By Vincenzo Villamena, CPA
Just before the end of 2017, Republicans passed sweeping tax reform legislation without a single Democratic vote. Here, we explain the timpact of the “Tax Cuts and Jobs Act” (TCJA) on expats and nomads.
TCJA left key expat provisions FEIE and FTC intact
Many Americans abroad rely on the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC) to lower their US tax bill. Thankfully, the tax reform left both untouched.
Under the FEIE, expat taxpayers can exclude up to $104,100 (2018) of their foreign earned income from US income tax. The exclusion amount is adjusted annually for inflation. The tax reform did however change the way inflation is calculated for tax items like the FEIE.
In the past, increases were tied to the Regular Consumer Price Index. Starting in 2018, the Chained Consumer Price Index will be used instead, which grows slightly slower. This will result in a slower increase in deductions and exemptions linked to the inflation rate over the years.
Foreign reporting requirements remain unchanged
Despite intense lobbying by expat groups, the reporting requirements for foreign bank accounts and assets remained in place. FATCA is here to stay.
The tax reform bill did not change FBAR (FinCen 114) requirements for cumulative foreign bank account balances of over $10,000. Likewise, Form 8938 and other foreign information forms are still required.
The tax reform lowered income tax rates
Despite all the talk about collapsing the number of tax brackets from 7 to 3 or 4, the passed tax reform keeps 7 tax brackets. The tax brackets increased a little, so you may find yourself in a lower tax bracket than before. Furthermore, individual tax rates see a temporary cut that expires after 2025.
Standard deduction increased but personal exemption eliminated
Under the tax reform, the standard deduction nearly doubled. This is good news for many expats, as expats often don’t itemize.
However, the $4,050 personal exemption has been eliminated until after 2025.
For single tax filers without children or other dependents, the higher standard deduction makes up for the loss of the personal exemption. The new standard deduction of $12,000 is higher than the old one of $6,350 and personal exemption of $4,050 combined ($10,400), a net increase in their deductions of $1,600.
On the other hand, married filers with one or more kids see their total deduction/exemption amount decrease under the new tax bill. Instead of claiming three or more personal exemptions in addition to the standard deduction (3x$4,050 plus $12,700) for a total of $24,850, they can only claim the new standard deduction of $24,000 if they don’t itemize. This may however be offset by changes to the Child Tax Credit.
TCJA eliminated, capped or changed some itemized deductions
State and local taxes capped
The biggest change to specific deductions affects state and local taxes, which are now limited to $10,000. This means that the amount that you can deduct for all state and local sales, income, and property taxes together cannot exceed $10,000.
This cap applies to Schedule A deductions for individuals. If you run a business or trade and pay state, local, and foreign property taxes, or state and local sales taxes as part of a business or trade, those are deductible on Schedule C, Schedule E, or Schedule F and not capped. So if you hold rental property for the production of income, the taxes remain deductible and are not subject to these limitations.
Moving expenses eliminated
The tax reform bill fully eliminates the deduction of moving expenses. This may affect expats that are leaving from or returning to the US, or move between locations for work, and don’t have all moving expenses reimbursed by an employer.
Mortgage interest deduction capped
Previously, a taxpayer could deduct interest on the first $1,000,000 of a mortgage. The bill lowered this limit to $750,000.
Interest on a home equity loan is not deductible for the tax years 2018 through 2025.
Job expenses and certain miscellaneous deductions eliminated
The tax bill eliminates miscellaneous deductions subject to the 2% rule for the tax years 2018 through 2025. These deductions include unreimbursed employee expenses and tax preparation expenses, home office expenses, licensing and regulatory fees, union dues, professional society dues, business bad debts, work clothes that are not suitable for everyday use, and many others.
Medical and dental expenses threshold lowered
Previously, you could deduct medical and dental expenses that exceeded 10% of your Adjusted Gross Income (AGI) when itemizing. For the tax years 2017 and 2018 that threshold has been lowered to 7.5%. This is one of the few provisions of the tax reform bill that is effective retroactively.
Child Tax Credit doubled
Under the new tax bill, the Child Tax Credit rises to $2,000 from $1,000 before. The first $1,400 will be refundable, meaning that even if you don’t have to pay any tax, you can receive this portion of the Child Tax Credit as a refund. To receive this refundable credit, the claimed child must have a SSN and be younger than 17 years.
In addition, the tax reform created a non-refundable $500 credit for other dependents.
Healthcare mandate repealed in the new tax law
The Obamacare penalty for failure to purchase mandatory health insurance will be gone, starting in 2019. Unlike other tax changes for individuals, the elimination of the penalty does not reverse in 2025.
For expats that qualify for the FEIE, this is a non-issue as they have been exempt from the individual mandate. Likewise, expats with a qualifying plan in their host country didn’t have to pay the penalty before. So only a subset of expats might benefit.
On the flip side, US healthcare premiums are expected to go up as a result and obtaining coverage may be more difficult. Since travel insurance is only secondary insurance, some expats will have to rely on international expat healthcare plans, or forgo coverage altogether (which we do not recommend).
Alimony becomes tax neutral
The tax bill changed the existing rules for alimony, which was deductible to the payer and taxable to the payee. For new divorce agreement signed beginning 2019, alimony will not be deductible or taxable. This change simplifies alimony considerations for expats.
Alternative Minimum Tax (AMT) stays
Despite earlier discussions, the AMT for individuals was not repealed. Instead the bill made some adjustments to it for the tax years 2018 through 2025.
The AMT exemption amount increased to $109,400 for married couples filing jointly and $73,000 for individual taxpayers. The phase-out thresholds increased to $1,000,000 for married couples filing jointly and $500,000 for individuals.
Estate, gift and generation-skipping taxes amounts double
The basic exclusion amount for estate and gift taxes and for generation-skipping tax (GST) doubled to $10 million, indexed for inflation. This change is effective beginning 2018 for gifts made or descendants passing away after December 31, 2017.
However, after 2025, the exclusion amount reverts back to $5 million, adjusted for inflation.
Conclusion of the impact of the tax reform bill on expats
In general, many expats won’t see significant changes from the new tax bill. Those with children and especially those with businesses will see the biggest impact. We will publish shortly how the tax reform will impact expat entrepreneurs.
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Photo by Brandon Mowinkel