On December 13, 2017, a preliminary agreement was reached on a final tax bill that would significantly overhaul the Federal tax code. Titled the “Tax Cuts and Jobs Act,” the tax legislation represents a collaboration to sort out the key differences between the House and Senate proposals.
While the official text of the bill has not been publicly released as of this release, here’s what you need to know.
U.S. Domestic Mobility Programs:
Moving Expense Deduction
There has been agreement between both the House and Senate to repeal the moving expense deduction effective January 1, 2018. This means that costs currently excluded from taxation associated with the following categories of relocation expenses would become taxable for U.S. individual income tax purposes:
- Household goods moving expenses
- Storage expenses
- Final Move Travel expenses
The immediate impact for consideration will be whether these expenses will be grossed-up by employers going forward. Assuming the intent of the employer is to gross these expenses up and not put this added tax burden on the employee, you should consider taking the following actions:
- Update your relocation policy to include these costs as covered expenses for tax purposes. Any changes would likely require an approval process internally as well as a communication plan for both internal stakeholders and impacted employees.
- For any relocations in process or in the pipeline, consider preparing an updated cost estimate to incorporate the added tax burden.
- Consider the financial impact on the company going forward. You could review your total costs over the past year(s) for these categories and apply a gross-up percentage to those costs. Based on our experience with our clients, we’d estimate using a gross-up amount between 60%-70%. For example, if you determine your average moving expense cost is $7,500 per move, the tax burden and added cost for your program in 2018 would be estimated at $4,500-$5,250 per move. You could then extrapolate this over your anticipated relocation volume going forward and adjust your budget(s) and/or accrual(s) accordingly.
On the positive side, relocation taxation will be simplified as the IRS criteria currently leveraged to determine the exclusion of these costs would no longer be required. This would include the distance test (50 mile rule) and the time test (the 39 week rule). Also worth noting, while no guarantee, is that most states currently adhere to Federal tax rules and we anticipate that these states will continue to follow this approach tied to the changes from the proposed Federal tax bill
In addition, while the tax cost may increase for these relocation expenses going forward, the potential broader impact to your company may be less, assuming the company can incorporate these added costs to reduce its corporate tax exposure.
Potential Impact on Itemized Deductions and Benefits Provided
It has been widely reported that under the preliminary agreement reached, the mortgage interest deduction threshold will be reduced to $750,000. This represents a compromise between the previous House ($500,000) and Senate ($1m) proposals. There does appear to be agreement that Home Equity Line of Credit (HELOC) debt will no longer be deductible as well as mortgage points paid. There is the possibility that certain loans will be grandfathered under the current rules, but what’s anticipated is that any new mortgage debt will fall under these rules going forward.
Also noteworthy under the compromise reached this week is that a cap of $10,000 has been agreed for any combination of state and local property, sales and income taxes. This means that individuals living in high tax states like California and New York could see a significant reduction to their itemized deductions. Likewise, individuals living in low or no tax states like Texas or Florida may see little or no impact from this change. However, there has been acceptance in both the House and Senate throughout the tax reform process that the standard deduction would increase to approximately $18,000-$18,300 for single filers and $24,000-$24,400 for joint filers.
For mobility managers, there are several actions that we’d recommend for consideration as follows:
- Another impact we anticipate is that employees may be more resistant to moving to high income/property tax states and/or purchasing a home in the new location. Consideration should be given to how this might impact acceptance rates for relocations going forward and what modifications to your policies need to be considered to address the potentially lower acceptance rates.
- If your relocation policy provides a mortgage interest subsidy benefit or reimbursement of mortgage points, while these are taxable benefits and includible as taxable income, our experience has been that most companies have only grossed them up for social tax purposes on the assumption that the individual would deduct these on his or her individual income tax return(s). With the potential deductibility of these two benefits ceasing, you should consider whether these are benefits you want to continue to provide as your tax cost to gross them up for Federal and State purposes, in addition to social taxes, will increase.
- Anticipating decline in the number of individuals that will itemize their deductions going forward, this could push company gross-ups higher. For example, the company will still have the obligation to gross-up for State tax purposes, but may no longer reap a tax benefit on the Federal tax return.
Change to Exclusion of Gain on Sale of Primary Residence
Throughout the tax reform process, the House and Senate have been aligned on making a change to the rules under IRC Section 121 governing how the calculation of the gain on the sale of a primary residence is calculated. Under the current rules, an individual must live in and own the property for 2 out of the previous 5 years prior to sale. Under the proposed legislation, this period will increase to 5 out of 8 years and only allow the exclusion once every 5 years. Further, income thresholds have been introduced whereby the exclusion of income would be phased out dollar for dollar for higher earners ($250,000/single; $500,000/married). We anticipate the exception available under IRC Code Section 121 which allows for a prorated exclusion for anyone relocating for a job change would still be available. However, we also anticipate that the proration period would be based on the 5 out of 8 years under the new legislation. We also noted that, under the Senate bill, sales completed under a binding contract as of January 1, 2018 would still qualify under the current rules.
From our perspective, this change has several implications for mobility programs. We have summarized these below.
- Employees considering relocating and taking advantage of home sale programs that currently qualify for the gain exclusion may no longer qualify or may receive a prorated exclusion tied to the income thresholds or longer holding period required. We see two likely outcomes as a result. First, the employees may be inclined to retain their home (i.e. rent it out) instead of selling it. This could save companies considerable cost if they don’t have to pay out the home sale benefits and any applicable gross-ups. You may want to consider offering property management in your policy to accommodate this potential trend. Alternatively, employees will sell their home and incur a partial or fully taxable gain. You will need to consider what your policy states today and if you’re willing to add in any language to cover the added Federal and State (if applicable) income tax burden tied to the taxable gain.
- Employees, now being limited to claiming the gain exclusion once every 5 years, may be less inclined to purchase in the new location. Instead, they will choose to rent and may not require any home purchase benefits included in your policy.
- For group moves within the US, this exposure for employees to be taxable on the sale of their primary residency would be magnified by the high volume. As a mobility manager, it would be prudent to undertake an analysis of the price appreciation of home values in the location your employees are primarily moving from. This may give you some indication on whether your employees may be facing potential tax bills. It would also be beneficial to provide group tax briefings to explain the new home sale rules and impact of any differences in State and local property and income taxes between the two states.
- We highly recommend adding the benefit of an individualized tax briefing as well as tax preparation for the transfer year to your current mobility policies. In our experience, this will provide important and valuable information to your employees on the tax impacts of the move and take much of the confusion and ‘noise’ out of the program.
- Some employees will exceed the income thresholds introduced in the legislation as a result of added income from taxable relocation expenses and the applicable gross-ups. This could expose the employee to considerable additional Federal and State (if adopting Federal rules) taxes. Whether you decide to provide tax gross-up or tax protection against this added tax burden, we recommend that you are prepared to address this tax impact in your policy.
Comparison of the Tax Brackets: In the preliminary agreement reached earlier this week by Republicans, the top tax rate was reduced from the original proposals (House @ 39.6% and Senate @ $38.5%) down to 37%. A comparison of the tax brackets under current law and the GOP proposal, for example, is provided below and incorporates the new 37% rate.
COMPARISON OF TAX BRACKETS
SINGLE FILERS CURRENT LAW vs. GOP TAX PROPOSAL
10% on income from $ 0 – $ 9,325 vs. 10% on income from $ 0 – $ 9,525
15% on income from $ 9,326 – $ 37,950 vs. 12% on income from $ 9,526 – $ 38,700
25% on income from $ 37,951 – $ 91,900 vs. 22% on income from $ 38,701 – $ 70,000
28% on income from $ 91,901 – $191,650 vs. 24% on income from $ 70,001 – $160,000
33% on income from $191,651 – $416,700 vs. 32% on income from $160,001 – $200,000
35% on income from $416,701 – $418,400 vs. 35% on income from $200,001 – $500,000
39.6% on income from $418,401 and up vs. 37% on income from $500,001 and up
Note: The personal exemption deduction would reduce from $4,050 to $0.
COMPARISON OF TAX BRACKETS – MARRIED FILERS
CURRENT LAW vs. GOP TAX PROPOSAL
10% on income from $ 0 – $ 18,650 vs. 10% on income from $ 0 – $ 19,050
15% on income from $ 18,651 – $ 75,900 vs. 12% on income from $ 19,051 – $ 77,400
25% on income from $ 75,901 – $153,100 vs. 22% on income from $ 77,401 – $140,000
28% on income from $153,101 – $233,350 vs. 24% on income from $140,001 – $320,000
33% on income from $233,351 – $416,700 vs. 32% on income from $320,001 – $400,000
35% on income from $416,701 – $470,700 vs. 35% on income from $400,001 – $1,000,000
39.6% on income from $470,701 and up vs. 37% on income from $1,000,001 and up
Note: The personal exemption deduction would reduce from $8,100 to $0.
Upon review of the proposed tax brackets above, there appears to be an intent to lower the overall tax burden for most individual filers. That said, each individual’s tax situation could dictate otherwise. From a corporate mobility perspective, we anticipate that gross-up percentages may decline slightly when the final bill is revealed from a high-level perspective. However, when considering the impact of other changes proposed in the tax reform—such as the reduction to itemized deductions–it is entirely possible that any savings from the lower tax brackets could be offset by these and increase the cost of tax gross-ups. It is important to note that we anticipate supplemental withholding percentages may change as well as a result of having new tax brackets. Based on the anticipated changes in the tax brackets, you should consider the following impacts and actions:
- Review your gross-up methodology internally or with your RMC or tax firm to determine if it provides the desired outcome for your program going forward. We anticipate that there will need to be some transition time following the passing of the tax reform to update cost projection software and/or gross-up software, so please keep this in mind when considering this step.
- As a result of the tax reform, employees may be more sensitive to how the gross-ups are calculated and if they have been made whole or have been positively or negative impacted. We recommend that your policy is clear on your gross-up methodology and that there is clear communication with your employees when receiving their tax report at the end of the year summarizing their grossed-up relocation expenses.
Impact on Company Payroll
Recognizing that we are about to begin a new calendar tax year in the U.S., it’s highly likely that company payroll systems will be delayed in implementing the new tax rates and rules. That said, typically payroll providers wait for guidance from the Internal Revenue Service (IRS) in order to implement any changes to the payroll withholding software. While we anticipate that payroll providers will move as quickly as possible to modify their programs, we do anticipate that any companies that manage their payroll in-house on their own systems may be further delayed in implementing the changes. We recommend the following:
- Any gross-ups that you process early in the new tax year before the payroll systems are updated may need to be reconciled these later in the year to ensure that the withholding aligns with the new tax rates and your methodology. We suggest having an open dialogue with your provider and/or in-house payroll department to have a plan to address this.
- It’s highly likely the majority of employees on U.S. payroll will need to provide an updated W-4 form to account for the changes forthcoming. While this may not be specific to mobility, you would want to ensure the correct state form(s) are completed for the new work location and are reflective of the tax changes.
Additional Observations for Consideration
- We do not anticipate the favorable tax treatment of home sale programs to be impacted by the new legislation as it’s not been specifically addressed by the House or Senate.
- Under the preliminary agreement, the Alternative Minimum Tax (AMT) for individuals would remain, but the thresholds would be increased to exclude any individual under $500,000 in earnings and married couples under $1m in earnings. This should reduce the number of employees that are unexpectedly impacted by AMT when filing their tax returns and potentially facing an under-funded gross-up.
- There appears to be agreement that the child tax credit will increase to between $1,600-2,000, but a phase-out of the credit may still exist.
International Mobility Programs with US-touching Inpats/Expats:
Impact of Changing Tax Brackets
As outlined above in the tables, we anticipate significant changes to the tax brackets for individual tax filers. For U.S.-based expats who are currently or anticipated to go on an international assignment abroad, this will have immediate impact on their personal tax responsibility. If tax equalized to the U.S. and your policy allows for hypothetical itemized deductions, the hypothetical tax will be impacted. As hypothetical tax is a pre-tax deduction, this will have a direct impact on your program tax costs. So, for example, if your expats’ hypothetical taxes reduce collectively, this will increase the cost of your US outbound assignments.
For U.S. inbound assignments where the employee is tax equalized to their home country, any difference in tax costs will have a direct impact to company tax costs. What’s unique for consideration is that many countries outside of the U.S. tax on a “territorial” basis, which means they tax individuals based on where the income is earned. That said, for inbounds into the US on long term assignments, they will typically break tax residency in their home country for actual tax purposes (individual fact patterns need to be considered). So any tax increase or decrease in the U.S. (as the host country) would directly impact the company.
Here’s a summary of potential actions to consider:
- We recommend that you recalculate the hypothetical tax of any U.S. outbound employees tax equalized to the U.S. to reset their withholding. It is important that the hypothetical taxes being deducted are accurate to minimize the potential for large over/under payments when the tax equalization calculation is prepared. Depending on when you implement merit increases or incentive compensation, you may be able to time the hypothetical tax reset to align with this and provide a catch-up for the year to date all at the same time.
- You should work with your tax advisor to communicate clearly with your U.S. expats on any changes to the hypothetical tax deductions. Otherwise, you may experience some “noise” when the annual tax equalizations are completed in the following year and their expectations aren’t set.
- For your U.S. inbound population that are tax equalized to their home country, it will be important for them to understanding any changes in what they will need to report going forward on their U.S tax returns.
- For any permanent transfers to/from the U.S. that are responsible for their own worldwide tax liabilities, it will be very important to communicate these changes to them. We highly recommend authorizing a tax briefing for them with your tax advisor to discuss the changes to the tax law and specifically how this will impact their tax situation(s). For example, if you have an US inbound permanent transfer that purchased a home in the US, the change in the rules outlined above for the sale of a primary residence and deductibility of home mortgage interest and property taxes will be of critical importance to them.
Impact of Change to the Exclusion of Gain on the Sale of a Primary Residence
Most tax equalization policies are very specific on whether the gain on the sale of a primary residence is covered under the policy. Alternatively, many tax equalization policies also include a cap on how much personal income is tax equalized (i.e. $10k, $25k, 50k), thus limiting the company’s exposure. If your policy specifically includes coverage of the tax on the gain on the sale of a primary residence or has a cap on personal income being tax equalized and includes in its definition the sale of a primary residence, the added exposure that more individuals selling homes will face a tax liability creates exposure for the company under the policy.
Additionally, employees on short or long term assignments to/from the U.S. typically experience a significant increase in their reportable income due to assignment allowances. With the income thresholds being introduced whereby the exclusion of income would be phased out dollar for dollar for higher earners ($250,000/single; $500,000/married), this could create a real hardship for these expats that might otherwise qualify for full exemption of tax.
- Consider reviewing your tax equalization policy language to determine how home sale gains are treated. If you currently cover this in your policy, you may want to consider a) removing this benefit completely; b) reducing the amount you will cover (i.e. introduce a cap); c) redefining what is included on personal income; or d) making no changes and assuming the added exposure.
- Consider addressing situations where assignment allowances increase an employee’s tax on the sale of their primary residence. While this could become a common occurrence for U.S. expats while on assignment, it could also impact them in years following repatriation where there are lingering reportable compensation items.
Deductibility for Foreign Property Taxes
Currently under consideration is the continued deductibility of foreign real property taxes, other than those incurred in a trade or business. The draft legislation has indicated that these would no longer be deductible. This could potentially increase the cost of long term U.S. inbound tax equalized assignments. Further, for permanent transfers into or out of the U.S. that own foreign real property, this deduction would no longer be available to them, increasing their personal tax liability for Federal and potentially State tax purposes.
Tax Impact of the Moving Expense Deduction on International Assignments
Similar to domestic relocations, the repeal of the exclusion of qualified moving expense reimbursements discussed above would increase the tax cost, potentially considerably, when sending employees on international assignments to/from the U.S.. It’s important to understand that the qualified moving expenses, while now being subject to U.S. tax and grossed-up, could also further be taxable in the other country moving to/from.
- In our experience, most short and long term assignment policies, permanent transfer, and local+ polices provide a gross-up for relocation expenses that are considered taxable in the home or host country. We recommend that you review your current policies and ensure that they include these costs as covered expenses for tax purposes. Alternatively, you may consider changing your philosophy on whether you will gross-up relocation expenses on international relocations or whether you may want to reduce the amount of the benefit provided to reduce your tax exposure. Any changes would likely require an approval process internally as well as a communication plan for both internal stakeholders and impacted employees.
- For any international relocations in process or in the pipeline, consider preparing an updated international cost estimate to incorporate the added tax burden. You should also consider amending any cost projections for active US-touching assignments to quantify the impact of the relocation costs tied to repatriation to the home country. We’d recommend updating your accruals accordingly with your business units.
- Consider the financial impact on the company going forward. You could review your total costs over the past year(s) for these categories and apply a gross-up percentage to those costs. Based on our experience with our clients, we’d estimate using a gross-up amount between 60%-70%, noting that you may want to look at these case by case due to the significant differences in tax rates between various countries.
Topics discussed are meant to provide general information and should not be acted on without professional advice tailored to your company’s individual needs.
- IRS Publication, Moving Expenses
- BDO Federal Tax Alert, December 13, 2017
- Tax Reform Update: Moving Expense Deduction Proposed for Repeal, Worldwide ERC