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President Donald Trump made tax reform a part of his campaign. He promised to simplify the U.S. tax code and reduce tax burdens, particularly on corporations and small businesses. On December 22, 2017, after months of intense debate in Congress, Trump signed the Tax Cuts and Jobs Act (TCJA), the first substantial change to the tax code in decades. But does the law live up to his promises for U.S. citizens living overseas? Will the new U.S. tax laws make expats' filing obligations easier or their tax burden less expensive?
Expats with foreign financial accounts, investments, businesses, or even personal savings accounts in other countries have historically faced complicated reporting requirements. Expats and other taxpayers with money overseas are required to file annual tax returns that disclose their foreign-held assets. Depending on the nature, and the size of their foreign assets, they may also have to file:
Failure to file any of these tax forms can result in substantial fees, penalties, and interest. In some cases those costs can quickly add up to hundreds of thousands of dollars. The TCJA keeps all these filing requirements in place. Even under the new system, expats will have to disclose their foreign assets to the IRS and the U.S. Department of the Treasury.
For years, expats have relied on the Foreign Earned Income Exclusion and the Foreign Tax Credit to comply with the U.S. Tax Code and protect themselves from double taxation. These exemptions allow U.S. taxpayers living in other countries to exempt certain foreign taxes and income from U.S. tax calculations.
The TCJA preserves those exemptions. However, the amount that can be claimed under the Foreign Earned Income Exclusion depends on inflation, and those laws have changed. Under the TCJA, inflation is calculated according to the "chained consumer price index" instead of the "regular consumer price index" -- which is the current standard. Over time, this change will result in a lower rate of inflation, which means smaller Foreign Earned Income Exclusions and higher taxes for expats in years to come.
One of the most publicized features of the TCJA was the changes made to tax brackets. There are now fewer tax brackets, each of which are larger. This means that taxpayers may now be in a lower bracket than they were previously. That could affect the base tax rate of expats and U.S. residents alike.
However, this tax bracket change is offset in part by changes to allowable deductions. The standard deduction has nearly doubled, making it impractical for many U.S. taxpayers to itemize deductions including business travel. In addition, the moving deduction has been completely eliminated, as has the penalty for failing to maintain individual health insurance under the Affordable Care Act. However, the Net Investment Income Tax survived the changes, so it will continue to affect expats' tax obligations.
The Trump Administration (and campaign) had promised that tax reform would be good for corporations and small business owners. However, one of the most significant changes under the TCJA means those benefits won't necessarily extend to expat foreign business owners. Under the existing Tax Code, the U.S. operated using worldwide taxation. Corporations paid U.S. taxes on income their earned abroad. Under the TCJA, the U.S. transitions to a territorial system. In the long run, this means foreign corporations will only pay U.S. taxes for income earned in the U.S.
That may sound like good news. However, to make the transition, expats who own foreign corporations or small businesses will face a one-time repatriation tax of 15.5% on any overseas profits previously not taxed. For small business owners affected by this change, that could cause a substantial tax obligation all at once. Expats may need to work with a U.S. tax attorney familiar with the TCJA and the effects of the changes to negotiate payments over time or correct the calculation of this repatriation tax so it won't put them out of business.
The Tax Change and Jobs Act doesn't seem to live up to President Trump's promises for simplicity and corporate tax relief, at least when it comes to expats. The new law doesn't make filing requirements any simpler, and could cost some expats more in the long run. Owners of foreign businesses could see the consequences of the new tax law even sooner. Whether they are happy with the changes could depend on whether they can weather the storm during the transition.
Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 30 years’ experience. If you have questions about the new U.S. tax law, contact Joe Viola to schedule a consultation.