Tax Cuts and Jobs Act: Individual Provisions of Key Interest to U.S. Expatriates
Through a somewhat choreographed partisan political maneuver, the Republican-controlled Congress and White House enacted the Tax Cuts and Jobs Act (“TCJA”), the first major tax reform legislation since the Reagan administration, on December 22 in record time. The individual provisions are generally due to sunset and not apply to tax years beginning after tax year 2025 unless extended by a future Congress. Also, Chained Consumer Price Index for All Urban Consumers (“C-CPI-U”) will be used permanently in place of Consumer Price Index for All Urban Consumers (“CPI-U”) for inflation adjustments, which should produce a more muted rate of change.
With the law being effective from January 1, 2018, the IRS will be on overdrive to promulgate regulations for the interpretation of the relevant code sections and to develop various forms of guidance for implementation. It remains to be seen whether any tax bill for technical corrections will be introduced by the Congress to rectify unintended consequences or anomalies that may have been overlooked during the expedited legislative process.
In this newsletter, we will take a first look at the individual provisions that may be of key interest to U.S. expatriates.
Under the TCJA, there will be no change to the number of tax brackets, as originally proposed in the Senate bill. However, tax rates for all but two brackets will be reduced; 10% and 35% will remain unchanged. In addition, tax brackets for all tax rates, except those for 10% and 15%, will be realigned. Below is a side-by-side comparison of how the new tax rate schedules under the TCJA stack up against the pre-Act schedules for 2018. It should be noted that the 3.8% Net Investment Income Tax (“NIIT”) and the 0.9% additional Medicare tax will continue to apply. Expatriates should also be mindful that their tax liabilities will still be affected by these changes even if their compensation could be fully excluded by foreign earned income and housing exclusions, to the extent they have any taxable income, as these exclusions must be taken into account for the determination of marginal tax rates.
Notwithstanding the across-the-board reduction in tax rates and realignment of tax brackets, these changes will inevitably impact taxpayers differently. What may not be evident, nevertheless, is that tax saving does not seem to be distributed lineally or over any curve once taxable income reaches about $78,000 as illustrated by the divergence in the graph below.
If we consider tax rate schedules in isolation, Single and Head of Household filers who used to be within the 33% tax brackets may even experience a tax increase because substantial portions of the income within those brackets will be subject to tax at 35% under the TCJA; interestingly, this does not affect married taxpayers, whether they file jointly or separately. We will discuss in the later part of this newsletter how the enhanced standard deduction (and child tax credit) not accounted for in the graph below could affect the tax saving.
|Pre-Act 33% Tax Brackets
|Married taxpayers in these brackets under the pre-Act structure will generally see larger tax saving than those in the lower brackets because substantial portions of the 33% brackets will be incorporated into the new 24% and 32% brackets.
Single and Head of Household taxpayers who used to be within the pre-Act 33% tax brackets may, however, see an increase in tax because substantial portions of the income within those brackets will be subject to tax at 35%.
|New 37% Tax Brackets
|High-income taxpayers subject to the new 37% bracket will stand to gain from the rate reduction from 39.6%.
Simplification of Kiddie Tax
Unearned income of a child* in excess of $2,100 would have been subject to tax at the parent’s rate, if higher, under pre-Act law but will now be taxed entirely in accordance with the brackets applicable to trusts and estates, with respect to both ordinary income and income taxed at preferential rates. As in the past, taxable income attributable to earned income will be taxed according to the child’s own rates for Single individuals.
The child’s tax, under the TCJA, will be unaffected by the tax situation of the parent(s) or the unearned income of any sibling.
* Certain conditions must be met.
Maximum Capital Gains Rate
The TCJA generally retains the existing capital gain tax regime for long-term capital gains and qualified dividends. Dollar thresholds of the tax brackets under pre-Act law, adjusted for inflation, would also be referenced for the determination of applicable capital gain tax rates in spite of changes to the tax brackets under the TCJA.
|Capital Gains Rate
|Pre-Act – 2018
|Tax Cuts & Jobs Act
|Tax brackets below 25%
|Taxable income up to*:
|Tax brackets from 25% to below 39.6%
|Taxable income up to*:
|39.5% tax bracket
|Taxable income above those for 15% capital gains rate
|25% (Max Rate)
|Unrecaptured §1250 gain on depreciation
|28% (Max Rate)
|Collectibles and §1202 Qualified Small Business Stock
* Indexed for inflation. These figures differ from those published by the IRS in Rev. Proc. 2017-58 due to the change from CPI-U to C-CPI-U.
Alternative Minimum Tax Retained but with Temporary Relief
The TCJA, as proposed by the Senate amendment, retains the Alternative Minimum Tax (“AMT”), a complex parallel tax system originally designed to ensure wealthy taxpayers who may otherwise exploit various deductions and exclusions would pay a minimum amount of income tax but has since affected about 4.5 million families. As a temporary relief, the AMT exemption amounts and phaseout thresholds (both indexed for inflation annually) are increased for tax years 2018 to 2025.
Although this is not the full repeal that some had hoped for and the exemption amounts are increased only by slightly over 25%, the significant increase in phaseout thresholds should help many taxpayers avoid or reduce AMT by taking advantage of the exemption amounts, which may otherwise be phased out under pre-Act law. These changes may also create larger room for taxpayers with Minimum Tax Credit (“MTC”) from AMT paid on “deferral items”, such as Incentive Stock Options (“ISO”), which cause merely timing differences in income recognition, to apply the credit against their regular tax.
|Pre-Act – 2018
|Tax Cuts and Jobs Act
|MFJ: $1 million
New Deduction for Qualified Business Income (“QBI”) of Pass-Through Entities
This provision, which follows Senate amendment and aims to lower the tax burden of pass-through business owners, is one of the most anticipated aspect of the TCJA. Pass-through businesses include sole proprietorships, partnerships, S corporations, and LLC’s treated as partnerships. In the case of a partnership or S corporation, the provision applies at the partner or shareholder level. The deduction of 20% for “qualified trade or business” is meant to reduce the top rate on income from pass-through businesses from 37% to 29.6% and restore parity with the new top rate for corporate tax at 21%.
Before we go any further, it would be helpful to keep in mind the distinctions among the following terminologies –
- QBI: Reference for an amount that is used to compute the “tentative deductible amount” of each qualified trade or business;
- Combined QBI: Reference for the sum of tentative deductible amounts from all qualified trade or business and amounts from other qualified income; and
- Deductible Amount: Actual deduction for QBI allowed, after subjecting Combined QBI to a formulaic overall limitation.
(B) Qualified Trade or Business Eligible for Deduction
Generally, only trades and businesses other than (a) a “specified service trade or business” and (b) the trade or business of performing services as an employee are deemed “qualified trade or business” eligible for the deduction. Specified service trade or business means any trade or business that –
- Involves the performance of services in the fields of health, law, consulting, athletics, financial services, brokerage services;
- Where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners; or
- Involves the performance of services that consist of investing and investment management trading, or dealing in securities, partnership interests, or commodities.
The provision, however, provides an exception for taxpayers whose taxable income is at or below the threshold amount (see “Threshold Amount and Phase-In Range” below) for their respective filing status to treat specified service trade or business as a qualified trade or business but this exception is phased out for taxpayers with higher taxable income (see “Exception for Specified Service Trade or Business” below).
Generally, QBI used to compute the tentative deductible amount for each qualified trade or business is its net amount of qualified items of income, gain, deduction, and loss (“qualified items”) that must be (a) effectively connected with the conduct of a trade or business within the U.S. and (b) included or allowed in determining taxable income for the tax year. Qualified items also do not include the following –
- Specified investment-related income such as capital gain or loss, dividend income, and interest income among others as well as any item of deduction and loss properly allocable to such items; and
- Reasonable compensation, guaranteed payments, and to the extent provided in regulations, amounts paid or incurred by a partnership to a partner who is acting other than in the individual’s capacity as a partner for services.
If the net amount of QBI from all qualified trades and businesses during the tax year is a loss, no deduction for QBI is permitted and any such amount will be carried forward to a succeeding year to reduce the combined QBI.
(D) Tentative Deductible Amount and Limitation
Tentative deductible amount (see “Tentative Deductible Amount” below), which is subject to limitation based on the taxpayer’s taxable income (see “Limit for Taxpayer with Taxable Income Above Threshold Amount” below), must be computed separately for each qualified trade or business. Broadly speaking, this limitation takes into account not only (a) W-2 wages subject to wage withholdings, elective deferrals, and deferred compensation paid by the qualified trade or business with respect to the employment of its employees and for which returns were filed with the Social Security Administration within the prescribed timeframe but also (b) a capital element based on tangible “qualified properties” that are of a character subject to depreciation and meet all of the following requirements –
- held by, and available for use in, the qualified trade or business at the close of the tax year;
- used at any point during the tax year in the production of qualified business income; and
- the depreciable period for which must NOT have ended before the close of the tax year (based on General Depreciation System (“GDS”) but no earlier than the date that is 10 years after the property was first placed in service).
The capital element was added to the conference agreement at the 11th hour, as a compromise to garner sufficient votes in the Senate, to ensure large real estate businesses which have relatively few employees will be able to benefit from the deduction, based on assets they hold.
(E) Qualified REIT Dividends, Cooperative Dividends, and Publicly Traded Partnership Income
An amount based on 20% of the sum of qualified REIT dividends, cooperative dividends, and publicly traded partnership income may also be deductible under this provision.
(F) Combined QBI and Limitation
To ensure the deductible amount is not disproportional to the taxpayer’s taxable income, adjusted for certain items, the combined QBI is subject to an overall limitation, regardless of the taxpayer’s taxable income (see “Overall Limitation” below). The deduction is allowed only as a deduction against taxable income* for both regular tax and AMT, irrespective of whether itemized deductions are claimed, and does not affect the computation of Adjusted Gross Income (“AGI”).
As expected, this deduction applies only to domestic qualified business income. As a result, income from foreign pass-through entities will not be eligible to the extent it is not effective connected with the conduct of a trade or business within the U.S. Expatriates with pass-through businesses in the U.S. should assess how this and other provisions of the TCJA could impact their overall tax liabilities and plan accordingly.
Many have asked whether rental income from passive activities in which an individual did not materially participate is eligible for the deduction. Passive business activities and section 469 were discussed in the House bill but are missing from the Senate amendment, which was adopted, the conference agreement, and the new section 199A for this provision. In the absence of a statutory definition for what constitutes a “trade or business” in the tax code and regulations, its interpretation based on facts and circumstances has largely relied on court rulings, which hold that participation in the activity must be on a regular, continuous, and substantial basis and that the taxpayer’s primary purpose for engaging in the activity must be for income or profit. Consequently, rental activities are generally considered investments and do not usually rise to the level of a section 162 trade or business. When the law for the NIIT was enacted, section 1411 and its regulations clearly stipulate that rental income from passive activities within the meaning of section 469 (passive activity loss rules) is subject to NIIT and the term trade or business has the same meaning as under section 162, so that there is no ambiguity in its application. Unfortunately, we lack that level of clarity for this provision and will need to wait further guidance to be issued by the IRS.
|Taxation of Pass-Through Entities
|Tax Cuts & Jobs Act
|Qualified Trade or Business
|Any trade or business other than the following:
(a) a specified service trade or business; or
(b) the trade or business of performing services as an employee.
|Exception for Specified Service Trade or Business
|If taxpayer’s taxable income is –
(a) Up to threshold amount: Treated in the same manner as qualified trade or business eligible for QBI deduction;
(b) Within phase-in range: QBI, W-2 wages, and unadjusted basis for computing deduction prorated;
(c) Above phase-in range: Not treated as qualified trade or business and excluded from QBI deduction.
|Threshold Amount and Phase-In Range^
|Based on taxpayer’s taxable income –
MFJ: $315,000 to $415,000
Others: $157,500 to $207,000
|Tentative Deductible Amount
|Lesser of –
(a) 20% of QBI; or
(b) Limit for Taxpayer with Taxable Income Above Threshold Amount, if applicable
|Limit for Taxpayer with Taxable Income Above Threshold Amount
Apply greater of the following ratably over phase-in range for marital status:
|Lesser of –
(a) Taxpayer’s taxable income (reduced by net capital gain); or
(b) Sum of –
(i) the lesser of:
(1) combined QBI of taxpayer; or
(2) 20% of the excess of taxpayer’s taxable income over any net capital gain and qualified cooperative dividends
(ii) plus the lesser of:
(1) 20% of qualified cooperative dividends; or
(2) taxable income (reduced by net capital gain).
|To be issued by the IRS
* For purposes of this provision, taxable income is determined without regard to the deduction allowable under the provision.
^ Indexed for inflation annually.
Related Business Provisions
(A) Recovery Period for Residential Property Used Predominantly Outside the U.S.
The TCJA shortens the Alternative Depreciation System (“ADS”) recovery period for residential properties from 40 years to 30 years but keeps the General Depreciation System (“GDS”) recovery period unchanged at 27.5 years. Since tangible properties used predominately outside the U.S. are required to use ADS for depreciation in place of GDS, which generally provides for a shorter recovery period, taxpayers who place in service buildings or structures (including structural components such as furnaces, waterpipes, venting, etc.) after 2017 for use with their residential rental activities will be impacted by this change. The use of this new recovery period will result in a larger depreciation allowance, compared to pre-Act law, to offset the rental income but will not create any depreciation adjustment for AMT purposes.
(B) New Limitation of Losses for Taxpayers Other Than C Corporations
The TCJA extends the limitation on “excess farm losses”, with some modifications, to all non-corporate taxpayers for tax years 2018 to 2025. Under this provision, passive activity loss (“PAL”) rules are to be applied first and “excess business losses” from non-passive businesses for the tax year will be disallowed but treated as part of the taxpayer’s net operating loss (“NOL”) carryover to the subsequent tax year. In effect, a taxpayer who has losses from non-passive businesses in a tax year will not be allowed to use more than the threshold amounts ($500,000 for MFJ / $250,000 for others – indexed for inflation) from such losses to offset other income. In the case of a partnership or S corporation, it is stipulated that this provision will apply at the partner or shareholder level.
Enhancement of Standard Deduction and Suspension of Personal Exemptions
The TCJA follows the Senate amendment to temporarily increase standard deduction and suspend the deduction for personal exemptions until tax year 2025 (by reducing it to zero so as not to alter the operation of other code sections that refer to the taxpayer’s entitlement for such exemptions). As in the past, standard deduction will be indexed for inflation annually.
While the increases may seem generous at first, it should be noted that these have already incorporated personal exemption(s) otherwise allowable under pre-Act law. Perhaps a more significant effect is that these increases, together with the repeal and suspension of various deductions, would curtail taxpayers’ ability to itemize their deductions (and benefit from the deduction of personal exemptions at the same time under pre-Act law). We will discuss under Enhanced Child Tax Credit below how these changes, when considered in conjunction with Child Tax Credit (which includes a new “partial credit”), tax rate reduction, and tax bracket realignments, could impact taxpayers with different filing statuses and family composition.
Effect on Wage Withholding: The IRS released on January 9, 2018 the updated withholding tables for 2018. The new tables reflect the increase in the standard deduction, repeal of personal exemptions and changes in tax rates and brackets under the TCJA and are designed to work with the existing Form W-4 that employees have already filed, so that no further action by taxpayers should be required at this time. Employers are advised to begin using the 2018 withholding tables as soon as possible, but not later than February 15, 2018. This is the first in a series of steps that the IRS will take to help improve the accuracy of withholding following major changes made by the new tax law. The IRS is also working on revising the Form W-4 and the revised calculator to reflect additional changes in the new law, such as changes in available itemized deductions, increases in the child tax credit, the new dependent credit, and repeal of dependent exemptions.
|Standard Deduction and Personal Exemption
|Pre-Act – 2018
|Tax Cuts & Jobs Act
|Married Filing Jointly or Qualified Widow(er)
|Married Filing Separately
|Head of Household
|Aged or Blind
|And Unmarried But Not Surviving Spouse
* Based on figures published by the IRS in Rev. Proc. 2017-58 as adjusted with CPI-U but may be revised for C-CPI-U.
Simplification and Reform of Deductions
Many of the familiar deductions would be suspended or repealed under the TCJA, as summarized in the table below. It is anticipated that these changes would result in fewer than 10% of the taxpayers choosing to itemize their deductions, compared to about 33% today.
Considerations for Expatriates
(A) Alimony Payments
Alimony and separate maintenance payments would not be deductible by the payor. By the same token, neither would these payments be includible in the income of the payee. These changes would apply to –
- Divorce decrees or separation instruments executed after 2018; and
- Any such instrument executed before 2019 but modified after 2018, if expressly provided for by such modification(s).
Under pre-Act law, alimony and separation payments includible in the recipient’s gross income are deemed “compensation” for the purpose of IRA contributions. This is no longer applicable to divorce decrees or separation agreements affected by this provision. Taxpayers who are in receipt of alimony payments and planning to contribute to IRA using these payments should consider their eligibility for such contributions.
Taxpayers whose divorce or separation agreements are executed before the end of 2018 but modify their agreements in future years would then have the additional considerations of whether this provision should apply and how their tax liabilities may be impacted.
(B) Moving Expenses
Under pre-Act law, taxpayers may claim a deduction for certain moving expenses paid or incurred in connection with the commencement of work as an employee or as a self-employed individual at a new principal place of work, provided certain conditions were met. In addition, expatriates relocating to a foreign country may claim a deduction for reasonable expenses related to storage during their employment overseas. Deductions for these qualified moving expenses were allowable whether or not the taxpayer itemized his or her deductions. Similarly, payments of or reimbursements for such qualified moving expenses by an employer were excluded from the employee’s income. During the period of suspension until 2025, qualified moving expenses would neither be deductible nor excludable from taxable compensation.
Expatriates who plan to relocate for employment/assignment overseas or are in the process of negotiating the terms of their relocation/assignment should consider the tax implications of these changes.
(C) Mortgage Interest
Expatriates who have entered into a binding contract before December 15, 2017 to close on the purchase of a principal residence by December 31, 2017 should ensure the purchase does take place no later than March 31, 2018 in order for the binding contract exception to apply. Expatriates planning to purchase a home, especially in locations known for high housing prices, such as Hong Kong, Singapore, and London, would likely see the deduction of their mortgage interest limited and their ability to itemize deductions hampered, depending on the structure of the loan and rate of interest.
(D) State and Local Taxes
The temporary limitation on the deduction for state and local taxes is one of the most contentious topic for states with high taxes; there are already reports of discussions between state officials and businesses about alternatives to conventional income tax assessment.
Expatriates who have not broken tax residency with states, due to domiciliary or other reasons, particularly those that do not allow foreign earned income exclusion and/or foreign tax credit may like to reconsider their state tax residency in light of these changes.
(E) Foreign Real Property Taxes
Foreign real property taxes are no longer deductible, unless paid or accrued in carrying on a trade or business or for the production of income (e.g. residential rental overseas). Expatriates who purchased personal residence overseas would lose the ability to deduct foreign real property taxes they pay on these properties.
Prepayment Provision: Taxpayers who prepaid state, local, and foreign taxes in 2017 with respect to taxes imposed for a future year will only be allowed to claim the deduction in that future year and not in 2017. Similarly, the IRS issued guidance (IR-2017-210) on December 27, 2017 to clarify that property tax, even if prepaid in 2017, is deductible only in the year such a tax is assessed, as determined by state and local law, which is generally when the taxpayer becomes liable for the property tax imposed. The mere fact that the state or locality accepts prepayment before taxes are assessed is irrelevant.
(F) Foreign Income Taxes
Under pre-Act law, when deduction for foreign tax was not limited, it was usually more beneficial to elect for foreign tax credit in favor of claiming a deduction. Since the TCJA limits the deduction for (1) state and local property taxes as well as (2) state, local, and foreign income, war profits, and excess profits taxes (or sales taxes in lieu of income, etc. taxes) to $10,000 ($5,000 for MFS) in aggregate, electing for foreign tax credit may now be an even more attractive option for expatriates who claim itemize deductions with state and local taxes.
|Tax Cuts & Jobs Act
|Repealed from 2019 1
|Suspended until 2025 (except for members of the Armed Forces 2)
|Deduction threshold reduced to 7.5% for regular tax and AMT until 2018 3
|Limited to $750,000 ($375,000 for MFS) for loans after December 15, 2017 4,5
|Deductible as pre-Act law, subject to relevant limits 5
|Deductible as pre-Act law, subject to relevant limits of refinanced indebtedness 5
|Home Equity Loan
|Suspended until 2025
|State and Local Taxes
|Limited to $10,000 ($5,000 for MFS) 6
|Income Taxes or Sales Taxes
|Real Property Taxes
|Disallowed until 2025 6
|Cash Contributions Deduction Limit
|Increased to 60%
|College Athletic Event Seating Rights
|Personal Casualty Losses
|Suspended until 2025 (except to the extent attributable to a Federally declared disaster) 7
|Miscellaneous Itemized Deductions Subject to 2% Floor
|Suspended to 2025
|Limitation of Itemized Deductions for High Income Taxpayers
|Suspended to 2025
1 For (i) divorce and separation instruments executed after 2018 and (ii) those executed on or before December 31, 2018 but modified after that date, if the modification expressly provides that these amendments to the Internal Revenue Code apply.
2 Member of Armed Forces of the United States on active duty who moves pursuant to a military order and incident to a permanent change of station.
3 Retroactive from 2017.
4 Binding Contract Exception: Related indebtedness of up to $1 million would be deductible if (i) a written binding contract was entered into prior to December 15, 2017 to close on the purchase of a principal residence before January 1, 2018 and (ii) the purchase of such residence does take place before April 1, 2018.
5 For tax years beginning 2026, up to $1 million ($500,000 for MFS) of indebtedness may be treated as acquisition indebtedness, regardless of when it was incurred.
6 Taxes paid or accrued in carrying on a trade or business or for the production of income not subject to these limits and disallowance.
7 Personal Casualty Gains Exception: If a taxpayer has personal casualty gains, the suspension of personal casualty loss not attributable to a Federally declared disaster does not apply to the extent such loss is not in excess of the gains.
Enhancement of Child Tax Credit
The provision for Child Tax Credit under the TCJA largely follows the Senate amendment. Enhancements include the following, albeit only as temporary measures available for tax years 2018 to 2025:
- Doubling the amount of child tax credit for qualifying child;
- Substantially increasing the phaseout thresholds;
- Increasing the refundable portion of child tax credit while reducing the earned income threshold; and
- Providing a new nonrefundable “partial credit” for certain other dependents (see below for more information).
The increase in child tax credit and thresholds for phaseout are, indeed, welcome news as more expatriates should be able to benefit from the credit. Nevertheless, taxpayers with qualifying dependents aged 17 or above, for whom personal exemptions would have been allowed in full under pre-Act law because their Modified Adjusted Gross Income (“MAGI”) was below the thresholds for phaseout, may find themselves losing the benefits of these exemptions as the partial credit of $500 per non-qualifying child dependent might not quite make up for the increase in income taxable at their marginal tax rates. Fortunately, tax saving from the new tax rate schedules should generally be more than sufficient to offset the tax effect, at least for taxpayers who claim standard deduction instead of itemize.
Taxpayers whose filing status is Head of Household and inpatriates (i.e. foreign expatriates working in the U.S.) may be the hardest hit by these changes. Head of Household filers partly because the partial credit for non-qualifying child dependents is subject to a lower threshold for phaseout at MAGI of $200,000 (compared to $293,350 for personal exemptions) and partly due to the shift of taxable income from the pre-Act 33% bracket to the new 35% bracket. Inpariates because qualifying child dependents who reside in the U.S. on non-immigrant visas are now only eligible for the partial credit of $500 each and deduction for personal exemptions has been suspended until tax year 2025.
Child tax credit will only be allowed if Social Security Number (“SSN”) for the qualifying child is issued prior to the filing date date (including extensions) and included on the parent’s tax return. U.S. citizens, nationals, and green card holders whose children are born overseas but have not yet applied for a SSN should contact the nearest U.S. embassy or consulate to start the process as early as possible, especially if their children’s U.S. status have not been officially established by the Department of State.
|Child Tax Credit
|Pre-Act – 2018
|Tax Cuts & Jobs Act
|Child Tax Credit
|Maximum Refundable Portion
|Under the age of 17
|Eligible but SSN or ITIN required before return due date
|Eligible but SSN required before return due date
|Green Card Holders
|Other Resident Aliens
|Partial Credit for Certain Other Dependent (Nonrefundable)
|MAGI Phaseout Thresholds
|Married Filing Jointly or Qualified Widow(er)
|Married Filing Separately
|Head of Household
* Indexed for inflation and limited to $2,000
Repeal of Special Rule Permitting Recharacterization of Roth Conversion
With the enactment of the TCJA, the special rule that allows a contribution to one type of IRA to be recharacterized as a contribution to the other type of IRA no longer applies to a conversion contribution to a Roth IRA. For example, a taxpayer who rolled over or directly transferred money from a traditional IRA to establish a Roth IRA during the year will not be permitted to recharacterize the contribution to a traditional IRA (thereby unwinding the conversion).
While the provision does not shut out backdoor Roth IRA, which enables high income taxpayers to circumvent income and contribution limits, by converting traditional IRA into Roth IRA, it updates an antiquated code section that has allowed taxpayers to strategically recharacterize the losers and keep the winners, based on account performance, sometimes well after the close of the tax year if their returns have a valid extension.
Taxpayers who wish to recharacterize their Roth conversions for 2017 should have until the due date for filing their 2017 tax returns (including extensions) to do so, on the basis this provision is effective only “for taxable years beginning after December 31, 2017.”
New Election for Deferral of Income Tax on Qualified Equity Grants
The TCJA makes available, subject to certain limitations and conditions, an “inclusion deferral election” for a “qualified employee” of an “eligible corporations” to defer for income tax (but not FICA or FUTA) purposes, the inclusion of income attributable stock received in connection with options exercised or restricted stock units (“RSUs”) settled after December 31, 2017. Generally speaking, a corporation is an eligible corporation with respect to the calendar year in which such election is made if –
- no stock of the employer corporation (or any predecessor) is readily tradable on an established securities market during any preceding calendar year; and
- the corporation has a written plan under which, in the calendar year, not less than 80% of all employees who provide services to the corporation in the U.S. (or any U.S. possession) are granted stock options, or RSU, with the same rights and privileges to receive qualified stock.
Inclusion deferral election is made in a manner similar to how a section 83(b) election is made, within a 30-day window, and defers income inclusion to the tax year that includes the earliest of –
- the first date the qualified stock becomes transferable, including, solely for this purpose, transferable to the employer;
- the date the employee first becomes an excluded employee, that is, an individual:
- who was a 1% owner of the corporation at any time during the 10 preceding calendar years;
- who is, or has been at any prior time, the chief executive officer or chief financial officer of the corporation or an individual acting in either capacity;
- who is a family member of an individual described in (a) or (b); or
- who has been one of the four highest compensated officers of the corporation for any of the 10 preceding taxable years.
- the first date on which any stock of the employer becomes readily tradable on an established securities market; or
- the date five years after the first date the employee’s right to the stock becomes substantially vested; or
- the date on which the employee revokes her inclusion deferral election.
Taxpayers may make an inclusion deferral election with respect to qualified stock attributable to statutory option such as ISO and ESPP but should be aware that such options would be treated as nonqualified stock options (“NQSO”) and subject to FICA, regardless of the holding period. Similar to section 83(b) election, taxpayers intending to make an inclusion deferral election should carefully consider various risks, including the following, and educate themselves about the compliance requirements in advance –
- Being subject to tax based on a higher stock price, with reference to when the rights in such stock first become transferable or not subject to substantial risk of forfeiture, if the value of the stock is to decline during the deferral period; and
- Potential impact from changes in tax regime or rates.
Consolidation of Education Savings Rules
(A) Section 529 Qualified Tuition Programs (“QTP”) Funding for Elementary and Secondary Education
The TCJA expands QTP’s to cover expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school. Tax-free distributions from all plans for such expenses incurred during each year is limited to $10,000 in aggregate per beneficiary.
Coverdell education savings accounts (“ESA”) used to be favored, in part, by families that intend to send their children to private grade schools because distributions can be made tax-free for a range of related expenses, even though contributions are limited to $2,000 per year and subject to phaseout based on MAGI. As a result of these changes, more families, especially those with high income and would otherwise not be eligible for contribution to ESA’s, may now find QTP’s (which have no age, annual contribution, or MAGI limits) to be an attractive option.
(B) Contributions to Achieving a Better Life Experience (“ABLE”) Section 529A Acounts
Between tax years 2018 to 2025 only, the TCJA also allows rollovers, without penalty, from section 529 QTP’s to section 529A ABLE accounts provided certain conditions are met –
- Rollover is to an ABLE account of the designated beneficiary or a member of that beneficiary’s family; and
- Amount rolled over, when added to all other contributions made to the ABLE account for tax year, does not exceed the overall limitation, determined based on the prevailing per-donee annual gift tax exclusion ($15,000 for 2018).
During that same period, a designated beneficiary of an ABLE account may, after the overall limitation on contributions to such account is reached, make additional contributions (for which saver’s credit may be claimed) by meeting the following conditions –
- Additional contributions must be the lesser of:
- Compensation includible in the individual’s gross income for the tax year; or
- Amount equal to the Federal poverty line for a one-person household; and
- The individual (or a person acting on his/her behalf) must maintain adequate records for the purpose of and is responsible for ensuring that the requirements of contribution limitations are met.
Estate, Gift, and Generation-Skipping Transfer Taxes
The TCJA follows the Senate amendment to only double the basic exclusion amount for estate and gift tax from $5 million to $10 million (based on 2011 value), which translates to $11.2 million for 2018, after inflation adjustments. This is effective only for estates of decedents dying and gifts made after December 31, 2017 and before January 1, 2026. The provision offers no additional reprieve to expatriates who are not U.S. citizens and those with non-citizen spouses.
American Expatriate Tax is a part of Contexo Global Mobility Solutions & Tax Consulting Ltd. registered in Hong Kong. Together, we help companies and individuals navigate through the complexities of global mobility and related tax issues. Here is where you will find a blend of expertise from Big 4 accounting firms and Fortune Global 500 companies but the attention of a boutique consulting practice. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.