Don't Mess With Taxes

It's Columbus Day, when we in the United States commemorate Christopher Columbus' landing in the New World back in 1492.

So it seems only fitting that today we look at the tax implications of working abroad.

OK, it seems fitting to me, especially since the IRS just made some adjustments to a new tax law that would have cost many U.S. employees living in other countries a lot of money.

First, some background. When U.S. citizens make money overseas, Uncle Sam wants a cut.

Yes, when you move abroad, the IRS travels with you, at least figuratively. America is one of the few nations that taxes its workers on worldwide income, meaning that regardless of where you earn your money, if you're a U.S. citizen or even resident alien, Uncle Sam wants his applicable portion of your pay, regardless of whether your pay is in Euros or Yen, Pesos or Rupees.

There are ways to reduce the amount the IRS gets of your international income. You're allowed to exclude from U.S. taxation up to $82,400 you earn abroad this year. That amount was increased in May when the Tax Increase Prevention and Reconciliation Act (TIPRA) became law.

But in addition to giving American taxpayers overseas a bit more of a tax break, TIPRA also took away much of the benefit of another break used by  many international workers, the exclusion for the cost of housing abroad. There's now a cap of $11,536 on the housing deduction.

Previously, international workers could use the U.S. tax rules to exclude or deduct most of their housing costs. That was particularly appealing for folks in countries with enormous housing costs, such as the Far East.

An even more frustrating aspect of the change: The housing limit was made retroactive, meaning that people who started out 2006 in another country planning to write off their housing costs suddenly were facing a potentially huge, unexpected IRS bill.

As soon as the housing cap change was made, American workers in countries with high housing costs cried foul, saying that under the new law they likely wouldn't be able to continue working abroad.

Heeding the housing-cap howls: The IRS heard the protests and has announced a change from the law's original, and in the opinion of many, paltry, annual housing exclusion of $11,536.

In this IRS notice, foreign-based workers will find a table (beginning on page four) of locations that the U.S. State Department has identified as countries with high housing costs. Based on this data, the housing expenses limits in those areas have been adjusted accordingly.

Be careful though. These figures are not the final amount of housing costs you can exclude from your income. Remember, we are talking about U.S. tax law, and that means figuring your actual housing exclusion is not that simple.

Tax calculations times two: Let's start with the new $11,536 cap amount. Under TIPRA, this figure was arrived at after making two separate calculations.

First, the base housing amount is now capped at 16 percent of the foreign earned income exclusion amount; in 2006 that would be $82,400 x 16 percent, or $13,184. Then a foreign-based filer's housing costs are limited to 30 percent of the income exclusion, less the base housing cap.

So this means a U.S. taxpayer who worked abroad all of 2006 would be limited to maximum housing expenses of $24,720 (the $82,400 earned income exclusion x 30 percent). And the maximum housing cost amount that taxpayer could exclude from income is arrived at by taking the $24,720 expense limit minus the housing cap figure of $13,184. Thus, the housing exclusion for the year is $11,536.

The notice of housing expenses states that taxpayers who work and live in the cities listed in the table now can use those figures in lieu of the law's original housing expenses limitation of $24,720. So if you're based, for example, in Hong Kong, you take that city's adjusted allowance of $114,300, subtract the cap amount of $13,184 (that we figured above) and now get to exclude $101,116 in housing costs on your 2006 taxes.

Of course, that's if you lived in Hong Kong for the whole year. If not, you have to make the calculations using the daily amounts (the third column) times the actual number of days you lived in that foreign city.

How do you say "math help, please?" in any -- every! -- other language?

More foreign tax blogs: If you want more detail on international taxes, then I recommend from milan to mumbai by Rutgers-Camden School of Law professor Mike Livingston, and Talking Tax, operated by my Bangalore-based blog buddy Lubna Kably (mentioned previously in this item).

Considering Columbus and his legacy: Although there are various other claims of actual "discovery" of America, since 1937 we've celebrated Columbus' arrival on our shores with his own special day. Thanks to the Monday holiday convention, it's been commemorated since 1971 on the second Monday of October.

Like most U.S. holidays nowadays, the historical connection is, at best, an afterthought.  For folks who get the federal holiday off, it provides a welcome three-day weekend. For retailers, another hook for a sale. New York and a few other cities hold an annual parade. For the postal service, it means one less day of home delivery. For most of us, though, it's just another day.

But maybe it shouldn't be. As we here in the United States continue to debate the issue of immigration, Columbus Day is a good reminder that most of us originally hailed from somewhere else. Whether our ancestors got here via political and territorial incursions, administrative channels or stealth, we're here now.

So before you head out to buy that half-price pair of shoes, I urge you to take a minute to recognize the various and ongoing contributions of all of us who share this nation.

OK, you're now free to shop.

Image is of Columbus' arrival is a photoreproduction from Theodor de Bry and Charles de la Roncière, La Floride Française: Scènes de la vie Indiennes, peintes en 1564 [facsimile of the 1564 original (Paris, 1928)], courtesy of the Library of Congress' Rare Book and Special Collections Division.