Just
when it seemed Uncle Sam had forgotten those Americans living abroad, the
IRS and Congress have again changed the expat tax laws involving Americans
living and working abroad. The new tax provisions take effect for
the 2006 tax year and will benefit many expatriates and hurt others.
For many years
the foreign earned income exclusion has been set at a maximum of
$80,000 of earned income for those working and living abroad. That
exclusion has been increased to $82,400 for 2006, and $85,700
for 2007. To qualify for that exclusion you must live and work abroad
for a full calendar year or work abroad for a 12 month fiscal year period
and not return to the US more than 35 days during that 12 month period.
This change is obviously good for everyone. For partial tax years
the exclusion is pro-rated.
The not so
good part of the change involves the tax that will now be imposed on the
income (foreign or from the US) that you make in excess of the foreign
earned income exclusion. Under the old law, all taxable income in
excess of the exclusion on your expat tax return began to be taxed in the
lowest brackets (as if you had no previous income) and then the
rate increased as the amount in excess of the exclusion increased.
Under
the new tax law, all income in excess of the exclusion will now be taxed
at the same tax bracket as it would have been taxed if the $82,400 exclusion
had also been taxed. Therefore, for 2006 each dollar of income you
make over the maximum exclusion amount will be subject to a 28% tax bracket
rate if are single whereas previously it would have only been subject to
a 10% tax rate. This will cause a lot of high earning Americans in
low tax countries to pay taxes since the higher bracket may not be totally
offset by the credit of their Mexican income tax.
The next change
in the expatriate laws involves the foreign housing exclusion or foreign
housing deduction. Those expenses would be rent expense on your foreign
residence plus cleaning, maintenance and utilities incurred in connection
therewith. The housing deduction or exclusion is allowed in addition to
the maximum foreign earned income exclusion and therefore comes into play
when you exceeded that maximum amount. Previously in 2005, you could
deduct all of these housing expenses in excess of approximately $12,000
without any maximum limit. Now for 2006 you can only deduct these expenses
in excess of $13,184 up to a maximum of $11,536 in most of the world. The
IRS has published Notice 2006-87 which gives a higher maximum deduction
to those living in countries with a higher cost of living. Hong Kong
is the highest with the maximum over $100,000. So if you are paying high
rent, utilities, etc.
You can no
longer deduct those amounts. If you own your foreign residence, you
can still deduct all of your property taxes and mortgage interest on Schedule
A but with some exceptions you cannot use the housing exclusion or deduction.
Remember, if
you live abroad on 4/15/07, your 2006 return receives an automatic extension
until June 15th, but any tax due (as it may be for the first time in 2006)
is payable on April 15th to avoid imposition of interest and penalties.
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