US Expats Hit By New Tax Rules

by Mike Godfrey, Tax-News.com, Washington

22 June 2006

After recent legislation worseneed the position of US citizens working abroad, the Center for Freedom and Prosperity Foundation has released a research study indicting Section 911 as hurtful for the economy.

On June 20, the CFPF released a research paper examining the taxation of Americans living and working abroad. Entitled "Making Section 911 Universal is Good Economic Policy and Good Tax Policy," the study is authored by Dr. Yesim Yilmaz, a research fellow with CF&P Foundation. Dr. Yilmaz finds that imposing a second layer of tax on overseas Americans is bad tax policy. Double-taxation hurts the American economy and employment, both domestic and overseas. The solution is for Congress to make Section 911 universal so that there is no double-taxation of foreign earned income, just as Senator Jim DeMint has proposed in his legislation the Working American Competitiveness Act (S. 3496).

Dr. Yilmaz also suggests that lawmakers should remove all caps and limitations that are currently attached to Section 911. The forgone revenues would be trivial, especially compared to the gains to employment, exports and the overall economy, and improvements in the tax code.

Andrew Quinlan, CF&P Foundation ~ "Policy makers recently made the tax law more onerous for overseas Americans. Dr. Yilmaz's study explains why this was a mistake and points the way to a pro-growth, territorial system."

Daniel Mitchell, The Heritage Foundation ~ "In a competitive global economy, the United States cannot afford to impose discriminatory taxes on American workers and American companies. The CF&P Foundation's new study shows how double-taxing overseas Americans is anti-competitive."

Veronique de Rugy, American Enterprise Institute ~ "The United States is the only developed nation to double-tax citizens who live and work abroad – thus putting the US tax code to left of the French tax code. Dr. Yilmaz explains why a territorial tax system is better for America."

The Tax Increase Prevention and Reconciliation Act of 2005, signed into law on May 17, generally is a pro-growth legislation, says the study, but it has significantly increased the tax obligations of American citizens who live and work overseas.

'A last-minute amendment attached to the bill has curtailed — and for some expatriates, effectively eliminated — Section 911 benefits, which allow US workers abroad to protect a portion of their overseas compensation from being hit by a second layer of taxation by the Internal Revenue Service. (Overseas Americans must pay all applicable taxes to the government of the country where they live and work, just as foreigners who live and work in the US pay tax to the IRS). The amendment retroactively increases the total allowable foreign-earned-income exclusions from $80,000 to 82,400. But this limit now includes housing benefits (which were previously separate from income exclusions) , and also requires expatriates to stack their residual income on top of the excluded amount before determining the rate at which they ought to pay taxes. Both these changes will lead to significant tax increases for many overseas Americans.'

'Senator Chuck Grassley (R, Iowa), who slipped the last minute amendment into the Act, maintains that this move will help pay for the tax breaks introduced by the same Act, and make the US tax system fairer by closing the tax gap between US residents and expatriates.'

Senator Grassley is wrong on both counts, says the CFPF.

' First, the potential tax revenue gains from the recent changes are modest, especially compared to the associated losses in exports and employment. The new limitations are expected to generate $200 million every year in additional taxes from Americans who live and work abroad. At the same time, one study estimates that the near-elimination of the housing allowance will reduce US exports by $2.5 billion, or add 25,000 more people into the pool of unemployed. Second, while this amendment indeed makes the tax treatment of expatriates and US residents more similar, it would tax the expatriates at even higher rates compared to their competitors from other nations (no other developed nation taxes the employment income of its citizens that live and work abroad), while forcing expatriates to pay for public services they will not get to enjoy.'

In return, the increased tax burden threatens the livelihood of expatriates because it makes hiring US citizens more expensive compared to potential employees from countries with no home-tax requirements. Given these serious problems expatriates are now facing, it is not clear how the new changes make the US tax system "fairer", says the study.

'Curtailing Section 911 is bad economic policy and bad tax policy. Double-taxing US citizens who live and work overseas is bad economic policy because it hurts US employment abroad, and consequently stifles US exports and employment here at home, without generating tax revenues large enough to justify these losses. By increasing the costs on US companies that hire expatriates, double taxing also hurts US's overall competitiveness around the world. Limiting Section 911 benefits is bad tax policy because it makes the US tax system unfair and complicated, and renders compliance too costly, and sometimes, impossible.'

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