The Trump administration has revealed its official tax reform plan. While it’s clear that the plan would make drastic changes to the current U.S. tax system, the brevity of the plan leaves a host of ancillary issues and details either unclarified or unaddressed in the one-page document. This is particularly true for expats – the tax plan gives little insight into whether changes will be sought by the administration that specifically address U.S. expat concerns.
Here is the short list of reforms intended to affect the individual U.S. taxpayer under the plan:
Repeal The 3.8% Obamacare (“Net Investment Income”) Tax
This provision would have a significant effect specifically on the taxation of expats for the following reason. The foreign tax credit cannot be used to reduce the Obamacare tax. Consequently, a U.S. expat who otherwise has 100% foreign source income and sufficient foreign tax credits to credit against such income, can still end up paying U.S. federal income taxes. This would no longer be the case if the Obamacare tax were repealed.
Doubling The Standard Deducation
As practical matter, many expats find that their U.S. tax obligation can be significantly reduced or eliminated utilizing either the foreign earned income exclusion or foreign tax credit. In the case of foreign pension earnings, however, neither benefit may be available, leaving a number of expats with a significant U.S. tax bill (particularly in the case where treaty relief is unavailable). Doubling the standard deduction would go a long way towards reducing or eliminating such residual tax on foreign pension earnings.
It could also be that a higher percentage of expats will benefit from this reform versus the general taxpayer population, because expats have less opportunities to benefit from itemized deductions (which are sometimes dependent on U.S. residence) and are therefore more likely than the average U.S. taxpayer to utilize the standard deduction.
Repeal The Death Tax
While the estate tax applies equally to citizens living within and without the United States, and a relatively small number of taxpayers are actually affected by the estate tax in any event, this provision could have a significant effect if it includes a repeal or modification of the gift tax. The requirement of gift tax reporting is quite prevalent among expats with non-US spouses, family, or friends (reporting is generally done via the IRS Form 3520), and the repeal of the gift tax would lighten the reporting obligations of expats significantly.
Ever since Trump introduced the idea of a death tax repeal during his presidential campaign, commentators have questioned whether the repeal would include the gift tax or not. On the one hand, the gift tax serves as a backstop to the estate tax so the two taxes may be repealed together. On the other hand, repealing the gift tax in particular heightens opportunities for tax avoidance schemes, so the gift tax may stay even if the estate tax is dropped. It remains to be seen what Trump has in mind for the gift tax.
Providing Tax Relief For Families With Child And Dependent Care Expenses
This provision may ultimately prove less beneficial to the average expat, depending on what type of relief is provided and what limitations are associated with the relief. The current child care credit, for instance, cannot be claimed when utilizing the foreign earned income exclusion, so this type of relief is already limited for a number of expats.
REDUCING THE 7 TAX BRACKETS TO 3 BRACKETS OF 10%, 25% AND 35%
This taxpayer-friendly reform would certainly simplify the bracket system and lower taxes for many individuals, but this is equally true for those on land and abroad. This provision has no specific effect on expats per se.
ELIMINATE TARGETED TAX BREAKS THAT MAINLY BENEFIT THE WEALTHIEST TAXPAYERS / PROTECT THE HOMEOWNERSHIP AND CHARITABLE GIFT TAX DEDUCTION / REPEAL THE ALTERNATIVE MINIMUM TAX
These provisions also do not seem to have a specific effect on expats per se.
As a general matter, it’s important to note that Trump’s tax reform plans require the approval of the U.S. Congress, a process that will take time. There is also no guarantee as to which of Trump’s proposed changes will ever come to legislative fruition.
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