Global Watch - US expatriates will pay more US Taxes 

Background
 
Prior to the new bill taking effect, the foreign earned income and housing exclusions would have permitted certain US citizens and residents to exclude from their 2006 taxable income:

• A maximum of $80,000 annually of their 'foreign earned income' and
• Certain reasonable foreign housing expenses in excess of a base amount (currently 16% of the grade GS-14, step 1 amount), limited only to the taxpayer's foreign earned income.

The taxpayer's income tax was calculated on the taxable income remaining after the exclusion.

Changes
 
The foreign earned income and housing exclusions will change as follows for 2006:

1. Accelerate inflation indexing of the maximum $80,000 foreign earned income exclusion.  Previously, indexing for inflation was to begin after 2007.  With this change, the maximum foreign earned income exclusion for 2006 will be $82,400.
      
2. Change the way the base housing amount is calculated from 16% of a GS-14 salary to 16% of the foreign earned income exclusion limitation (computed on a daily basis).  This will increase the base housing amount to a maximum of $13,184 on an annual basis.
       
3. Generally limit the maximum amount of excess housing costs that may be excluded from income, to 30% of the foreign earned income exclusion limitation ($24,720 = $82,400 x 30%) less the base housing amount ($13,184 = $82,400 x 16%) resulting in a maximum 2006 housing exclusion of $11,536.
         
4. Apply an "exclusion with progression" methodology which adds back the exclusion to determine the rate of tax to ensure that international assignees are subject to the same US tax rates on income not excluded under Section 911 as taxpayers living and working in the US.

The bill also provides the Secretary with the authority to issue regulations or other guidance which would provide for an adjustment to the 30% housing cost.  This would apply in cases where geographic differences in housing cost exist, and provides the Secretary with the discretion to adjust the general 30% limit upward or downward as required.  It is intended that the Secretary make these adjustments on an annual basis.
 
Impact
 
As the following illustrations demonstrate, the US income tax impact of the new provisions varies widely based on the individual's income level, the cost of housing in a particular jurisdiction, and the foreign tax imposed by that jurisdiction.
    
For purposes of this illustration, we have calculated the impact of the changes to the Section 911 exclusion based on two variables.

• Low ($20,00), Medium ($50,000) and high ($100,000) housing costs
• No foreign tax, Low Foreign Tax (15%), Moderate Foreign Tax (30%) and High Foreign tax ($45%)

Each calculation is based on the following assumptions:

• Annual salary and bonus of $200,000
• Married filing joint status
• No dependents
• Standard deduction
• No outside income or losses
• All compensation, housing, etc. are taxed by the foreign location

No Foreign Tax Imposed

	Housing $20,000	Housing $50,000	Housing $100,000
Tax - Old Rules	$20,002	$22,002	$22,002
Tax After Tax Bill	$31,586	$40,306	$56,806
Difference	$9,584	$18,304	$34,804

15% Foreign Tax Imposed

	Housing $20,000	Housing $50,000	Housing $100,000
Tax - Old Rules	$6,938	$7,625	$8,773
Tax After Tax Bill	$18,956	$24,837	$36,062
Difference	$12,018	$17,212	$27,289

30% Foreign Tax Imposed

	Housing $20,000	Housing $50,000	Housing $100,000
Tax - Old Rules	$0	$0	$0
Tax After Tax Bill	$0	$0	$2,379
Difference	$0	$0	$2,379

45% Foreign Tax Imposed

	Housing $20,000	Housing $50,000	Housing $100,000
Tax - Old Rules	$0	$0	$0
Tax After Tax Bill	$0	$0	$0
Difference	$0	$0	$0

For countries which do not tax foreign housing (when provided as a benefit), the results are somewhat more dramatic. The calculations below assume that the foreign jurisdiction does not tax the housing costs.  Aside from that, the examples below use the same basic assumptions as before:

No Foreign Tax Imposed

	Housing $20,000	Housing $50,000	Housing $100,000
Tax - Old Rules	$20,002	$22,002	$22,002
Tax After Tax Bill	$31,586	$40,306	$56,806
Difference	$9,584	$18,304	$34,804

15% Foreign Tax Imposed

	Housing $20,000	Housing $50,000	Housing $100,000
Tax - Old Rules	$8,449	$10,888	$13,982
Tax After Tax Bill	$20,272	$28,279	$43,351
Difference	$11,823	$17,391	$29,369

30% Foreign Tax Imposed

	Housing $20,000	Housing $50,000	Housing $100,000
Tax - Old Rules	$0	$0	$0
Tax After Tax Bill	$0	$7,166	$22,144
Difference	$0	$7,166	$22,144

 45% Foreign Tax Imposed

	Housing $20,000	Housing $50,000	Housing $100,000
Tax - Old Rules	$0	$0	$0
Tax After Tax Bill	$0	$0	$0
Difference	$0	$0	$0

Observation: These changes will have limited negative impact on individuals paying foreign tax on foreign-source income at a rate that is higher than their US effective tax rate.  This is especially true where the individual has no US source income, as the foreign tax credit will continue to offset the US income tax on such foreign income.  Additionally, the change will only impact people in high tax jurisdictions to the extent of any personal income and/or attributable US workdays, and then only to the extent that these amounts exceed the standard or itemized deductions and allowable personal exemptions.  This is because the new stacking calculation will impose the tax on these items of income at a higher rate.  The new law will generally have a more significant impact on US taxpayers working/living in low or no-tax foreign locations.