One of the much-touted aspects of the new tax laws that came into effect at the start of 2018 is the abolishment of the personal exemption and the increase of the standard deduction.
These changes are part of the “tax reform” bill passed in late 2017 whereby ordinary individual taxpayers are supposed to benefit from a simpler system and a lower overall tax bill. I put the words “tax reform” in quotes because, well, I have opinions.
In today’s discussion, I will examine how these changes will impact people who expatriate in 2018 and later years, and specifically, expatriates with low income.
The personal exemption has been around in various forms since 1913, and the standard deduction since 1944.
Both tax return items have seen a number of changes over the years, both in the amount a taxpayer can claim, and in the manner in which the item is applied against income.
To make a very long and possibly boring story short, in recent years the standard deduction has been applied as approximately $6,000 off the amount upon which tax is computed for single filers (double that for married couples filing jointly), and the personal exemption has been approximately $4,000 each for you, your spouse, and each of your dependents.
For a family of four, this adds up to about the first $30,000 of income not being subject to tax, assuming that they do not itemize deductions.
The massive set of new tax laws that passed in December 2017, commonly referred to as the Tax Cuts and Jobs Act, changed the way the standard deduction and personal exemption are applied effective January 1, 2018.
The personal exemption is gone entirely, at least until 2025. You will see it appear for the last time on 2017 tax returns.
The standard deduction has increased substantially – almost double what it was for 2017. For 2018 it will be $12,000 for single filers and $24,000 for joint filers. There is now less of a motivation for taxpayers to claim itemized deductions unless they have substantial deductible expenditures.
To return to our example above for a family of four, under the 2017 system the first $30,000 of income will be tax free. Under the 2018 system only the first $24,000 of income will be tax free.
The difference between the two is mitigated by increased child tax credits and other benefits here and there that taxpayers can take advantage of, so the average family is likely either a little worse off or a little better off than before, but with no extremely significant change to their overall tax situation.
Taxpayers who change their US residency status in a tax year typically have what is called a “dual-status” tax year. For part of the year you are a US tax resident, and for part of the year you are not.
There are a set of rules for how you determine the end of your US residency, which you can find in IRS Publication 519.
This is the most common situation for expatriates to be in: they renounce their citizenship or turn in their green card at some point other than December 31, typically, and according to the rules for residency termination dates, they report their income for part of the year as a resident and for part of the year as a non-resident.
In a dual-status tax year, you report your income separately for the two periods. For the period of US tax residency, you compute tax on your worldwide income. For the period of non-US tax residency, you compute tax only on your US source income according to the normal rules for nonresidents.
In addition, there are some special rules that apply to dual-status returns. The IRS has created Publication 519 and a special web page to make this information available to taxpayers.
The items from the special rules that are relevant to our discussion today are the following:
The rules for dual-status returns say you cannot take the standard deduction, and there are limitations on how you can apply the personal exemption.
The 2018 tax law changes eliminate the personal exemption and substantially increase the standard deduction.
If you are an expatriate in 2018, you will probably be planning to file a dual-status return. You will not be able to take advantage of the personal exemption, because it is gone, and you cannot use the now-doubled standard deduction, because it is not allowed on dual-status returns.
Contrast this with 2017, where you would at least get a personal exemption for yourself on a dual-status return.
This puts people who expatriate in 2018 and later years in a slightly worse situation than those who expatriated before 2018. For low income taxpayers, a “slightly worse” situation can be a pretty bad thing.
If it will be detrimental to you to lose the standard deduction on your expatriation year tax return, think about ways that you can plan your income and organize your life so that you can lower the amount of income that is subject to US tax before expatriating.
For each situation, there may be a different answer. Being aware of the issue at least allows you to look for ways to fix it.