U.S. Tax Reform: What Does It Mean for U.S. Citizens, Green Card Holders Living Outside the U.S.?

We commonly get asked “I don’t even live in the U.S., why would this matter to me?” With the increase of global economic expansion we are starting to see more and more United States individuals moving to other countries throughout the world. Due to this influx of Americans living and working for non-U.S. organizations outside the U.S., changes to the U.S. tax regime will inevitably impact these individuals and the way they are taxed. U.S. tax reform also impacts non-U.S. spouses of U.S. tax residents and/or the non-U.S. organizations they work for. Additionally, there are many individuals who find themselves as U.S. citizens in name only, as they may have been born in the U.S. or they may have parents where one or both are U.S. citizens.

U.S. Personal Income Tax Regime
The U.S. government is unlike most countries in the world in the way that it taxes its citizens and tax residents (green card holders). They are referred to as “U.S. persons.” This concept of worldwide taxation is a fundamental concept within U.S. tax law.

Regardless if a U.S. person lives and works outside of the U.S., they are required to file annual U.S. income tax returns and report their worldwide income on their annual returns. If the income is also subject to tax in the non-U.S. country it is sourced to, the U.S. person would be allowed to exclude the income (under certain circumstances), or claim a credit for the foreign taxes on the U.S. income tax return as a means to mitigate double taxation. One rationale for this system is that if the U.S. person lives and works in a tax country with a lower tax rate than the U.S., then under this global tax regime the U.S. person would have to pay the difference between their local tax obligation and the higher U.S. tax obligation to the U.S. government. They would not benefit from the reduced tax rate in the local jurisdiction.

Another motivation for requiring U.S. persons to file annual returns is to enable the U.S. government to collect information about the holdings of U.S. persons outside the U.S. The U.S. government likes to know and understand where U.S. persons have invested their money to ensure compliance with this worldwide basis of taxation. The U.S. government has implemented a series of U.S. International Informational Returns/Forms which under certain circumstances would require many U.S. persons (U.S. citizens, green card holders, and U.S. tax residents) to file the following informational returns.

• FinCEN Form 114 – Foreign Bank Account Reporting
• Form 8938 – Reporting of Ownership in Specified Foreign Financial Assets
• Form 5471 – Reporting of Ownership of Foreign Corporations
• Form 5472 – Reporting of Foreign Corporation Engaged in U.S. Trade or Business
• Form 8865 – Reporting of Ownership of Foreign Partnerships
• Form 8858 – Reporting of Ownership of Foreign Disregarded Entities
• Forms 3520/3520-A – Reporting of Ownership or Distributions of Foreign Trusts

Failure to file these informational returns would likely result in significant civil penalties and possible criminal penalties if the failure to file these forms is determined to be willful in nature. Even non-willful significant penalties could be assessed if there is a general disregard by the U.S. person to comply with the filing requirements associated with these informational returns/forms.

Leading up to tax reform there was a lot of talk about the U.S. moving to more of a territorial system in the way that the U.S. taxes their citizens and other U.S. persons. However, in looking at the details of the tax reform bill signed into law by President Trump, it is clear that the U.S. did not make this move to a territorial system with respect to individuals and will continue to tax U.S. persons as it has in the past with the exception of a few changes which we will discuss.

Tax Reform Changes to the U.S. Personal Income Tax Regime
The Tax Cuts and Jobs Act was signed into law by President Trump on December 22, 2017. The changes below will predominately impact individuals and in most cases went into effect January 1, 2018. It is important to note that due to certain procedural issues, most individual tax reform changes are temporary and will expire after December 31, 2025. As this section demonstrates, one of the underlying objectives of U.S. tax reform was to make it simpler for individuals to file their U.S. tax returns, and in quite a few cases the changes accomplish that.

1. New Income Tax Rates
   • The U.S. taxes individuals based upon income at varying marginal tax brackets. Under the old law income tax brackets were 10, 15, 25, 28, 33, 35 and 39.6 percent. And for individuals filing married filing jointly, your income would be subject to tax at the highest marginal tax rate starting at $470,700.
   • The new tax law changes these brackets to 10, 12, 22, 24, 32, 35, and 37 percent. And for individuals filing married filing jointly, your income would be subject to the highest marginal tax starting at $600,000
2. Increased Standard Deduction
• The U.S. for a long time has allowed taxpayers to choose between claiming a standard deduction (a statutory fixed deduction amount based on filing status) and something called itemized deductions, which are a compilation of various allowable deductions that are specific to a particular individual. Typically a U.S. taxpayer would add up all of their allowable itemized deductions and compare the amount to the standard deduction and take the higher amount. In the spirit of simplification, the U.S. government has increased (almost double) the standard deduction amount with the expectation that fewer individuals will file U.S. income tax returns and claim itemized deductions. The U.S. will still allow returns with itemized deductions higher than the standard deduction amounts but expect those returns to be far fewer in number. And with these significant increases in standard deduction amounts, it is easy to see that fewer Americans will be itemizing going forward.
• The standard deduction under the new law has been increased from $12,700 to $24,000 for taxpayers using a status of married filing joint, from $9,350 to $18,000 for head-of-household filers, and from $6,350 to $12,000 for all other taxpayers. These amounts will be adjusted for inflation in tax years beginning after 2018.
3. Personal Exemptions Suspended
• Previously, the U.S. government allowed U.S. taxpayers to deduct from their taxable income a statutory amount (approximately $4,000) per person in their household (for example the primary taxpayer, spouse, and dependent children or other household members that depend on the U.S. taxpayer for their support). These deductions were referred to as personal exemptions. However, under the new U.S. tax reform the deduction for personal exemptions has been suspended. In 2017 the personal exemption for each individual on the tax return was $4,050, so a family of four would have been able to reduce taxable income by $16,200. However, starting in 2018, this exemption deduction is no longer available.
4. Child Tax Credit Increased
• In order to help families from the impact of losing personal exemption deductions, the U.S. tax reform is revamping the child tax credit. This is a credit for U.S. taxpayers that have dependent children under the age of 18. For tax years beginning after Dec. 31, 2017, and before Jan. 1, 2026, the child tax credit has been increased from $1,000 to $2,000. Other modifications to the child tax credit are:
1. The income levels at which the credit phases out are increased to $400,000 for married taxpayers filing jointly ($200,000 for all other taxpayers, not indexed for inflation).
2. A $500 nonrefundable credit is provided for certain non-child dependents.
3. The amount of the credit that is refundable is increased to $1,400 per qualifying child, and this amount is indexed for inflation, up to the base $2,000 base credit amount. The earned income threshold for the refundable portion of the credit is decreased from $3,000 to $2,500.
4. No credit is allowed to a taxpayer with respect to a child that would otherwise qualify unless the taxpayer provides the child's SSN on the U.S. tax return.
5. For families with qualifying children, the increased child tax credit will help offset the loss of the personal exemption. The expanded credit will also benefit some taxpayers that were previously phased out of using the child tax credit due to income limitations.  
5. Moving Expenses
• Under the prior law, qualified moving expenses reimbursed by an employer were not included in compensation. That law has been suspended until 2026, meaning that all reimbursement related to moving expenses will be considered taxable income to the employee. Previously, qualified moving expenses paid by a taxpayer were allowed to be deducted even if the taxpayer didn’t itemize. Moving expenses are no longer deductible. 
• This tax reform change will have one of the bigger impacts to expats or individuals who live overseas. As many times the reason these individuals move overseas is due to a job change in which their employer will provide them a moving allowance or offer to pay for this move. Under the old law, much of these expenses were not taxable, and under the new law this elimination of the tax deduction for moving expenses will require these companies to consider grossing up these allowances going forward.
6. State and Local Tax Deduction Limited
• Prior U.S. tax law allowed a U.S. taxpayer to claim as an itemized deduction any U.S. state or local income taxes that were paid during the year. For tax years beginning after Dec. 31, 2017, and before Jan. 1, 2026, itemized deductions for an individual's state or local taxes will be limited. The aggregate deduction for an individual's state and local real property taxes; state and local personal property taxes; state and local, and foreign, income, war profits, and excess profits taxes; and general sales taxes is limited to $10,000 ($5,000 for married filing separately). The deduction for foreign real property taxes is completely eliminated unless paid or accrued in carrying on a trade or business or in an activity engaged in for profit.
7. Home Mortgage and Home Equity Interest Limitation
• For tax years beginning after Dec. 31, 2017, and before Jan. 1, 2026, the deduction for interest on home equity debt is suspended, and the deduction for home acquisition mortgage interest may be limited to underlying debt of up to $750,000 ($375,000 for married taxpayers filing separately).
8. Miscellaneous Itemized Deduction Suspended
• For tax years beginning after Dec. 31, 2017, and before Jan. 1, 2026, there's no deduction for miscellaneous itemized deductions that are subject to the 2 percent-of-adjusted-gross-income (AGI) floor.

Revamping of U.S. Taxation of Foreign Corporations Controlled by U.S. Persons
Before the latest U.S. tax reform was enacted, the U.S. government generally taxed U.S. persons based on a worldwide tax system. Under the worldwide tax system, U.S. corporations have been subject to tax on their worldwide income at marginal tax rates with a top rate of 35 percent however, they were allowed to defer the taxation of income earned by any foreign corporate subsidiaries until the income was sent back to the U.S. in the form of dividends. With the implementation of the new tax reform bill, the U.S. is moving to a modified territorial system.

The U.S. move to a modified territorial tax regime begins January 1, 2018. Under the modified territorial system, U.S. corporations who own a foreign corporation(s) that receive dividend income from their foreign corporate subsidiaries would be eligible for a 100 percent dividend received deduction against that dividend inclusion. Thus, foreign dividends received by a U.S. corporate shareholder of a foreign corporation would not be subject to U.S. taxation on those repatriated amounts.

It is important to note that this dividend received deduction generally does not apply to U.S. persons (citizens and tax residents) who are individuals or pass-through entities. Thus, dividends from foreign corporations which are received by U.S. individual shareholders will still be included in their taxable income on their U.S. tax return and they will not receive a dividend received deduction.

Repatriation Tax or Toll Charge
As a transition to a territorial tax system, the U.S. government is implementing a one-time deemed distribution of any foreign corporation’s post-1986 accumulated earnings and profits which have not been taxed in the U.S. This deemed distribution is treated as a special type of income (deferred subpart F passive income). This categorization of income is generally considered to be outside of the income typically considered in the multi-lateral income tax treaties that the U.S. has with various countries. In the recent tax reform legislation, the provision that includes this mandatory deemed repatriation, and resulting tax, is known as the “repatriation tax” or “toll charge” and applies U.S. income tax to a foreign corporation’s accumulated earnings and profits where applicable.

This repatriation tax is applicable when the foreign corporation is considered to be a controlled foreign corporation (defined as a non-U.S. corporation with more than 50 percent ownership by U.S. persons) or in the case where a U.S. domestic corporation owns at least 10 percent of a foreign corporation. It is important to note that this income inclusion is applicable for all types of U.S. shareholders, including individuals, corporations, partnership, LLCs, or even trusts. Due to the unique characterization of this deemed repatriation income under U.S. tax law, there are limited options to avoid the effects of this legislation on U.S. shareholders that meet the stipulations in the law and are subject to this “repatriation tax” or “toll charge” due to the fact that multilateral tax treaties do not address this type of income. Additionally, most U.S. tax treaties include a savings clause that allows the U.S. to assess tax on its residents and nationals as though the treaty were not in effect so for U.S. residents (green card holders) and nationals (citizens) there are few remedies to mitigate the effect of this tax.

This income inclusion and resulting tax applies to tax years of deferred foreign income corporations which began before January 1, 2018. Thus, for a foreign corporation with a calendar year end of December 31, 2017, this repatriation tax would apply to that tax year.

As part of this transition to the territorial system, U.S. shareholders are allowed a deduction to offset the deemed repatriation income inclusion. This calculation is very complicated but works to bring the effective tax rate on the income inclusion to an amount between 15.5 percent and 8 percent. Individuals are also eligible for this deduction; however, the effective tax rate may be different, as the resulting income is taxed at a shareholder’s U.S. marginal tax rate and U.S. individuals are generally taxed at higher marginal tax rates relative to corporate entities.

Any shareholder for which this repatriation tax or toll charge applies may make an election to pay the tax liability which results from the income inclusion in installments annually. The installment payments are structured as follows:

• 8 percent of the net tax liability in the case of each of the first five installments 
• 15 percent of the net tax liability in the case of the sixth installment 
• 20 percent of the net tax liability in the case of the seventh installment 
• 25 percent of the net tax liability in the case of the eighth installment 

If an election is made, the first installment must be paid on the due date of the U.S. tax return without regard to filing extensions.

Certain acceleration events may trigger immediate payment of any future unpaid installments. These acceleration events include a failure to timely pay an installment; liquidation or sale (including by reason of bankruptcy) of substantially all of the U.S. shareholder’s assets; or stoppage of the U.S. shareholder’s business. 

Before tax reform was finalized, there was some anticipation by U.S. persons living overseas that the U.S. government may move to a territorial tax regime for both personal and corporate taxes. However, as outlined in this article regarding the U.S. tax reform, U.S. persons living overseas are impacted by tax reform at a personal tax level, but individuals continue to be taxed on a worldwide basis. The change from a worldwide tax basis to a territorial tax basis is confined solely to U.S. corporations with foreign subsidiaries. The tax provisions that tax foreign corporate earnings related to U.S. individuals and flow through entities continue in effect.

The repatriation tax is a very complicated calculation due to the circular nature of the deduction referenced above. In the event that this new U.S. tax provision applies to U.S. persons outside the U.S., assistance will need to be secured to appropriately calculate and report any repatriation tax or toll charge that would apply.

Contact your Eide Bailly professional or a member of our international tax team with questions.

This article was first translated into Dutch and published in Over de Gren a business publication in the Netherlands.