Highlights of New U.S. Tax Code for Cross-Border Individuals
On December 20, 2017, President Trump signed into law a significant revision to the U.S. tax code, to take effect starting January 1, 2018. However, it will take some months for the IRS to iron out details and provide guidance and information to professionals and individual taxpayers. One thing for certain is that the rules have changed dramatically, particularly for folks living in high-tax states or for people with significant itemized deductions. Less understood are a number of important changes affecting taxpayers who either live internationally or who have taxable assets outside of the U.S.
The changes to the tax code are extensive, and it will take some time to understand how certain provisions will work in practice, so this discussion is really only an overview of the broad strokes, plus a few details that may impact cross-border families but are overlooked in the mainstream discussion of the changes.
Basic Summary of U.S. Tax Code Changes
The main goals of this revision were to lower taxes and simplify the tax calculations for the majority of taxpayers, both individuals and businesses. The signature achievement was a reduction of U.S. corporate tax rates from a top rate of 35% to 21%, with the intention to better align U.S. corporate tax rates with the rest of the world, and to dissuade the practice among U.S. multinationals to hold profits offshore in order to lower their effective tax rates.
For individuals, tax rates were reduced somewhat, and the standard deduction was basically doubled. The deduction for home mortgage interest was retained, but at a lower $750,000 total mortgage balance for new mortgages (down from effectively $1.1m). While the standard deduction was meaningfully increased, many deductions were eliminated or greatly reduced, including eliminating all personal exemptions and imposing a $10,000 cap on any state and local taxes, which includes property tax (collectively referred to as the SALT deductions). The result of these limits will be a significantly lower number of taxpayers reporting itemized deductions. To partially soften the blow for taxpayers losing a large amount of itemized deductions, Alternative Minimum Tax (AMT) thresholds were increased. Small businesses organized as a “pass through” entity also received a tax break, if they conform to certain requirements.
The Bottom Line for Most Families
It is impossible to generalize the aggregate effect on families due to the complexity of the changes involved. However, we can say two things with a large degree of confidence. First, the changes will result in either a wash or a somewhat lower tax burden for the vast majority of U.S. taxpayers. Secondly, accountants will remain gainfully employed as everyone tries to figure out how all this works.
You have undoubtedly been following all this in the news, and there are many excellent articles that outline the changes in much greater detail. Here are just a couple for your reference:
Potential Impact on International Families
What has not been in the news and which we would like to bring to your attention is how the new tax code might affect individuals with cross-border tax situations. Here are a few specifics that might affect you and your family, if you reside abroad or have assets outside of the U.S. Again, this is just a first-pass sampling as many details are still emerging.
- The $10,000 property tax deduction limit does not pertain to foreign property tax, which is now non-deductible, unless the property is for business purposes (such as a rental property).
- There is an improved child tax credit. However, it may not be available if one elects the Foreign Earned Income Exclusion, which many families with children living abroad do. Because of this, expat families may benefit from relying solely on foreign tax credits to minimize U.S. tax.
- Moving expenses are no longer deductible.
- The reduced tax rates on certain pass through income is only available to domestic (U.S.) sourced income.
- Shareholders of controlled foreign corporations (CFC), including small businesses, may fall under the new corporate tax regime and the repatriation tax. This is very complicated and definitely requires the expertise of a tax professional.
- Finally, the number of changes in the new tax code means that there will likely be new mismatches between how the U.S. and other jurisdictions treat taxable income and deductions. One prominent example is that the U.S. no longer recognizes alimony as tax deductible for the payer and taxable to the recipient. This is a reversal of the prior rules, and differs from the treatment in many foreign countries.
As we all digest the new system and look ahead to what this new tax year will bring, we invite you to contact us to discuss these or any other topics that are of interest to your financial well-being. If you know someone who can benefit from our wealth planning services, please feel free to make the connection. We are here to help!