TCJA (the new tax bill that will take effect in 2018) is now law for two months. While there is plenty of media coverage on how it might impact the global economy, you might be wondering how TCJA impacts Americans working overseas – aka someone like you and me.
First of all, there isn’t any change to the tax code on the personal income side that specifically targets US expats. Rules surrounding foreign income and account reporting, such as Foreign Earned Income Exclusion (FEIE), Foreign Housing Exclusion, Foreign Tax Credit, FBAR, and FATCA reporting, remain the same. US citizens living and working abroad continue to pay taxes on their worldwide income, minus the tax breaks.
Nevertheless, some changes to the tax code may impact expats on the peripheral in ways that you may have not have expected. Below I’ll point out a few common scenarios that expats experience and how tax liability may change under those circumstances.
It is worth noting that Congress conceived TCJA to make US companies more competitive through lower taxation. Therefore, the most significant changes to the tax law actually happen on the business side, not on personal income. It may have huge implication for those who own large shares in foreign corporations, either as an individual or through US entities. I will not cover those changes here. If you are interested in learning more, here is a very detailed summary.
Who may not see any change in their taxes
If your household earnings in a foreign country will continue to be under the Foreign Earned Income Exclusion limit, and you don’t have any other income, it’s likely the new law does not change your tax liability in the US. It will remain zero when you claim exclusion.
However, you may want to compare your local tax liability against US tax liability pre-exclusion. It is possible that your US liability may now be lower than local tax liability. In this case, it is more beneficial for you to pay taxes in the US and claim Foreign Tax Credit on the taxes you pay to a foreign government.
Please note that if you have claimed exclusion in the past, you need to revoke the selection if you wish to switch to claiming credit instead. Once you do, you need to reapply for IRS approval to claim the exclusion again within 5 years. Therefore, this tactic may be more appropriate for those who stay in one country for a long period of time.
How TCJA impacts American working overseas and their tax liability
Your earned income is higher than exclusion limit
Depending on your income level, you may have had to pay taxes on the part of your income above Foreign Earned Income Exclusion, minus deduction and exemption.
Under the new tax law, the standard deduction doubled but exemption was taken away. It means your final taxable income may differ from what you’ve seen in the past.
For example, if you are married without children, you are able to claim only $12,700 in standard deduction and $4,050 x 2 = $8,100 in exemption in 2017. In 2018, you are able to claim $24,000 in standard deduction, which is $3,200 higher than before.
This additional deduction may save you taxes at the tax bracket above exclusion level, which for married filing jointly is 24% for 2018. This means you will save $3,200*24% = $768 in taxes.
(If your income is above Foreign Earned Income Exclusion limit, the taxable part of the income is taxed at the marginal brackets before exclusion. In practice, you get a “tax credit” that is equal to the tax on the excluded part of the income.)
For those with children, you may now claim extra qualifying dependent credit in exchange for exemption. Exemption merely decreased your taxable income, while credit reduces your tax liability dollar for dollar. Therefore you may also see your taxes go down, if your pre-exclusion income is not above the threshold for claiming the credit.
You are self-employed overseas
One of the most discussed provisions in the new tax law is a special 20% deduction for pass-through entities that earn Qualified Business Income (QBI). Self-employed expats who have certain types of business income will in effect pay taxes only on 80% of their income.
So what counts as QBI, and how much of it is deductible? There are some pretty complicated rules around this. Below is a brief summary. I recommend you refer to the IRS publication once it is available, since no one knows how it will look like on the tax form yet.
- QBI is supposed to be the pass-through business’ operational profit for an investor after costs such as compensation to the owner. So it does not include guaranteed payments for your work as a member of a LLC or a partnership. It also does not include “reasonable compensation” if you file taxes as S-Corp. Lastly, it doesn’t include investment income.
- You are able to claim the full deduction if your final taxable income is less than $157,500 for single filer, or $315,000 for married filing jointly. (The income threshold is likely to be “pre-exclusion” income for those who claim FEIE.)
- For those with higher income from these pass-through businesses, your business needs to meet certain criteria to qualify for a part or full deduction.
After this additional deduction, self-employed expats with income higher than FEIE limit may see their US tax liability further reduced.
On the other hand, QBI deduction may also make your US tax liability pre-FEIE lower than the taxes you pay locally. You may want to consider the pros and cons of taking foreign tax credit as mentioned earlier.
You used to itemize deductions
Expats generally do not itemize deduction because they usually don’t pay state and local taxes, one of the biggest items on Schedule A.
Another significant item on Schedule A is mortgage interest deduction. While many expats may still hold mortgages on their real estate back home, it is more likely they claim it against rental income on Schedule E.
That leaves one major item that might have made itemized deductions more beneficial for you – charitable contributions.
Given that the standard deduction is now double what it used to be, it is even more unlikely that expats claim itemized deductions. It might impact which organization you donate to if you know you will not be able to claim the itemized deduction.
In order to deduct charitable contributions, you need to donate to US-based 501(c)(3) organizations. Without having the need to deduct these contributions to lower your taxes, you may be more willing to donate to local, foreign charities.
On the other hand, if you have been paying state tax and claiming mortgage interest deduction on primary residence while you work abroad, you may want to consider donating to US domestic charitable organization to compensate for the capped state tax deduction (at $10,000 starting in 2018.)
You incur substantial moving expenses
Some expats move duty station quite a bit. Moving expenses used to be an above-the-line deduction, meaning it further reduces your AGI, and thereby taxable income, if your foreign earned income is above FEIE amount.
In the new law, the moving expense is no longer deductible. Not only that, US-based employers will no longer be able to pay for your moving expenses tax-free. It means that the employer-paid moving expenses may show up as W-2 income and become taxable to you before exclusion.
(The moving expense deduction is still available for certain moving expenses for active duty military.)
For those who work overseas for a US-based employer, the extra tax burden from the moving year alone may wipe out tax savings for several years under the new tax law. I wonder if this may change how often you wish to move.
It is unclear to me how this may affect US expats whose employers are not US-based. Depending on your location, your moving expenses may already have been taxable locally and show up on your paystub. If your international employer pays for all moving expenses and does not report the expense on your paystub, it might be difficult for you to self report moving expenses and pay taxes. We will see whether IRS provides clearer guidelines in the future.
I hope beyond knowing your US taxes may change this year, these scenarios help you consider your life choices this year, such as saving more, starting a business, or even moving.