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By Thomas S. Bissell, CPA
Although there has been much discussion recently about changing the U.S. tax rules that apply to foreign income earned by U.S. corporations, there has been very little discussion about changing the U.S. tax rules that apply to cross-border "expatriate" workers. However, the proposed Tax Reform Act of 2014 would repeal the deduction for "moving expenses" under §217 for both domestic and international moves.1 Depending on a particular employee's facts, the proposal in many cases could increase the cost to U.S. multinationals of sending employees abroad, because of the "gross-up" cost that the employer would often feel obliged to incur in order to induce its employees to make the move.2
Despite the potential cost to employers and/or employees if §217 is repealed, the proposed repeal of §217 must be viewed in the much broader context of overall tax reform. The proposal to repeal §217 is dwarfed in the proposed Tax Reform Act of 2014 by additional proposals to repeal a number of other individual deductions, including the deductions for medical expenses, for most state and local taxes, and for unreimbursed employee expenses (among many others) – all within a framework, however, that would reduce individual tax rates and repeal many "stealth taxes" (such as the individual alternative minimum tax (AMT) and the Pease deduction phaseout). Accordingly, this commentary takes no position on the advisability of repealing §217 with respect to cross-border employees and/or their employers. It does, however, attempt to analyze the possible U.S. tax ramifications of the proposed repeal on cross-border employees.
In evaluating the possible repeal of §217, it should be stressed that since 1993 the expenses that qualify for §217 have been much more limited than they had been prior to the 1993 amendments. Under present law, a §217 deduction is allowed only for travel costs for the employee and his/her family to the new work location, and the cost of moving the family's household goods. Prior to 1994, a deduction was also allowed for additional expenses, such as househunting trips, temporary living expenses at the new work location, and certain expenses related to the sale or lease of the former residence and the purchase or lease of a new residence. Nevertheless, the cost alone of moving household goods and personal effects to or from a foreign location can easily add up to tens of thousands of dollars.
However, in addition to limiting the deduction to actual moving expenses, §217 under present law contains several additional rules that benefit only employees who are (or have been) working abroad. Section 217(h)(1) allows an employee who makes a "foreign move" to deduct the cost of storing goods during part or all of the period during which he/she works abroad, and to deduct the cost of moving goods to or from storage during the foreign move. This deduction is not allowed to individuals who make a wholly domestic move. In addition, §217(i) allows a deduction for "qualified retiree moving expenses" where an individual who was working abroad retires and moves back to the United States. (A similar deduction is allowed for "qualified survivor moving expenses," where a working spouse dies while living and working abroad and the surviving spouse moves back to the United States.) Again, this particular rule is not available to an employee working within the United States who retires, or to such an employee's surviving spouse.
Where a U.S. citizen or resident alien moves from the United States to a foreign country, the moving expense reimbursement (which is included in gross income under §82) is usually classified as foreign-source income under Reg. §1.861-4(b)(2)(ii)(D)(6).3 Therefore, if §217 is repealed and if the individual moves to a country where personal income tax rates are higher than the comparable U.S. rates, U.S. income tax on some or all of the reimbursement would often be sheltered by foreign tax credits on the individual's regular salary under §901 (either currently or during the 10-year carryforward period).4 If the individual moved to a low-tax country or to a "tax haven," however, U.S. tax on the reimbursement would often not be indirectly reduced, with the result that in many cases the employer might want to "tax-protect" the employee by reimbursing him or her for the U.S. tax (as "grossed up") on the reimbursement. Although in theory the reimbursement would qualify for the §911 exclusion, in many cases the employee's regular salary and other taxable allowances would exceed the relevant dollar amount of the §911 exclusion.
Where a U.S. citizen or resident alien who has been working abroad moves back to the United States, the §82 moving expense reimbursement is often classified as U.S.-source income, although if the employer and employee satisfy the requirements of Reg. §1.861-4(b)(2)(ii)(D)(6), the reimbursement may be classified as foreign-source, and thus eligible to be sheltered by any excess foreign tax credits that the employee may have.5 As noted above, where the employee retires and moves back to the United States, §217(i) generally allows the moving expense deduction. If §217 were to be repealed, paragraph (i) would no longer be relevant, but presumably the §861 regulations (if fully complied with) could still be relied upon so as to classify the reimbursement itself as foreign-source. Thus, if the individual had excess foreign tax credits, part or all of the reimbursement might be sheltered from U.S. tax under §901.
Comparing the net U.S. tax effect "with" and "without" the §217 deduction is actually a bit more complicated in the case of employees moving abroad from the United States, because: (1) if following the move the employee claims the §911 exclusion, part or all of the §217 deduction would be disallowed under present law as allocable to excluded income;6 and (2) the portion of the deduction that is not disallowed under §911 would usually be allocable to foreign-source income in calculating the individual's allowable foreign tax credit, a calculation that usually would reduce the amount of the individual's allowable credit and potentially generate excess credits.7 However, in the case of individuals moving to lower-tax foreign countries whose total compensation packages are well in excess of the §911 amount,8 the proposed repeal would often result in a U.S. tax increase.
In the case of aliens who move to the United States to work, the U.S. tax analysis is different. The §82 reimbursement would typically be classified as U.S.-source income and would be taxable, whether the alien were a resident alien or a nonresident alien on the date it was paid (although in some cases a tax treaty exemption might be available). With respect to an alien moving out of the United States at the end of the U.S. assignment, any reimbursement would be taxable to him or her if the employee were still a resident alien when it was paid, but tax-exempt if it were paid after the individual had resumed nonresident alien status and it was classified as foreign-source income. On the basis of the §861 regulations, however, the reimbursement would probably be classified as U.S.-source income (and thus taxable in any event) if the employer had promised "up front" to reimburse the employee for moving back to the home country.9 Of course, to the extent that the reimbursement is U.S.-source income, there would be no foreign tax credits available to shelter the income.
If §217 is repealed, an obvious question is whether a deduction for some or all of an individual's moving expenses might nevertheless be deductible under the "employee business expense" rules of §162. The answer would seem to be no, because under current law §162 and §217 are probably mutually exclusive. Where an individual is temporarily away from his or her "tax home," a deduction is allowed under §162(a)(2) for "traveling expenses," including the cost of moving household goods that accompany the individual during the temporary move. However, §162(a) was amended in 1992 to provide that a taxpayer would not be considered to be "temporarily away from home during any period of employment if such period exceeds 1 year." Thus, where a foreign move is expected to last for more than one year, a deduction as an alternative to §217 would not be allowed. Even where such a deduction might be allowed (for example, if a foreign move would not exceed one year), no deduction is allowed for the travel costs of other household members, or for the cost of shipping their goods.10
Although it is impossible to know at this point how the possible repeal of §217 might affect specific U.S. industries or companies (and their employees), undoubtedly industry-specific estimates will be developed if and when it becomes more likely that the proposal will be enacted. The revenue will be $8 billion over 10 years, according to an estimate by the Joint Committee on Taxation, although that estimate might not include the deduction effect to employers who may feel obligated to tax-protect their employees on the amount of the §82 reimbursement.
If the §217 deduction does come under closer congressional scrutiny during the next few years as part of comprehensive individual tax reform, it may nevertheless be appropriate to consider retaining §217 for foreign moves. As noted above, §217(h) and §217(i) for many years have included special provisions for individuals working abroad. Thus, if Congress considers the repeal of §217, it should nevertheless consider retaining it for individuals who move outside North America,11 at least in situations where it is likely that the cost of moving household goods to or from an overseas location (and/or storing them in the United States) could be extremely high.
This commentary also will appear in the January 2015 issue of the Tax Management International Journal. For more information, in the Tax Management Portfolios, see Maule, 503 T.M., Deductions: Overview and Conceptual Aspects, Blessing and Lubkin, 905 T.M., Source of Income Rules and in Tax Practice Series, see ¶2870, Moving Expenses, ¶7150, U.S. Persons – Worldwide Taxation.
Copyright©2015 by The Bureau of National Affairs, Inc.
1 See §1412 of the proposed Tax Reform Act of 2014, released by the then-chairman of the House Ways and Means Committee on February 26, 2014 and introduced as H.R. 1 on December 10, 2014. The Ways and Means Committee's announcement of the proposals is at http://waysandmeans.house.gov/news/documentsingle.aspx?DocumentID=370987, which contains links to the text of the bill and to a section-by-section summary of the bill. For a detailed discussion of all of the bill's proposals by PricewaterhouseCoopers, see http://www.pwc.com/en_US/us/tax-services/publications/insights/assets/pwc-overview-ways-means-chairman-camp-tax-reform-discussion.pdf. The bill would leave intact the provisions of §82, which require an individual to include in gross income moving expense reimbursements that are paid on the individual's behalf.
2 The proposal could also have an impact on self-employed individuals (including partners in partnerships) who move abroad, and who are also entitled to claim moving expense deductions under §217. This commentary primarily discusses the potential impact on employees.
4 Although this author has not made a study of how moving expense reimbursements are treated under the tax laws of other members of the Organization for Economic Cooperation and Development (OECD), this author believes that they are tax free in most of these countries, although sometimes within certain limitations.
5 The regulation provides that if before the initial move the employer and employee agree that the employer will reimburse the employee's expenses for moving "back home" at the end of the assignment, the reimbursement at the end of the assignment will be sourced in the same way as the reimbursement at the start of the assignment.
7 In either case the net effect could be a partial or total disallowance of the §217 deduction, depending on the individual's facts. In some cases, therefore, the repeal of §217 might not result in a net increase in U.S. taxes.
10 If the move does qualify under §162(a), however, the cost of temporary lodging in the foreign country would be deductible by the employee (or non-taxable to him or her, if reimbursed by the employer pursuant to an "accountable plan"). For further details on tax planning involving the "tax home" rules, see Bissell, 6820 T.M., International Aspects of U.S. Income Tax Withholding on Wages and Service Fees, at XII.B.
11 Not covering moves within North America would be based on the assumption that the cost of moving household goods to or from Canada or Mexico is roughly equivalent to moving them between two locations within the United States.
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