Higher Tax for US Expats
How the recently passed Tax Increase and Reconciliation Act of 2005 affects Americans working abroad
Congress recently passed the curiously-named Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA), retroactively increasing taxes for some Americans working abroad
The widely-hyped change which gave the law its name now indexes the foreign earned income exclusion to inflation several years earlier than originally planned. Under the old rules the exclusion would have remained at $80,000 until being indexed to inflation beginning in 2008. Under the new rules, the 2006 exclusion amount is $82,400 (and $85,700 for 2007).
Despite the name of the tax act, there are other changes that may increase taxes for highly compensated taxpayers in excess of the savings to be gained from accelerating the indexing of the exclusion.
Higher Marginal Tax Rates
Long-term expats know that that the US allows its globetrotters to exclude earned income and/or some housing costs from US taxation up to certain thresholds. These thresholds and the way they are calculated have been modified by TIPRA. Expats earning just above the old thresholds used to pay tax at the lowest income bracket on the non-excluded income. No more! Expats that have taxable earned income above the maximum exclusion amounts (earned income, housing or both) will now pay “ordinary income tax rates”. Under the new law, expatriates must use the tax bracket that would apply had they not claimed the exclusion. For many people, that means they will start with the 25% or 28% tax brackets, instead of the more favorable 10% bracket.
The foreign tax credit (Form 1116) continues to be available and will reduce some of the impact of this change for expats living in countries with high relative individual tax rates.
The second change is in the way that the foreign housing exclusion is calculated. The result of the calculation change is an increase in the “base amount” (the part you can’t exclude). The new law subjects more income to tax. The formula is somewhat complex but the maximum amount that can be excluded for 2006 is $11,536 for someone who qualifies for the whole year. There are additional regulations that adjust this exclusion depending on what country you are living in.
This article is intended to be an overview. The issues are complex and you should read the information available at www.irs.gov or seek the advice of a tax professional. For further information, we recommend you consult:
• Rev Proc 2006-51 for the foreign earned income exclusion amount
• Notice 2006-87 for foreign housing exclusion
• When it becomes available refer also to the 2006 edition of Publication 54
CFO2GO is an independent consultancy focused on assisting SMEs and their owners and executives to achieve their operating and objectives when internal or alternative means of doing so are inadequate to the task. We work closely with executives to help them comply with their personal Czech and US tax obligations.
The comments in this article are not intended to constitute an opinion regarding any specific tax issues because additional tax issues may exist that could affect the tax treatment of the tax issues addressed in this memo. This memorandum does not consider or reach a conclusion with respect to those additional issues and was not written and cannot be used for the purpose of avoiding penalties under code section 6662(d).
For further information, please contact CFO2GO Europe.
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