Barron's International Tax Service

« The TaxBarron » Serving the American Expatriate Community

Double Taxation Can Affect Americans Abroad

In the past forty-four years, the Congress of the United States has vacillated in its tax treatment of Americans living abroad.  From 1962 it has in fits and starts raised the Foreign Earned Income Exclusion (FEIE) from $15,000 to $82,400.  In the interim, it actually eliminated the Exclusion for a time, replacing it with specific deductions.  In 1986, Congress limited the foreign tax credit for Alternative Minimum Tax (AMT) purposes.  Two years later, it did away with the marital deduction for property passing upon the death of a U.S. citizen to a non-citizen spouse, but then allowed $100,000 annual gift tax exclusion on property passing to the same spouse during the lifetime of the American citizen husband/wife.. 

The rub is that any American expatriate with earned income above the FEIE threshold could be subject to double taxation.  His or her income being fully taxed by the foreign country of residence’s tax authority, it can then be taxed above FEIE by the Internal Revenue Service.  A Foreign Tax Credit (FTC) is fortunately available to mitigate if not eliminate this above the threshold income being double taxed.  But understand that the word mitigate means to ‘make less severe’.  Meanwhile between 1986 and 2004 the FTC as applied to AMT was limited to 90%.    

Consider J.J.  In 2002 he earned $253,400 in salary from his European employer.  His income tax liability was $74,250, which was mitigated $71,500 by the FTC, leaving a remaining liability of $2,750 ($74,250 - $71,500).  AMT added another $64,500 to this liability, which the AMT FTC could reduce by $58,050 ($64,500 x 90%), leaving an AMT balance of $6,450.  So J.J. ended up owing the taxman $9,200 ($2,750 + $6,450) on earnings we must not forget are already fully taxed in his foreign country of residence. (This is a simplistic example.)

In 2004 Congress eliminated this 90% provision.  From 2005 AMT FTC became 100% (which doesn't mean you can't still be liable for AMT depending on circumstances).  But when President Bush signed into law the Tax Increase Prevention and Reconciliation Act (TIPRA) of 2005, American expatriate taxation came under siege.  FEIE was increased from $80,000 to $82,400 with a twist (see ‘New tax legislation set to hit Americans abroad’, in The Portugal News, 20 May 2006).  More foreign income could now be excluded from U.S. taxation.  But taxable income would henceforth be taxed as though the FEIE had not been applied.  What does this mean?

John and Marsha filed their joint tax return in 2005. John had the following income:  pension, $70,000; dividends, $28,000; interest, $16,000.  Marsha who is younger than her husband earned $75,000 profit from her clothing store.  Marsha’s income was fully excluded from U.S. taxation by FEIE.  In 2005 the couple’s taxable income was $97,600 (70,000 + 28,000 + 16,000 – 16,400 (Standard Deduction + two Exemptions), resulting in a tax liability of $17,700.  Assuming the same income amounts in 2006 for purposes of this example, John and Marsha’s tax liability without TIPRA should have been $17,400 (or slightly less than 2005) but instead will be $25,720; the reason being that Marsha’s foreign earned income under the new law is factored into the tax calculation.   And we haven’t yet talked about TIPRA and the Foreign Housing Exclusion.