updated 6:36 PM CET, Mar 18, 2023

Frustration across Expatland as ‘final Transition Tax’ regs published

American owners of small businesses who are resident outside of the U.S. are reacting with frustration, and in some cases dismay, to the news that the U.S. government has published its final draft of the so-called Transition Tax element of Donald Trump’s Tax Cuts and Jobs Act without taking into account concerns about what the legislation would do to them.

As reported here today, the Internal Revenue Service last week posted on its website what it said was the final draft of Section 965 of the Internal Revenue Code, which introduces a one-time, retroactive "Transition Tax" on the previously untaxed foreign earnings of foreign corporations (“controlled foreign corporations”, or CFCs), owned by U.S. shareholders.

 The 305-page package of regulations comprised the latest installment of a final version of the full TCJA that has begun gradually emerging from Washington lawmakers.

The regulations have yet to published in the Federal Register, which is normally the point at which such regulations become law, but the document published last week notes that this will be the next step. It's thought the delay is due to the ongoing U.S. government shutdown.

The Transition Tax, also sometimes referred to as the Repatriation Tax, is said to hit individual owners of small businesses and partnerships located outside of the U.S. particularly hard, because many of them had been counting on their set-aside corporate profits to either expand their businesses in the short term, or to rely on them later in life to fund their retirements. 

The Transition Tax rate varies depending on the situation but for some individual Americans abroad, who would be taxed at a top rate of 39% in 2017, it can run as high as 17.54% on liquid/cash assets and approximately 9% for fixed assets. The rate for corporations – including large companies of the kind the the legislation was designed to target – are taxed at a slightly lower rate, at 15.5% on liquid/cash type assets and 8% for fixed assets.

Given that non-American-owned small businesses won't be expected to pay this tax, many of those facing these new charges say it could make it difficult for any American expat owners of small businesses outside of the U.S. to compete with their non-American rivals – or even simply stay in business.

'Virtual confiscation of retirement plans'

One of the most exasperated of those interviewed by the American Expat Financial News Journal over the weekend and today about the new tax was John Richardson, a Toronto-based American tax and citizenship legal expert. 

“For Canadian-Americans this means the virtual confiscation of their retirement plans,” Richardson said.

“For other small business owners it means that they lose the capital that was being retained for future expansion, meaning that their dreams of growing their businesses are compromised.

“I know of people who have been hospitalized over the stress of this. I know others, who are already retired, who have had to mortgage their own homes to pay for this.

“To add insult to injury, the compliance costs – if one can comply – are crippling.

“This is, without a doubt, the most unjust, despicable atrocity ever imposed by the United States on its own citizens abroad."

Another Canadian who expressed displeasure at the news of the Transition Tax regs being finalized was Suzanne Herman, who lives in Vancouver with her husband – who is also a dual American/Canadian citizen – and with whom she shares the ownership and running of a small film business.

Herman, who first came to Canada at the age of 12 with her Canadian mother, says she is "beyond furious" over the way the Transition Tax "was progressed into law over the past 12 months with virtually no changes made, even though officials kept saying how the initial draft had been done in haste and would be fixed" in due course.

Like others interviewed, she believes that Washington officials were aware that the tax would have implications for expat small-business owners like her and her husband, yet they still opted not to fix the legislation accordingly, and that as a result, the Transition Tax and other elements of the Trump TCJA will effectively make it impossible for American expats to compete with non-Americans outside the U.S., unless they renounce their citizenships first. 

Herman insists the battle isn't over yet, though, and says she's urging other expats to join her in "contacting their [Congressional] representatives in the U.S. to support Congressman George Holding’s Tax Fairness of Americans Abroad Act (HR 7358)" in order to begin to address some of the issues affecting American citizens living outside the U.S.

Competitiveness issue

Also citing competitive concerns for Americans abroad going forward was Keith Redmond, a France-based American business consultant who is an outspoken advocate on American citizenship and tax issues.

The Transition Tax, Redmond says, will be "yet another reason" Americans overseas will find it increasingly difficult "to stay in, or even enter, the U.S. tax system."

"Those Americans overseas with small businesses who are in the U.S. tax system [now] are faced with two choices," he adds.

"They can [either] continue to comply and [risk] losing everything, including their retirement pots, as a result of the Transition Tax, or stop filing [U.S. tax returns]." 

The situation inadvertently will reward those Americans with small businesses who keep them out of the U.S. tax system, he points out – which possibly wasn't the U.S. lawmakers' intention.

'Can't be a technical fix'

One expert on the tax treatment of expatriate Americans who stpped short of joining in the chorus of general exasperation with the IRS document posted last week was Republicans Overseas chief executive Solomon Yue.

Noting that it's the job of Congress, not the U.S. Treasury, to draft legislation in the U.S., he said expats unhappy with elements of the Tax Cuts and Jobs Act should focus their efforts on persuading Congress to change the law as needed, rather than expecting the necessary fixes to come from the government's tax collection and revenue management agency.

"It requires a legislative solution," Yue said. "[Fixing the issues for small businesses that are created by the Transition Tax] can't be a technical fix."

A Republican senator, whom he didn't identify, "has been looking into the solution," Yue added.