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Recent US Tax Developments For The American Expatriate Community
The Tax Cut and Jobs Act of 2017 (TCJA) brought about sweeping tax reform that significantly impacted the American expatriate community. Additional assistance channeled to expatriate parents through expansion of the child tax credit was largely offset by fresh tax compliance aggravations for expatriate entrepreneurs with the new Global Intangible Low Tax Income (GILTI) regime. The international tax landscape has remained dynamic since and several new developments over the past year continue to have relevance for American expatriates. Fortunately, the changes since the TCJA have been overwhelmingly favourable and continue to signal an understanding of the burdens Americans living abroad have faced with respect to tax reporting back home.
Importantly, several less prominent provisions of the Coronavirus Aid, Relief, and Economic Security (CARES) Act of March 27, 2020, may also have the potential to provide some assistance to American expatriates. And much of this assistance will lapse at the end of 2020. Additionally, while many business owners abroad were ineligible to take advantage of the CARES Act business provisions, recent changes to the GILTI regime create a new tool to efficiently manage this tax exposure. Finally, a new relief programme was launched for American owners of foreign retirement vehicles and certain savings arrangements that will eliminate a challenging annual tax reporting obligation.
COVID-Related Relief The $1,200 Economic Impact Payments issued by US Treasury earlier this year provided much needed support to eligible members of the American expatriate community who had been impacted by the pandemic. In addition to the cash payments, several lesser-known elements of the CARES Act may also have the potential to help expatriates who have needed to tap into savings or have incurred losses from their business during the shutdown.
Changes to Qualified Retirement Plan Access. During the 2020 calendar year, qualified individuals may access up to $100,000 from their US retirement accounts under preferential rules. The 10% penalty on early distributions is waived and income tax exposure can be spread across the year of distribution and the two following years.
In order to qualify for this relief: 1. The taxpayer, a spouse, or dependent must have been diagnosed with COVID-19 by a test approved by the CDC; or 2. The taxpayer must have experienced adverse financial consequences as a result of: a. being unable to work due to lack of child care; b. being quarantined; c. being furloughed or laid off; d. having work hours reduced; or e. closing or reducing hours of a business due to COVID-19. These provisions also allow any qualified plan distributions to be returned to the arrangement within three years without adverse tax consequences. Any tax paid on distributions that had been included in income, but later recontributed back to the plan within the three-year window, can be reclaimed by filing an amended return requesting a refund. Note that while tax relief on such retirement distributions may be offered in the United States for eligible individuals, it will be important for American expatriates to determine how such a distribution would impact their UK tax exposure.
The US-UK Income Tax Treaty does contain a provision that is designed to coordinate tax exemptions on pensions between the two countries; however, the exact language of the treaty may not be broad enough to encompass this specific treatment. Taxpayers living in the United Kingdom and claiming CARES Act-related retirement distributions will need to discuss UK tax implications of any distribution with their tax advisor.
Changes To Net Operating Loss (NOL) Rules The TCJA changed the rules for personal NOLs, eliminating the two-year carryback provision and allowing for an unlimited carryforward. The new CARES Act unwinds the TCJA treatment for NOLs incurred in 2018, 2019, or 2020. The carryback mechanism has been reinstated and expanded to five years from the two-year provision in place prior to the TCJA.
NOL planning may not create much opportunity for American expatriates who are using foreign tax credits or the foreign earned income exclusion to manage their US tax exposure; however, if the move abroad has been recent, this may still be a very valuable option. If a loss is incurred following the move, it could potentially be carried back to a year when income was fully taxed in the United States.
Of importance, when claiming the foreign earned income exclusion, expenses are disallowed to the extent attributable to excluded income. Taxpayers who have been claiming the foreign earned income exclusion may find that their net operating losses are reduced or eliminated by application of the exclusion. If the foreign earned income exclusion is revoked, it cannot be claimed again for five years without IRS consent.
Additionally, the TCJA had created a cap on NOLs, limiting the amount that can be claimed in any year to 80% of adjusted gross income for the year the loss is applied. The CARES Act relief also removes this restriction, allowing NOLs applied in years prior to 2021 to offset 100% of income reported in a carryback or carryover year. Any losses carried over beyond the 2020 tax year will be subject to the TCJA 80% limitation.
New Rules for Charitable Contributions For 2020, Taxpayers who will be itemising deductions are permitted to deduct charitable contributions up to 100% of their income, instead of the 60% limitation that would have otherwise applied.
Taxpayers who do not itemise will be permitted to claim a deduction of up to $300 in addition to the standard deduction for contributions to certain public charities with their 2020 tax return. Typically, in order to claim a benefit for charitable contributions, Taxpayers must elect to itemise deductions, thus losing the standard deduction ($12,200 for single taxpayers in 2019).
Changes to the Foreign Earned Income Exclusion Ordinarily, the foreign earned income exclusion will require that a taxpayer meet either the physical presence test, requiring 330-days of foreign presence during a 12-month period, or the bona fide residence test, which requires a full calendar year of presence in a foreign country along with strong connections. In Revenue Procedure 2020-27, the IRS indicated
that a waiver of these time requirements will be offered to individuals who left China after November 30, 2019 and before July 15, 2020, or any other foreign country after January 31, 2020 and before July 15, 2020.
In order to qualify for this waiver, a taxpayer must establish that he or she reasonably expected to meet either the bona fide resident or physical presence test but for the COVID-19 emergency. Historically, the waiver of time requirements for the foreign earned income exclusion has been very narrowly applied; however, with travel restrictions still in place for Americans as of the date of this article, this policy will clearly be expanding.
High-Tax Exclusion For GILTI The GILTI regime initiated by the TCJA added a challenging new compliance burden for American expatriate entrepreneurs. While various elections and planning strategies did allow for this incremental tax burden to be managed, the added costs of compliance and hassle were considerable.
On July 20, 2020, final Treasury regulations for the GILTI high-tax exclusion were adopted, now allowing Americans doing business in countries with a corporate tax rate that is at least 90% of the US corporate tax rate to avoid much of the compliance associated with this tax regime. Americans paying an effective rate of tax of at least 18.9% (90% of 21%) on the income from their corporate activities are eligible to make this election.
Notably, the final regulations were decidedly more lenient than the initial version of the high-tax exclusion law proposed last year. The new regulations establish an option for retroactive relief and permit the election to be made on an annual basis.
The high-tax exclusion rules are still complex and making the election will not be the best option for many US owners of limited companies abroad. Nevertheless, the simplicity in process of making the new election will be a breath of fresh air for expatriate entrepreneurs who have battled onerous reporting obligations in an attempt to mitigate past GILTI exposure.
Relief For Owners Of Certain Foreign Retirement And Savings Plans Largely overshadowed by the CARES Act aid package, in March of 2020, the IRS issued Revenue Procedure 2020-17 establishing a new relief programme for American expatriates who had been forced to comply with complicated foreign grantor trust tax rules and annual reporting obligations after having opened retirement and other savings vehicles in their countries of residence.
American owners of common retirement vehicles organised outside the United States were obliged to submit annual foreign trust reporting documents on Forms 3520 and 3520-A, with many being penalised for reporting errors. Failure to file Form 3520 and 3520-A can result in a penalty equal to the greater of $10,000 or 5% of the value of the trust, in addition to a range of other penalties for various levels of inaction or noncompliance. This new programme eliminates the annual trust reporting obligations.
Finding a silver lining for 2020 is difficult. At least it can be said that current US tax policy is continuing to make steps towards easing the pain
The exemption from reporting is reserved for trusts that meet the definition of a “taxfavoured foreign retirement trust” as follows: 1. The trust is established in a foreign country to operate exclusively or almost exclusively to provide pension or retirement benefits; 2. The trust is generally exempt from income tax or is “tax-favoured” under the laws of that trust’s jurisdiction. For this purpose,
“tax-favoured” would include arrangements where contributions are taxed at a reduced rate, give rise to a credit, or produce a separate tax benefit, in addition to straight deductibility or exclusion. The plan must also provide that taxation of investment income earned by the trust be deferred until distribution or that the investment earnings are taxed at a reduced rate. 3. Annual information reporting with respect to the trust is provided to relevant tax authorities in the trust’s jurisdiction. 4. Only contributions with respect to income earned from the performance of personal services are permitted. 5. Contributions to the trust are limited by a percentage of earned income of the participant, an annual limit of $50,000, or are subject to a lifetime limit of $1,000,000. 6. Withdrawals, distributions, or payments from the trust are conditioned upon reaching a specified retirement age, disability or death, or penalties apply to withdrawals, distributions, or payments
made before such conditions are met. 7. For employer-maintained trusts, the trust must be nondiscriminatory, the trust actually provides significant benefits for a substantial majority of employees, and the benefits provided to employees are nondiscriminatory. American taxpayers with personal pensions in the United Kingdom have been forced to deal with a tremendous amount of uncertainty related to the annual reporting obligations for their accounts. The spirit of the law would seem to cover this type of arrangement, but eligibility of specific arrangements is unclear and there are certain nuances with personal pensions that could impact qualification.
This relief from foreign trust reporting is also reserved for certain non-retirement vehicles established for a specific protected savings purpose. “tax-favoured foreign non-retirement trusts” will be exempt from foreign trust reporting if all the following requirements are met: 1. The trust is established to provide medical, disability, or educational benefits. 2. The trust is generally exempt from income tax or is otherwise “tax-favoured” under the laws of that foreign jurisdiction. 3. Annual information reporting with respect to the trust is provided to the relevant tax authorities in the trust’s jurisdiction. 4. Contributions to the trust are limited to $10,000 annually or $200,000 on a lifetime basis. Importantly, this new Revenue Procedure offers relief for taxpayers who have previously been assessed a penalty for not filing foreign trust reports for qualifying vehicles. Taxpayers who have been penalised for failure to file Form 3520 or 3520-A may request an abatement of penalties provided the statute of limitations has not expired.
Finding a silver lining for 2020 is difficult. At least it can be said that current US tax policy is continuing to make steps towards easing the pain American expatriates have been experiencing since the difficult adoption of the Foreign Account Tax Compliance Act (FATCA). While the number of Americans choosing to relinquish their citizenship continues to increase, hopefully, those who do decide to keep their passports will face a US tax compliance burden that continues to evolve pragmatically.
