Barron's International Tax Service

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So What Is TIPRA?

Over the years the United States has concluded double taxation treaties with many countries around the world.  The purpose of these treaties is touted to benefit Americans living abroad so that their various forms of income are not taxed twice:  once by their country of origin and once by their country of residence.  Occasionally these treaties actually define which country has the right to tax certain forms of income.  For instance the treaty between Portugal and the United States says that Portugal has the right to tax pensions.  As a result, pensions can be excluded from income on Form 1040 as long as the correct accompanying schedule is filed.

Actually double taxation treaties enable tax authorities to exchange information with the result that the otherwise unwary expatriate living abroad finds him or her self confronted sooner or later by his failure to report all income to one or the other taxman.  Since tax audits are often three to four years behind tax filing deadlines, such failures to report enable the taxing authority to levy hefty fines.  Stateside American citizens and residents are required to report their worldwide income from all sources.  In numbers of countries including Portugal, Spain and France, residents are required to report worldwide income.  Presumably in this taxing process, the compliant taxpayer can exclude certain forms of income from taxation by one or the other country or else apply a tax credit on taxes paid to one country to offset taxes levied by the other country.  The rub is that an American expatriate can find his income double taxed in spite of complying with the filing requirements of the Internal Revenue Service.

Consider TIPRA.  Recently signed into law, TIPRA (Tax Increase Prevention and Reconciliation Act of 2005) extends the expiration date for taxing Capital Gains and Qualified Dividends at lower rates through 2010.  It increases the AMT (Alternative Minimum Tax) exemption amounts for single and joint filers.  It extends the $100,000 equipment write-off to the end of 2009.  It provides an unlimited ceiling on Roth IRA conversions after 2009.  It restricts passive income on dependent children.  It requires corporations with assets of $1b to make larger estimated tax payments.  It simplifies the tax free spin-off of controlled corporations.  It changes the rules for offers-in-compromise.  It limits tax-free housing reimbursements.  It revises taxation of US real estate owned by foreigners.  It imposes penalties on tax exempt entities that are parties to tax shelter transactions.  And it taxes income above the Foreign Earned Income Exclusion (FEIE) at rates that would apply without the exclusion.

What this last provision implies is that high income expatriates will be hard pressed to exclude their excess income from US taxation.  This means that anyone whose income passes the $82,400 FEIE threshold could se his or her tax bill increase in spite of this excess income having already been taxed by the foreign country of residence and the Foreign Tax Credit.

Another example of double taxation lurks behind the increased AMT exemption ($40,250 to $42,500 for single taxpayers and $58,900 to $62,550 for joint filers).  Taxpayer Smith earned $442,500 in 2005.  His regular tax on this income was $105,600 which was eliminated by the application of the Foreign Tax Credit (he had paid over $139,000 in foreign taxes on this income).  Because his income was more than $191,000, however, this exemption was completely eliminated from the AMT calculation with the consequence that $98,000 in taxes was potentially owed.  Had the $40,250 counted, this tax would have been lowered to $86,730 ($98,000 - 40,250 x 28%).  But unless this $98,000 liability can be eliminated, Smith ends up paying taxes on the same income to two countries ($98,000 + $139,000 - $105,600).  Of course for this taxpayer the increase in the AMT exemption for 2006 is meaningless, assuming his same level of income.  Even though a substantial part of Smith's $98,000 tax can fortuitously be lowered by applying another form of tax credit, the AMT is another example that illustrates how American expatriates can be double-taxed on their worldwide income.