient foreign tax credit to offset their U.S. tax liability.
Deductions: A major repeal of itemised deductions at the same time as a near-doubling of the standard deduction will see many more taxpayers (up to 20% more), including expat Americans, cease to claim itemised deductions. Broadly, retained are the deductions for charitable contributions, mortgage interest on USD 1million of existing indebtedness, and State and Local income/property taxes up to USD 10,000. Gone are the deductions for all State and Local income and property taxes, home equity loan interest, new mortgage interest on principal exceeding USD 750,000 and non-US property taxes.
Exemptions: The personal exemption deduction has often been targeted for revenue raising tax law change: in 1987 the requirement to report SSNs reduced claimed exemptions by 7million and in 2014 higher earners began seeing their exemptions phased out. From 2018, exemptions become a thing of the past altogether. An expanded child tax credit (from USD 1,000 to USD 2,000 of which USD 1,400 is refundable) is a targeted offsetting measure although this will also be subject to a phase out from USD 400,000 for married couples.
AMT: Generally despised by individuals, the Alternative Minimum Tax survives but from 2018 the exemption rises to USD 109,400 for married taxpayers, only phasing out from income above USD 1million (USD 84,500 and USD 160,900 respectively, under current law). The effect will be many fewer taxpayers within the AMT regime… and a collective sigh of relief!
Sunsets: very few of the individual-focused provisions in the Act will take permanent effect, most ‘sunseting’ at 31 December 2025. You may recall the 2001 and 2003 “Bush tax cuts” – those cuts were due to expire at the end of 2010 but a combination of their popularity and the political environment at the time ultimately led President Obama to extend them permanently. The Republican Party will be hoping for a similar outcome 9 years from now.
What’s not in the Act? There are several expat related provisions which it was speculated might have been targeted for reform but which ultimately remain untouched:
- Taxation on Citizenship: America is almost unique (Eritrea being the only other country) in applying a citizenship-based model for individual taxation. Despite calls, neither House nor Senate proposals looked to replicate for individuals the territorial approach being adopted for corporates.
- 8% Net Investment Income Tax: The 3.8% tax on personal income, in place since 2013, largely helps fund the Affordable Care Act. With efforts to repeal and replace that legislation failing earlier this year, the NIIT remains. The tax cannot be offset by foreign taxes paid so, for expats, becomes a surcharge on the higher of the US or non-US taxes paid.
- 401(k) Plans: the popular, employer-sponsored, retirement plans, whereby an individual saves pre-tax cash and withdraws taxable income in retirement, might have been a target for reform. President Trump was reluctant, and so, it turned out, were Congressional Republicans.
- Foreign Earned Income/Housing Exclusions: the income exclusions which reduce foreign taxable earnings remain intact although a change in the inflation measure by which they are adjusted – CPI updated to “Chained CPI” – will deliver a slightly smaller annual adjustment.
We’ve focused here on the individual tax provisions most relevant to expatriate Americans but there are many, many more – to name a few: the elimination of the personal responsibility payment (Obamacare’s ‘individual mandate’), reform of education credits, reduced tax rate on income from ‘passthrough’ entities, alimony deduction repeal, expansion of estate tax exemption – which will advantage or disadvantage depending on individual facts and circumstances. The devil is, of course, in the detail, so whether expat Americans in 2018 will realise President Trump’s promised “great, big, beautiful, Christmas present” tax cut will be very much an individual issue.
Webcast: How U.S. Tax Reform will Impact Expat Americans
Join us for a “Q&A” webcast on Friday 26th January 2018 at 1pm where we will bring together KPMG’s experts in US expat tax to shed light on the questions we’re hearing from expat Americans on US Tax Reform. We look forward to hosting you then.