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Uncle Sam takes a bite out of expatriate incomes
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Fred Thomas
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May 30, 2006 08:31 PDT
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Uncle Sam takes a bite out of expatriate incomes
By Sharon Reier International Herald Tribune
FRIDAY, MAY 26, 2006
It may have been sold as a tax cut package, but the document that
President George W. Bush signed into law on May 17 will mean an extra
tax bite for many Americans who live abroad.
Those expected to feel the most pain are expatriate workers who earn
comfortable, but not lavish, livings and semi- retired workers earning
some foreign income while drawing U.S. Social Security, pensions and
other income from U.S. sources. Many of these expatriates will be pushed
into higher U.S. brackets, as will employees and independent
professionals in no-tax and low-tax areas like much of the Middle East,
some Caribbean nations and Hong Kong.
As Steven Horton, a certified public accountant practicing in Paris, put
it: "The middle class will get hammered."
Senior employees who collect generous expat benefits, like housing
allowances and reimbursement for their children's school fees, also are
expected to have bigger U.S. tax liabilities - but their companies
probably will pick up the costs as part of their benefit packages, tax
experts said.
The new law, however, does contain some good news. The foreign earned-
income exclusion, which was under threat of extinction just three years
ago, was maintained and will be indexed to U.S. inflation as of the 2006
tax year. That means U.S. taxpayers will owe no tax on their first
$82,400 of income earned abroad this year, up from $80,000 in 2005.
Indexing had been scheduled to start in the 2008 tax year.
On the negative side, the new law caps the exclusion for housing
allowances - rent, utilities other than telephone, property insurance,
occupancy taxes, maintenance and furniture rental - that U.S.
corporations often provide to executives sent overseas. The cap is
calculated as 30 percent of the foreign earned-income exclusion, minus
the 16 percent that it is assumed would be paid in the United States.
For 2006, it is set at $11,586; under the old law, the exclusion was
virtually unlimited.
Another significant change is the treatment of foreign income and of
ordinary income from U.S. sources, which includes Social Security,
pension income, interest income, income from U.S. partnerships and other
investment income, but does not include capital gains and qualified
dividends.
The change, known as the "stacking provision," will tax any income
beyond the foreign earned-income and housing exclusions at rates that
would apply if the exclusions did not exist. Previously, any income
beyond the exclusions was taxed as if it were the first dollar earned,
and therefore at the lowest tax rate.
Bob Hudson, a senior tax partner with Baker & McKenzie in Miami, said
the law essentially ends a "windfall" for middle-class people living
abroad. It will have less effect on the wealthy, he said, because they
are already taxed at a higher bracket.
The increase may be more hypothetical than real for Americans living in
countries where the tax rate is higher than in the United States - a
group that includes most of Europe, as well as Israel, Australia and
Japan. The United States, as part of treaties to eliminate dual
taxation, grants a credit for taxes paid to foreign countries. In
high-tax jurisdictions, these foreign tax credits help soak up the extra
U.S. tax liability. (The Alternative Minimum Tax used to contain a limit
on the amount of foreign tax credits expats could use, but that was
changed last year, Horton said.)
Expatriates in no-tax countries like Saudi Arabia and low-tax areas like
Hong Kong, where the maximum tax rate is less than 20 percent, will feel
the pain more acutely. While Americans who work in these countries are
still eligible for the foreign earned-income and housing exclusions,
their taxes on any additional foreign income, as well as on ordinary
income from U.S. sources, will jump to the higher brackets.
U.S. retirees living abroad on U.S. Social Security, pensions and other
investment income from U.S. sources, like interest, should see little
change in their U.S. tax bills, Hudson and others said.
"Investment income has never been allowed to be excluded," Hudson said.
"The philosophy behind the foreign earned-income provisions is they are
supposed to support people working overseas, not people clipping bond
coupons and sitting in overseas cafés."
But the stacking provision means the increasing number of retirees
abroad who are supplementing their U.S. retirement savings with
part-time work will pay higher tax rates on their ordinary income from
U.S. sources.
Multinational corporations, meanwhile, may find themselves paying higher
tax bills for their expat executives. Kent Klaus, a partner in the
international services practice at Deloitte Tax in Chicago, said that
many employers offer either tax reimbursement or tax equalization. Under
the former, the employer pays the tax on expat benefits such as school
fees and home leave, which are considered income; under the latter, it
pays the difference between actual tax liability and what the executive
would have paid at home.
The difference could be considerable, since expats tend to have more
expensive housing than they would at home, noted Paul Bodner, an
international tax attorney in Great Neck, New York. "It is not unusual
for the senior person to have a lavish house because the entertainment
responsibilities are different from back in the home office," he said.
Up-and-coming managers who might benefit from international experience
also have housing costs that typically outstrip those of a person in the
United States, since "the person doesn't know the area," Bodner said.
"You may have to be in an American enclave because the family needs to
be surrounded by people who speak English." So even if the statistics
say that housing costs more in the greater New York area than in, say,
Lyon, the cost for the expat family could be higher. Horton said the
lion's share of the $2.1 billion that the government expects in new tax
revenue over the next 10 years would come from "clawing higher taxes
away from the oil companies," which send platoons of workers to the
Middle East.
How much of the additional tab multinationals will pick up is subject to
negotiation. For the most part, Hudson said, employees enjoying posh
accommodations "in general are really important people, and the
corporations will pick up the bill." Professional staff in demand, like
petroleum engineers, are likely to "have enough leverage with their
employers" to negotiate a raise or bonus to cover the additional tax,
Hudson said. The losers in no-tax and low-tax countries will be
self-employed workers, like art dealers or computer consultants, who
have no corporate subsidies to rely on.
Apart from renegotiating their benefit packages with their employers,
Americans overseas have few ways of softening the blow, tax experts
said. They might try to take a page from the very wealthy and rely on
capital gains and qualified dividends for their investment income. The
new law extends the taxation of this income at 15 percent until 2010 -
one reason that some wags have nicknamed the legislation "No Millionaire
Left Behind."
U.S. executives warn expatriate tax increase may backfire
By Keith Bradsher and David Cay Johnston The New York Times
FRIDAY, MAY 26, 2006
The sudden, and retroactive, imposition by the U.S. Congress last week
of much higher taxes on Americans living abroad has left individuals and
companies scrambling to regroup, while many executives and entrepreneurs
assert that the move could backfire by hurting U.S. business interests
at home and abroad.
The $69 billion tax cut signed into law May 17 raises taxes on Americans
living overseas by $2.1 billion over the coming decade.
The law effectively forces many overseas Americans into higher tax
brackets by imposing complex new requirements for calculating the value
of housing allowances and then taxing the allowance at the lowest rates.
Americans in no-tax or low-tax jurisdictions with high housing costs,
like Bermuda, the Middle East, Singapore and Hong Kong, will be hit
hardest, partners at two major accounting firms said.
The legislation will more than triple the U.S. tax bill for Kristine
Kraabel, a gift shop owner in Singapore, and her husband, a former
marine who is now the regional human resources director for an American
company there.
Their tax adviser calculates that they will now owe more than an
additional $17,000 in U.S. taxes, even as they continue to pay $20,000
in Singapore taxes.
Last year the law allowed most overseas Americans to exclude $80,000 of
foreign earned income from the income taxed by the United States. The
new law adjusts the exclusion for inflation to $82,400 for this year,
but it raises taxes by adding complex new provisions on how the
exclusion is calculated. The changes are retroactive to the start of
this year.
Increasing taxes on overseas Americans was cited in a report last year
on tax reform and improving tax compliance by the Congressional Joint
Committee on Taxation.
The new law does nothing about the hundreds of thousands of Americans
living overseas who have stopped filing income tax returns, even though
Congress taxes Americans on their worldwide income regardless of where
they live. "This law is targeted at those who are filing tax returns,
not those who have stopped filing," said Peter Merrill, a partner in the
national economic practice of PricewaterhouseCoopers in Washington.
Merrill also said that he could "see no deep tax policy reason for this
change," which he characterized as a way to raise money from one group
of taxpayers to offset cuts for others. Other tax experts said they
concurred in that assessment.
Many overseas Americans say the measure will hurt exports and employment
in the United States. Jack Whiteford, a regional sales manager in
Taipei, said that in the past five years he had negotiated export deals
that have created 75 full-time mining jobs in the southeastern United
States.
But Whiteford said he was now worried that his employer, whom he
declined to identify, might not indemnify him against the much higher
taxes he will face under the new law, making it far less attractive for
him to stay overseas.
"It's pulling money out of all of our pockets," he said.
Michael Abdalian, a tax partner in Ernst & Young's human capital
practice, said he had spoken to many employers in the past week about
the increased tax burden. "Most companies have programs designed to
protect their employees from additional taxes," he said, so the expense
will probably be borne by employers.
Paying the higher taxes and then the taxes on the higher income to cover
the taxes is a costly proposition, Abdalian said. Because the new rules
will push many Americans overseas into higher brackets, he said, many
companies will spend $2 for each $1 their overseas employees pay in
taxes. The entire $2 will be deductible by the corporation.
Because the tax is retroactive, many families are just starting to
realize that they did not have their employers withhold enough tax from
their paychecks for the first five months of the year. Many employers
will have to adjust their budgets, cutting into capital available for
investment.
A common worry among many American lawyers, investment bankers,
executives and others living overseas is that their employers will start
hiring citizens of other countries instead of Americans. Other
industrialized countries do not tax their overseas citizens on foreign
income, so these citizens can afford to work for less than Americans and
still have higher take-home pay.
Abdalian said none of the many employers he had spoken with were
"pulling up stakes and running out" because of the higher costs, but he
cautioned that this could change.
Some experts also questioned whether the new measure would generate the
tax revenues anticipated by Congress. If companies bring Americans home
or some of those overseas renounce their citizenship, the revenue
estimates will not hold.
The law may also encourage more tax evasion, especially by Americans who
work for foreign employers, who do not pay taxes in the United States
and thus may not file tax documents with the U.S. Internal Revenue
Service.
The new legislation may discourage American entrepreneurs who have been
heading to Taiwan and elsewhere in East Asia so as to be close to
high-tech manufacturers while inventing new companies based on Internet
phone companies, biotechnology advances and other innovations, said
Philip Diller, the chairman and owner of Pristine Communications, a
multilingual publishing company in Taipei that processes economic data
and other information.
Many overseas Americans are especially upset because the tax increase
was approved so quickly.
Lindy Paull, a PricewaterhouseCoopers partner who is a former chief of
staff to the Joint Committee on Taxation of the U.S. Congress, said
that, like many others, she had "heard the rumor" that taxes on
Americans who work overseas would be increased just one day before
language to reconcile differences between the House and Senate versions
of the tax bill became public.
On the other hand, she said, the concept was raised last year by Senator
Charles Grassley, Republican of Iowa and chairman of the Senate Finance
Committee, and "we knew the hunt was on for revenue to make the bill
work."
The suddenness of the move meant that American Chambers of Commerce in
Asia did not have a chance to mobilize, as they did when the idea was
floated during previous sessions of Congress. "We were held back by the
U.S. Chamber because they didn't think it would be popped in this time,"
said Richard Vuylsteke, the executive director of the American Chamber
of Commerce in Taipei.
Keith Bradsher reported from Hong Kong, and David Cay Johnston from New
York.
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