US Expatriates Living Abroad – What You Should Know About the New Tax Law

The Tax Cuts and Jobs Act 2017 (TCJA) changed many things, including reporting and taxing requirements for US taxpayers living abroad. While the plan was marketed as a much needed tax simplification for Americans; the TCJA did not provide much relief, let alone simplification, for U.S. taxpayers living abroad (Expats).

Listed below are 12 items about TCJA that U.S. Expats need to know:

1. The Most Important Tax Code Provisions for Expats Remain. The Foreign Earned Income Exclusion and the Foreign Tax Credit help expats avoid double taxation and are included in the tax reform. However, the amount of the FEIE that can be excluded from taxes each year is indexed to inflation, which brings us to our second point.

2. Tax Brackets, Exemptions and Deductions Have Been Modified. Tax brackets are now larger, meaning taxpayers may now be in a lower bracket than they were previously, and the standard deduction has nearly doubled. For those considering a move to or from the U.S., two new issues should be considered. First, the moving deduction has been completely eliminated. Second, the individual mandate part of the Affordable Care Act has been eliminated. Unfortunately, the Net Investment Income Tax was not eliminated and will still impact expats.  

3. Inflation Calculations Have Changed. The tax reform law has changed the measure of inflation from the “regular consumer price index” to the “chained consumer price index,” and changing the way inflation is calculated will affect a number of tax-related issues. The end result is a lower rate of inflation used to calculate tax figures, which will increase taxes over time.

4. The Foreign Information Reporting Requirements are Generally Unchanged. The burdensome reporting requirements expats are required to submit in addition to their tax returns are unchanged. The Foreign Bank Account Report, also known as FinCEN 114, the FATCA requirements, Form 8938 (Statement of Foreign Financial Assets), Form 5471 (Report of Certain Foreign Corporations), and Form 3520 (Report of Foreign Trusts), are here to stay. This means that many expats will continue having trouble banking abroad and face onerous penalties if they fail to file.
  
5. Elimination of the CFC 30 Day Ownership Requirement. The TCJA eliminates the requirement that a U.S. shareholder must control a non-U.S. corporation for an uninterrupted 30-day period before Subpart F inclusions apply (the so-called "30 day rule"). This change is relevant for U.S. individuals that receive gratuitous transfers of foreign stock, such as individuals who inherit shares from non-U.S. family members. A popular technique that will no longer be as effective as it was in the past is to liquidate an inherited foreign corporation within 30 days of the decedent's death.
 
6. Elimination of the CFC Downward Attribution.  TCJA eliminates Section 958(b)(4), which prevents downward attribution of stock from certain non-U.S. partnerships, estates, trusts, and corporations to U.S. persons for purposes of determining whether the CFC and U.S. shareholder tests are satisfied. This repeal may result in unintended tax and reporting consequences.
 
7. Expands the CFC Definition of US Shareholder. The TCJA expands the definition of "United States shareholder" to include any U.S. person who owns 10 percent or more of the total vote or value of all shares of all classes of stock of a foreign corporation. Under current law, the definition of United States shareholder required a U.S. shareholder to hold 10% or more of the voting power of the CFC. Therefore, individuals that own non-voting shares in a foreign corporation that were not previously considered United States shareholders, should determine if their non-voting shares will cause them to become United States shareholders and also cause the entity to become a CFC.  
 
8. Corporate Taxes Have Changed Significantly. The tax reform bill has transitioned the U.S. to a territorial system of corporate taxation. Before, the U.S. operated using worldwide taxation, meaning that corporations had to pay taxes on the income they earned abroad. This change will affect expats who own corporations outside the U.S., because they will face a one-time deemed repatriation tax of 15.5 percent of any previously untaxed overseas profits as the U.S. transitions to a territorial system for corporations instead of a worldwide system (See Forced Repatriation Below).  

The individual reporting requirements are, for the most part, the same. U.S. expats who own small businesses abroad may find their situation is worse under the TCJA than under the old system. Most American Taxpayers living abroad will not find their taxes streamlined by the provisions of the TCJA. 
 
9. Forced Repatriation of CFC Deferred E&P (Post 1986 Retained Earnings). The bill's forced repatriation rule applies to U.S. individuals who own CFCs, or non-U.S. corporations that have at least one 10 percent U.S. shareholder that is a U.S. domestic corporation. It does not apply to individuals who own non-CFC PFICs. The tax applies as a Subpart F inclusion on all of the CFC's pre-effective date foreign earnings at an individual rate of approximately 9.05% for non-cash earnings and profits and 17.5% for earnings and profits held in cash. Individuals will not be afforded the benefit of foreign tax credits for any foreign tax imposed on the CFC's earnings.
 
The new provision will allow for an 8-year deferral on payment of the tax owed, meaning the majority of payments will be owed in the later part of the 8-year period. If the CFC was owned by an S corporation, there is an indefinite deferral of the tax that may apply until one of the following triggering events is met: 

1. The first type of triggering event is a change in the status of the corporation as an S corporation.
2. The second category includes liquidation, sale of substantially all corporate assets, termination of the company or end of business, or similar event, including reorganization in bankruptcy.
3. The third type of triggering event is a transfer of shares of stock in the S corporation by the electing taxpayer, whether by sale, death or otherwise, unless the transferee of the stock agrees with the Secretary to be liable for net tax liability in the same manner as the transferor.

10. Create an Alternative Methods for Taxing CFC Global Intangible Low-Taxed Income (GUILTI). The GILTI regime may cause income of a CFC that is not otherwise caught by the existing Subpart F rules to be includable in the gross income of its U.S. shareholders. This regime will affect almost all U.S. individuals that own CFCs, unless the CFC has incurred significant investment in tangible assets.
 
This GILTI tax would apply to U.S. shareholders of foreign IP Heavy CFCs, service provider CFCs, and CFCs with low basis assets, and which otherwise would not cause Subpart F inclusions for its U.S. shareholders.  

If a U.S. individual owns the CFC directly or through a pass-through entity, then the GILTI inclusion will be subject to ordinary U.S. federal tax rates of up to 37%. Furthermore:

• The individual will not be able to apply a tax credit against the income for taxes paid by the CFC. 
• The CFC will be subject to tax in the foreign country plus
• The individual will be subject to an immediate 37% tax on GILTI income. and
• Finally, the dividend withholding by the CFC's country of incorporation will likely not be able to be offset by foreign tax credits.

There are several options to improve the tax position of U.S. individual shareholders holding non-U.S. investments, such as forming a U.S. corporation to own the shares of a non-U.S. corporation. This can be especially beneficial to U.S. individual shareholders that own non-U.S. corporations in jurisdictions that do not have a treaty with the United States.

An alternative is for the shareholder to make an election under Section 962(b) to treat the CFC as if it were owned by a domestic C corporation. The 100% foreign source dividends exemption will not apply to dividends from passive foreign investment companies ("PFICs") even if the U.S. shareholder is a corporation. 

12. Expatriation Rules for Relinquishing US Citizenship and/or US Green Card Remain the Same. Congress did not touch Sections 877A or 2801 of the Internal Revenue Code. Those are the two special-purpose statutes that impose tax on people who renounce US citizenship or abandon their green cards. Therefore, someone who expatriates in 2018 will face the same tax laws that applied to someone expatriating in 2017, 2016, or before.  
 

Sources:

TCJA

taxproToday

Baker & McKenzie