The American tax season is here and independent taxation specialist Calvin Tong is back with some helpful information for U.S. citizens filing in 2018 — and some pointers to bear in mind when planning ahead for 2019. Tong, who is based in Tokyo, has assisted Lifelines with previous columns on taxation issues.
First up, there are some changes this year for Americans living in Japan to be aware of. Can you tell us about these?
In December 2017, the U.S. government passed the Tax Cuts and Jobs Act (TCJA). Most of its provisions start from tax year 2018. This means that while it affects what people do now and should be taken into account in any tax planning, it actually won’t be a filing matter until the spring of 2019.
Although the biggest changes were in areas that benefit U.S. corporations, a) some of the provisions affecting the individual may be relevant to Americans in Japan, and b) perhaps to a greater extent, affect Americans who own businesses in Japan. That being said, it may be better to discuss what hasn’t changed in order to provide context to what has.
OK, so what didn’t change?
For those of us who work for a company or are self-employed in Japan, the main tax breaks are the Foreign Earned Income Exclusion (FEIE) and foreign tax credits. These stay the same. One can earn up to $102,100 in wages (for 2017) without triggering a tax. Foreign tax credits can help mitigate the earnings above those thresholds. These benefits remain intact.
Also unchanged is the Net Investment Income Tax (NIIT). This is a tax to subsidize former President Barack Obama’s health care law (aka “Obamacare”) for our fellow citizens living in the U.S.
The foreign asset reporting forms also remain unchanged. Due to high penalties, irrespective of any earnings derived, one should pay careful attention to these forms. Here are those likely to be have the most relevance for Japan Times readers:
Report of Foreign Bank and Financial Accounts (aka FBAR or FinCEN114): Required if non-U.S. financial accounts are over $10,000. Penalties can start from $10,000 — or, if “ignored willfully,” from $100,000 or confiscation of half the unreported assets, whichever is higher.
Form 8938 (aka the FATCA form): Required if non-U.S. financial accounts are over $400,000 on Dec. 31 or over $600,000 at any time during the year if filing MFJ (married filing jointly). Or, if over $200,000 on Dec. 31 or over $300,000 at any time during the year for any other filing status. Penalties can start from $10,000.
Form 5471: Required if one has partial or full ownership in a K.K. (kabushiki gaisha or incorporated public company) or G.K. (gōdō kaisha or limited liability company). Penalties can start from $10,000.
Form 3520: Required if receiving gifts or inheritances of more than $100,000 in a year from a non-U.S. person, even if that person is a spouse. Penalties can start from $10,000.
So, what are some of the changes that will affect filing in 2019?
Firstly, in general, tax rates have been lowered, which is a good thing for bank balances overall. Although this will have little or no effect on people on who are covered by the FEIE and foreign tax credits, for those who aren’t covered, the lowered tax rates should help a bit.
The second major change is in the deduction areas. The standard deduction will be doubled, while the personal exemption will be eliminated. Currently, the standard deduction is $6,350 for those filing single or MFS (married filing separately), and $12,700 for those using MFJ. The personal exemption is $4,050 per household member. From 2018, the standard deduction will be raised to $12,000 for single and $24,000 for MFJ. Along with the disappearance of the personal exemption, the math here says that single people or small families will benefit, while large families will lose out.
Although the U.S. media have made a big deal out of the lost benefits of the itemized deduction option, it should not be a factor for most of us in Japan, as we do not file state taxes, nor have high property taxes and mortgage interest associated with more expensive properties in the U.S.
Those who are claiming a personal exemption for a noncitizen/non-green cardholder spouse will no longer be able to do so.
Third is the elimination of the “Obamacare” individual mandate. This will probably mean that the Form 8965 Health Coverage Exemptions will be eliminated. (However, the NIIT mentioned above remains in effect!)
What is this corporate repatriation tax that we’ve been hearing about?
In the beginning, I mentioned that the biggest changes are at the U.S. corporate taxation level. As with individual taxation, the U.S. tax system is unique in that it encompasses earnings derived from overseas.
Under the old rules, U.S. multinationals would have been hit with a high “repatriation tax” had they brought their profits earned from overseas back to the U.S. Thus, many of these companies preferred to keep their cash outside so as to avoid this tax.
Under the new rules, companies will be assessed a one-time tax on accumulated earnings held overseas. At 15.5 percent, it will be relatively low. It is effective for funds held before Jan. 1, 2018 — in other words, it may affect some 2017 filings.
These changes have two objectives: 1) To encourage U.S. companies to bring their cash back home with minimal tax cost. The funds may then perhaps be used to build more factories or hire more people in the U.S. 2) To pave the way for a significantly different corporate tax system called territorial taxation (TT).
Under TT, U.S. multinationals should henceforth be taxed only on profits earned within the United States. Earnings from overseas should, in principle, not be taxed. TT is not new and is the standard for other countries, and thus the U.S. will now be conforming to the global norm.
However, there may be potentially unintended and negative consequences, of which the 15.5 percent repatriation tax is one. This may affect Americans overseas who own companies that don’t do business in the U.S. The best example in Japan is the K.K.
These issues are still being sorted out by outside analysts at the time of writing. The Internal Revenue Service has yet to provide guidance in concrete language. The Instructions for Form 5471 — which is where the new rules should be addressed — was last updated in December 2017, and only makes references to the older 2015 tax law changes. (For such business owners, I recommend the helpful article from Advisor.ca in the links at the end.)
An interesting, and potentially positive, thing to come out of TT is that it may pave the way for territorial taxation for individuals (TTFI). TTFI means that for Americans living overseas, we should have U.S. filing obligations only if we have income derived from there. For those paid via gensen chōshūhyō, (tax withholding slip, like a U.S. W-2) and whose bank accounts are entirely in Japan, filing U.S. tax returns should no longer be required.
Efforts were made to try and get TTFI incorporated into the new U.S. tax bill during its deliberations last year, but ultimately failed. The fact that TT for corporations is becoming law, however, establishes a precedent, so that perhaps TTFI will find a place at the lawmakers’ table in the future.
Any tips to share with our readers as they grapple with their filings?
Pay more attention to the non-U.S. asset-reporting forms than the tax returns. The high penalties, irrespective of any earnings derived, make them scary! The IRS has an “amnesty” program in place, known as the Streamlined Procedures. I encourage anyone who has failed to file in past years to take a look at this.
Focus on trying to reduce Japanese taxes rather than U.S. taxes. Not only are taxes here higher for those with a reasonable level of income, but the FEIE and foreign tax credits should mitigate much of it on the U.S. side.
For American owners of local corporations, hold off on filing Form 5471 until better guidance emerges. Your deadline for filing for the 2017 tax year can be extended to Oct. 15, 2018.
Finally, are there any helpful websites out there that you would recommend?
For the 2018 tax filing season for tax year 2017: bit.ly/forbesUStax