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Information provided on this site is for general guidance
only and is often simplified. Actual IRS procedures
are complex, and taxpayers should obtain professional
assistance or use IRS sources for complete information.
The
Tax Reconciliation Act 2005
Under the Tax Reconciliation Act 2005 (signed by President
Bush in May, 2006) the Foreign Earned Income Exclusion
was indexed to US inflation as of the 2006 tax year,
meaning that the maximum deduction in 2006 was $82,400,
up from $80,000 in 2005.
However,
the new law capped the Housing Exclusion at 30% of
the foreign earned-income exclusion, minus the 16%
of a Step 1 salary. For 2006, this set the cap at
$11,586; under the old law, the exclusion was virtually
unlimited.
Another significant change, known as a 'stacking'
provision, was designed to tax US-source income as
if it was earned on top of the excluded foreign income;
previously, the excluded foreign income was disregarded
in calculating taxable US income. Evidently, this
has pushed many taxpayers into a higher tax bracket
for their US-source income, affecting many middle-income
people - higher-earning individuals are probably already
in top tax brackets.
The
IRS confirmed that:
"Effective
for tax years beginning after 2005, the amount of
foreign earned income (and foreign housing costs)
excluded from an individual's gross income will be
used for purposes of determining the rate of income
and alternative minimum tax (AMT) that applies to
his or her nonexcluded income."
"The
Tax Increase Prevention and Reconciliation Act of
2005 (P.L. 109-222) adds a new section 911(f) to the
Internal Revenue Code. An individual's tax will be
the excess of the tax that would be imposed if his
or her taxable income were increased by the amount(s)
excluded, and the tax that would be imposed if his
or her taxable income were equal to the excluded amount(s)."
"For
this purpose, the excluded amount(s) will be reduced
by the aggregate amount of any deductions or other
exclusions otherwise disallowed. In many cases this
will have the effect of increasing an individual’s
U.S. federal income tax to an amount greater than
it would have been under prior law."
When tax credits are available against the additional
taxable income (they cannot be claimed in respect
of excluded income), then if the foreign income was
taxed highly, as is the case in most of Europe, there
may be no signicant effect on after-tax income; but
if the foreign location has low income taxes or none
(as in many offshore locations, eg Bermuda), then
the 'stacking' provision will hit home.
In reality, many multinational corporations will have
no choice but to pay the higher tax bills of expat
executives. Many employers already offer either tax
reimbursement or tax equalization. Under the former,
the employer pays the tax on expat benefits such as
school fees and home leave, which are considered income;
under the latter, it pays the difference between actual
tax liability and what the executive would have paid
at home.
It
was anticipated at the time thar the legislation was
introduced that it would lead to a tendency for multinational
corporations to employ fewer Americans; and less incentive
for the expats themselves to want to work abroad.
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