It’s bad enough if you’re a U.S. citizen or permanent resident working outside the United States. Your co-workers from other countries only have to worry about paying tax in the country they’re working in. But thanks to the U.S. Tax Code, along with a Supreme Court decision from the 1920s, U.S. citizens must pay tax on their worldwide income, no matter where they live and work.
Ridiculous? Yes. But fortunately, the Tax Code contains an escape clause that allows you to earn up to $91,500/year tax-free (2010, adjusted annually for inflation) if you live and work outside the United States. If your spouse accompanies you overseas, you can double this exemption and jointly earn up to $183,000, free of U.S. income tax obligations. This provision is called the “foreign earned income exclusion” (FEIE).
However, Congress periodically tries to eliminate this benefit in the name of “fairness.” For instance, Sen. Chuck Grassley (R-Iowa) has repeatedly sought to repeal the FEIE. Back in 2003, he called it ”a tax loophole that forces you and me…to subsidize high-paid corporate employees and their companies.” Grassley and other opponents of the FEIE gloss over the fact that Americans working offshore often pay local taxes at higher rates than in the USA.
Now, a report from the U.S Treasury’s Inspector General for Tax Administration (TIGTA) is likely to spur further attacks on the FEIE. The report claims that “erroneous” claims for the FEIE cost the U.S. Treasury $90 million annually. It recommends that the IRS’ new Large Business and International Expansion initiative expand to encompass FEIE compliance. Indeed, the Inspector General wants the IRS to establish an ” international compliance unit” for this purpose.
Now, $90 million is a lot of dough. I wish I had that much in my account. But in the greater scheme of things, it’s not a lot of money, especially considering the costs of say, bailing out AIG ($150 billion and counting). Also, of the estimated 6 million Americans living offshore, only around 300,000 of them file for the FEIE. Essentially, the Treasury is singling these taxpayers who are attempting to comply with the Tax Code.
In any event, expect to see renewed attacks on Americans working overseas—and perhaps renewed efforts by Senator Grassley and his colleagues to eliminate the FEIE altogether. And if you’re an American working overseas, and claim the FEIE, be prepared for a tax audit.
If the FEIE were to be abolished, Americans working in high-tax jurisdictions could still take a credit for income taxes paid there against their U.S. tax liability. Indeed, if you work in a high-tax country, the foreign tax credit is often more valuable than the FEIE.
However, Americans working in jurisdictions with taxes lower than the United States would lose out. So would the Treasury, because I expect many of the taxpayers now filing for the FEIE would stop filing U.S. tax returns altogether. After all, if you live overseas and work for a foreign employer who doesn’t report your income to the IRS, the chances of getting caught may seem very low (although not as low as you might think). Others would seek a more permanent solution, and expatriate; i.e., give up their U.S. citizenship or permanent residence.
But don’t expect Senator Grassley, or his colleagues, to say anything about these unintended consequences. Their only interest is to sensationalize the problem, and turn public opinion against anyone who uses any means, however legitimate, to reduce their tax burden.
Copyright © 2010 by Mark Nestmann
