2017 Tax Reform For US Expats: Either Nothing Changes or Everything Changes
If you're an expat entrepreneur with a business making more than about $100k per year in net income, tax reform is ushering in a whole new world. For everyone else, nothing too exciting is changing.
Written by Stewart Patton
Timing Note
This article was originally written shortly after the 2017 tax reform. I’m leaving it up for a few reasons:
- Lots of old articles on the internet still act like it’s 2016, so this will still be news to some people.
- If you need to get caught up on past tax returns, you still may need to file for the 2017 tax year (and each year after that).
So, even though some aspects of this article are no longer breaking news, the core message is still relevant.
Tax Reform is Here
Move over Rudolph (with your nose so bright). The star of the 2017 Christmas season was the Tax Cuts and Jobs Act of 2017, which was enacted into law while we were all decking the halls and donning our gay apparel.
Even though tax reform was heavily covered in the news, very little of that coverage discussed the impact on expats. So, let’s jump in and see how Americans who live outside the US will fair under the new tax plan.
First, the Basics
Let’s make sure we’re all on the same page before diving into the details.
As an American citizen or green card holder, you are subject to US tax on your worldwide income no matter where you live. Simply living outside the US is not a fundamentally different thing to do than living in the US when it comes to US tax–you don’t get to stop thinking about US tax right when you board that outbound plane.
However, even though US tax is still a part of your life, there are several special rules that allow you to reduce your US tax bill. These rules may allow you to pay zero (or very little) US tax while you live outside the US.
For Most Expats, Nothing Changes
Maybe we’ve discovered the reason for the lack of tax reform coverage for expats–for most expats, absolutely nothing will change.
Sure, some of the general provisions that apply to everyone will also apply to expats. So, you may lose certain itemized deductions in exchange for the larger standard deduction, and the other general tinkerings and technicalities may affect you to some degree.
However, the tax reform bill doesn’t make any changes at all to the mainstay provisions for expats: the foreign earned income exclusion, the foreign housing deduction/exclusion, or the foreign tax credit (as applied generally to individuals).
New to expat tax? Click here to learn how it all works.
Also, tax reform doesn’t completely exempt Americans who live abroad from US tax. An earlier bill would have done exactly that (making the US more like every other country in the world), but it didn’t pass.
But for Expat Entrepreneurs . . .
If you own a business, then tax reform definitely rocked your world. Everything you’ve known and loved about US tax and legal structuring for expat entrepreneurs got shaken up; for some of you, it will turn completely on its head.
Under pre-2017 law, the best legal structure to operate your business through was a non-US corporation (as long as you don’t have people on the ground in the US running your business). A non-US corporation provided two groups of benefits before tax reform:
First, on the first about $100k of net income from your business, your non-US corporation allowed you to pay zero US tax. Your non-US corporation did away with the following three things, which would otherwise cause you to pay US tax on that first about $100k:
- The self-employment tax (which is about 15% on the first $118k);
- The scaleback rule (which reduces the effectiveness of the foreign earned income exclusion for a self-employed person with gross income over about $100k); and
- If you have a business where “capital is a material income producing factor” (e.g., Amazon FBA), the 30% rule (which allows a self-employed person in these businesses to only treat up to 30% of net income as foreign earned income).
Second, on your non-US corporation’s net income above about $100k, pre-2017 law allowed you to defer US tax by leaving the money in the company. You only had to pay US tax on these retained earnings when your non-US corporation paid the earnings to you as either (i) a salary in excess of about $100k or (ii) a dividend.
Here’s how tax reform changed things:
- On the first about $100k of your business’s net income, the new law didn’t change anything at all. You can still pay zero US tax on the first about $100k each year by operating your business through a non-US corporation. So, your non-US corporation is still necessary and beneficial—-it would NOT be better for all expat entrepreneurs to scrap their non-US corporation and instead operate through some other legal entity.
- However, on your business’s net profits above about $100k, the party’s over basically. You’re now required to pay US tax at standard ordinary income rates on the amount your business makes in excess of your salary (i.e., the amount that was previously the retained earnings of your non-US corporation). The ability to defer paying US tax on this amount by leaving it in your non-US corporation is just over and done with.
- It gets a little worse. As a transition from the old regime to the new regime, your 2017 income includes all of the retained earnings of your non-US corporation.
So, here’s the bottom line after tax reform: Being an expat allows you to operate your business through a non-US corporation, which gets you the first about $100k tax-free. However, on the amount above about $100k a year, you pay US federal income tax just exactly like you lived in the US.
A Glimmer of Hope for Some
The rules discussed above after tax reform apply only when the non-US corporation is a “controlled foreign corporation,” which is generally a non-US corporation where US persons own more than 50%. In certain situations, it may be possible to shift ownership of your company in ways to avoid “controlled foreign corporation” status.
For example, if you’re married to a non-resident alien, you could decide to give them a big kiss and half of your company. Then try to stay on their good side from here on out.
Now, I hesitated adding this section of the article because some people will get really bad ideas here. You can’t just put your uncle Igor’s name on the shareholder register and flip the bird to the IRS–you have to actually shift real beneficial ownership of your business. No shenanigans allowed.
Get your Tax Reform Plan Together
Before tax reform, a non-US corporation was all you needed for US tax purposes (and then of course you would typically have a US limited liability company under your non-US corporation so you can bank in the US). The non-US corporation was the go-to structure for all expats and digital nomads.
After tax reform, a non-US corporation is still clearly the best choice if you’re just starting out. So, if you already live outside the US (or are about to board that big bird to freedom), and you’re just starting your business, setting up a non-US corporation is still a great idea–that’s the only way to pay zero US tax on the first about $100k. To learn more, click here to register for my free Masterclass.
However, a non-US corporation may not make sense in other situations. For example, in certain cases, it may be best to include a US C corporation in your structure. Yes, that’s right, tax reform is turning the world upside down–using a US C corporation in your structure may actually be the best way to reduce your worldwide tax bill. Also, in certain other situations, an S corporation may be the best structure.
For new expats who already have a business, especially if it’s making over $100k of net income, there’s no more one-size-fits-all solution. We should talk so I can prescribe the best structure for your particular situation.
Have questions? Book a call so we can put together your personal tax reform survival plan.
