TCJA and US Expats

As 2018 draws to a close, the community of nonresident US taxpayers has been inundated with articles about GILTI and the transition tax. These provisions have a disproportionate impact on nonresidents because people tend to earn their income close to home, so US taxpayers living outside the US are much more likely to be individual shareholders in a corporation that the US deems a CFC. However, there has been less attention paid to several other provisions in the 2017 tax reform package that will also have a disproportionate effect on those US taxpayers who are residents and taxpayers of other countries.

Qualified Business Income

New code section 199A allows individuals running a qualified trade or business a deduction of 20% of the qualified business income of that trade or business. The provision is not simple, but there’s really no point in going over the details. Nonresident taxpayers running a business where they live are disadvantaged relative to their US-resident cousins because Qualified Business Income must be effectively connected to a trade or business located in the US.

Itemized Deductions

While the number of US taxpayers itemizing deductions will decrease in 2018 due to the substantial increase in the standard deduction to $12,000 ($24,000 on a joint return), those who had significant itemized deductions will find that some deductions no longer exist. The changes with a disproportionate effect on nonresident taxpayers are:

• Tax preparation fees: due to the highly complex foreign income provisions, nonresident US taxpayers often find that their tax preparation fees are much higher than those of their US-resident cousins. However, for 2018-2025 tax preparation fees are no longer deductible.
• Foreign property taxes: There was quite a bit of hype around the limitation of itemized deductions for SALT (State and Local Taxes) to $10,000. But there was very little coverage of the elimination of the itemized deduction for foreign property taxes on personal use assets (like your home). Congress must think that only the very wealthy can afford to buy property outside the US. While property values have soared in many major cities around the globe, suburban and rural properties are still quite affordable. If you live with your family in Goondiwindi, buying a house there just makes sense.
• Casualty losses: Deductions for casualty losses are now limited to losses incurred inside a federally-declared disaster area. US citizen victims of Cyclone Marcus will get no casualty loss deduction on their US return, while victims of last month’s California wildfires will be able to deduct their losses.

While I understand that Congress wants the benefits of tax reform to enhance economic activity inside the US, these provisions are further examples of why taxing the residents of other countries just isn’t fair. If the US is going to insist on taxing nonresident citizens, then those citizens should be allowed comparable deductions to their US-resident cousins.

Married Filing Separate

US taxpayers who are married to nonresident aliens (NRAs – that’s anyone living outside the US who is NOT a US taxpayer) often end up filing using the Married Filing Separate (MFS) filing status unless they have US citizen children who qualify them for head of household status. While it is possible for your NRA spouse to elect to be taxed as a US resident, this is only beneficial if the NRA spouse has very little income or assets. In 2016, 2.09% of all US individual tax returns were filed with MFS filing status – but 17.64% of returns filed from outside the US were MFS returns.[1] Clearly, nonresident taxpayers are much more likely to use MFS.

While TCJA didn’t make any specific changes to the MFS status, there was also some collateral damage in this area. In many ways, the thresholds and limits applied to MFS status are meant to discourage the filing of separate returns. The US tax system has a “marriage penalty” such that a married couple where the two spouses have similar income ends up paying more in US tax than they would have paid as single individuals. The thresholds for MFS are meant to help ensure that couples cannot undo this marriage penalty by filing separate returns. Additionally, if a couple files separately, they must both make the same decision on itemizing deductions or using the standard deduction. For this reason, the income threshold for filing is equal to just the personal exemption for MFS returns, while for all other filing statuses the income threshold for filing is equal to the personal exemption PLUS the standard deduction. TCJA eliminated the personal exemption while increasing the standard deduction.

Since there is no longer a personal exemption, those who use the MFS filing status are required to file a return if they have any income at all in 2018. In 2017 those filing MFS were required to file only if their income exceeded $4050. This change will impact those US citizens, mainly women, who are supported by their NRA spouses while they perform unpaid domestic duties (like raising children). If they are on a joint bank account that earns $5 during the year, they are required to file a US return which will cost them much more than $5 to prepare and will demonstrate that, just like 53.9% of US returns filed from overseas, they owe ZERO US tax. Congress could easily reduce this filing burden by increasing the filing threshold for married individuals with a NRA spouse to include the standard deduction that all such taxpayers are eligible to use.

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[1] Data source: https://www.irs.gov/statistics/soi-tax-stats-historic-table-2