How Do The Proposed US Tax Changes Affect Australian Expats
Last week the US House Ways and Means Committee Chairman Kevin Brady unveiled a much-anticipated House Republican tax reform bill, entitled the Tax Cuts and Jobs Act (the TCJA). The draft legislation will be a major step forward in tax reform and will have an impact on international assignment programs.
Whilst the legislative changes are quite broad this article seeks to narrow our focus on the key issues we believe Australian expats will face once it has passed. The bill will be the most comprehensive reform in US tax legislation in over 30 years and will set the foundations for years to come.
Why is the draft legislation important for Aussie Expats?
Well if you work for a big multinational company the changes will seek to have a dramatic impact on companies whose employees are on international assignments. US-based expats that are on an inbound assignment could end up being less expensive for these multinationals, but it will come down to the salary level of such employees. This will cause these companies to review and change their global mobility policies which could have an impact on the people that fall into this category.
Proposed changes for Individuals
The below table represents the tax rate changes for individual taxpayers
The TCJA proposes major tax cuts for the middle-class individual taxpayers and cuts the corporate tax from 35% to 20%. The proposed changes seek to capture a higher number of people falling into the 25% tax bracket, significantly expand the number of people falling into the 35% bracket and significantly reduce the number of individuals falling into the 39.6% tax bracket. So what does that really mean for Trump’s plan? Well due to the removal of some dependent related deductions the lowest-income earners could see taxes increase while the wealthy see a tax break.
Hypothetical Federal Tax Rate Changes
As an example of what the tax changes could mean, for this scenario we are not considering any Medicare levies, deductions or offsets. We purely just want to paint a picture of what the changes could mean for someone in your position when it comes to federal tax. For the following calculation we will consider an employee lodging an individual return on 4 different salaries US$75,000, US$100,000, US$150,000 and US$200,000 per year, excluding any 401K or retirement plan:
Deductions for Foreign Real Property
Expats who hold investment properties back home currently have access to the ‘Foreign Real Property’ tax concession where they can claim an offset for the tax they pay on the rental income they receive back in Australia. This tax concession will be removed as part of the new legislation and therefore increase an expat’s taxable income. This tax trap will catch a lot of expats out, as it is quite common for them to rent out their main residence which is usually positively geared. Not only this but with the Main Residence Exemption rule being abolished, expats need to make sure property is relevant to their financial plan.
Deductions for home ownership and Investment Property’s
Further changes have been brought in that will affect Expats holding property or investment property’s in the US. Firstly, there is the modification of the exclusion of gain from sale over a principal place of residence(PPOR). Currently, you can exclude up to USD$250,000(USD$500,000 for joint filers) of the gain from the sale of your PPOR, however you must have held this property as your PPOR for at least two out of the last five years. The bill will increase the required period of ownership to five out of the previous eight years. In addition, this exclusion can only be used once every five years.
Secondly, section 1302 of the bill will seek to reduce the amount of mortgage interest a person can deduct with respect to their PPOR. It will reduce the amount of debt that can be treated as ‘acquisition indebtedness’ from the current level of USD$1 million to USD$500,000. Any debt that occurred prior to 2 November 2017 would be grandfathered in under the current rules. Furthermore, they will be removing the number of property’s you can claim this deduction on; currently, it is two and claiming up to USD$100,000 in home equity indebtedness. This will be amended to only claiming interest on the PPOR and no longer access to the additional property or the USD$100,000 deduction cap. As you can see this will have an everlasting impact on expats who hold investment properties across the US. It will push up their taxable income by no longer having access to such useful deductions.
Lastly, we note in section 1303 of the bill will seek to limit the annual deduction for state and local ‘Real Property’ taxes to USD$10,000.The exclusion for these taxes will be if they are incurred in carrying on a business or some form of trade. This will have ramifications for those Expats who have invested in those states with substantially high state and local tax brackets.
Increased Dividend Payout Ratio
This is just speculation at the moment but it is expected that there could be an increase in dividends being paid out by the corporates with the introduction of the significantly reduced corporate tax rate dropping from 35% to 20%. At present, corporations seem to retain their profits at a significantly higher percentage in comparison to Australian based corporations which is mainly due to Australia having the double taxation legislation in place. In short, Australia doesn’t seek to tax its residents twice on franked dividends paid to shareholders. Investors get the added benefit of the franking credit attached to the dividend which offsets the income from the dividend at the corporate tax rate of 30%. Whilst double taxation legislation isn’t a talking point at the moment for the IRS, companies having to pay less tax could be enough for them to pass on the profits to their loyal shareholders upon which it would get taxed at a minimum of 15%.
What Does This All mean for Australian Expats?
So how do the proposed US tax changes affect Australian expats and what does this all mean for you? Well, nothing at the moment as it is at the draft stage but it’s fair to say that a lot of the above could be quite relevant for the 2018 tax year. It is important you review your current financial circumstances with a qualified financial planner or qualified tax accountant when the new legislation is passed so you don’t get caught out with a nasty tax bill.
Disclaimer – the above commentary is general in nature and should not be construed as tax or financial advice. Please consult a licensed tax accountant and financial adviser to determine whether the above information is suitable for you.