BC-WSJ--Tax Report,1568

Tax hike hits home for Americans abroad

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By CRIS PRYSTAY

and

TOM HERMAN

A new tax law that ratchets up costs for many Americans working overseas could change company hiring practices in certain countries -- and is causing some employees to consider coming back home.

The increased taxes are hitting hardest at American expatriates working in places where housing costs are high and local taxes are relatively low, such as Russia, Hong Kong and Singapore. The higher costs can fall on employers, some of which guarantee that their workers don't pay more in taxes than they would if they were living in the U.S. But many Americans living abroad aren't offered such guarantees, known as tax equalization, and must shoulder the increases on their own. The law, part of a broader tax bill signed in May by President Bush, is retroactive to Jan. 1.

In other places, such as some European countries where taxes are higher than in the U.S., American expats are little affected by the new law. That's because those workers already pay large sums in their host countries, which can be used to offset any U.S. tax liability. "In Germany we're lucky, because we pay such high taxes," jokes Jodi Gentilozzi, a partner at accounting firm Deloitte & Touche GmbH.

Among those most affected by the change are Americans earning relatively high salaries. Under the old law, Americans working abroad could exclude as much as $80,000 of their foreign-earned compensation, plus certain foreign housing costs, when they filed their U.S. taxes The new law increased the $80,000 limit slightly to $82,400 for this year, but income above that level now is subject to much higher tax rates. For many, the most significant change is that the new law greatly reduces the maximum amount of housing costs that workers abroad may exclude or deduct. Under the new law, there's a cap of $11,536 for 2006, although the Treasury Department has the authority to change this for places with especially high costs. In Hong Kong, it isn't unusual for an employee earning $200,000 in salary to pay as much as $50,000 in annual rent. Before the change, Americans typically could exclude or deduct the vast majority of these housing expenses.

Marc Halpern says he earns about $200,000 a year as a vice president at a major U.S. financial-services firm in Singapore. He figures his tax bill will rise by about $12,000 next year, an increase he will have to pay out of his own pocket. In part, this is because he pays $27,800 a year in rent. He says it's tough to find anything cheaper in Singapore to house a family of four. "The plan was to stick around a few more years, but in the last few weeks, I have given some thought to heading back to the States, in part because this is a significant burden," he says.

Peak International Ltd., a supplier of packaging for high-tech products, recently dismissed one American employee because of the new tax law and expects soon to decide the fate of two others, says President Dean Personne. Peak also must decide what to do with three additional Americans that work at its Hong Kong headquarters, including Mr. Personne himself.

"One option is to go back to the U.S. and just travel back and forth. But I don't think we can do that. You can't run a company that way," Mr. Personne says. To keep the three Hong Kong-based staff where they are will cost Peak an extra $120,000 a year, he says. "We're a relatively small company. Those kinds of costs are a big deal for us," he says.

Other companies say they can't reduce the number of Americans they employ abroad, and will have to swallow the extra cost. "Wall Street is still the most important market, and we need to employ people (in Asia) who have Wall Street experience," says a spokesman in the region for a U.S. investment bank. He says the bank may consider putting more of its new hires on local terms -- which means they won't get tax-equalization benefits and will have to foot any extra charges themselves. "But when it comes to hiring the right person, you do what it takes to get them," he says.

Other investment banks, including Merrill Lynch & Co. and Credit Suisse Group, say they are still evaluating the potential impact of the new tax law.

The impact of the new law can vary widely depending upon such factors as where an American lives and the details of that person's compensation and housing costs. Nobody knows for sure how many U.S. citizens are working in other countries, but Americans working abroad filed about 306,000 tax returns claiming the foreign earned income exclusion for 2003, the latest data available. Of those, about 126,000 returns had any U.S. tax liability.

Heavy equipment maker Caterpillar Inc., which currently employs about 1,000 Americans abroad, says the tax change could cost the company $15 million to $20 million a year and "means we must take a serious look at alternatives to continuing to place U.S. employees in international assignments." It called the change a "barrier to competitiveness," adding that the countries where it would be "most impacted" are "Japan, Switzerland, Singapore and China."

Oil giant Exxon Mobil Corp. says it will cover any additional tax liability that its U.S. expatriate employees may incur, but that the new law will have a "very small impact financially" on the company. Chevron Corp. says it currently has no plans to alter its policies regarding hiring expats or helping them to pay their taxes. Still, Chevron says it "is currently assessing the impact of the recent tax law change."

The new tax law has left many Americans, especially those working in Asia, feeling frustrated. "I think there are a lot of misperceptions out there about expats," says Peak International's Mr. Personne. "The vast majority is middle-income wage earners -- they're engineers, midlevel accounting managers -- they're not the top end, living the life of luxury over here," he says.

American Chambers of Commerce abroad, including those in Paris and Tokyo, have protested against the tax changes. The new tax law will cut down on the competitiveness of American hires at global companies, says Nicholas de Boursac, executive director of the chamber in Singapore. "If somebody suddenly costs $30,000 or $40,000 more, people who hire will think 'Am I better off with an Australian or New Zealander who's going to cost me less?'"

Andrew Somers, chamber chief in Moscow, was in Washington last month trying to win concessions from Treasury officials on the new law's housing exclusion, because the department has the discretion to provide relief in jurisdictions where this exclusion is unreasonable. Average annual rents for expat executives in Moscow range from $60,000 to $180,000, well above the new $11,536 cap, Mr. Somers says.

An American earning $1,000,000 in Russia pays $271,741 in U.S. taxes under the old rules and $315,259 according to the new ones, the Moscow chamber estimates. That is 143 percent more than what a European would pay, it says.

Sen. Jim DeMint, a South Carolina Republican, introduced a bill last month that would eliminate U.S. taxes on income Americans earn while living and working abroad. This would "help put U.S.-based companies and their workers on a level playing field with the rest of the world," he said. But prospects for the bill becoming law anytime soon appear slim amid congressional concern about budget deficits.

MORE TAXPAYERS join a "high income" club, an IRS report says.

About 2.5 million individual income-tax returns reported adjusted gross income of $200,000 or more for 2003, a new IRS publication says. That was up slightly from 2.4 million the prior year. For each of those years, the total represented just under 2 percent of all individual returns filed.

Of those "high income" returns, 2,416 showed no world-wide tax liability for 2003. That was down from 2,551 returns in 2002 and 2,875 for 2001.

More details are in an article by the IRS's Brian Balkovic in the latest issue of the IRS's Statistics of Income Bulletin.

BRIEFS: Federal estate- and gift-tax revenues rose to nearly $21.2 billion in the nine months ended June 30 from $18.4 billion in the year-earlier period, the Treasury Department says. ... Individuals reported "non-cash" donations, such as corporate stock and clothing, valued at $36.9 billion for 2003, the IRS said. Of that total, corporate stock donations were the largest type, representing about 37 percent of the total value deducted.

Long Reach

A new law sharply raises U.S. taxes this year on some Americans working abroad. Here's how it works:

Expats can exclude $82,400 in foreign earnings from their U.S. taxable income, slightly more than under the old law.

Income above that exclusion level now is subject to much higher effective tax rates than before.

The maximum in overseas housing costs that workers may exclude or deduct has been greatly reduced, though Treasury can grant exemptions.