U.S. Tax Reform as it Relates to Mobile Employees, both Domestic and International

The U.S. Tax Cuts and Jobs Act that was signed by President Trump on December 22, 2017, is said to be the most significant tax legislation in over three decades.  Most of the changes that were introduced went into effect January 1, 2018.  This alert will highlight several areas of the tax reform legislation that domestic relocation program managers and global mobility program managers should consider as it relates to their programs, their company and their assignees. 


Ordinary Income Tax Rates

The new tax brackets that went into effect on January 1, 2018, are 10 percent, 12 percent, 22 percent, 24 percent, 32 percent, 35 percent, and 37 percent.  The new rate structure is effective for tax years beginning in 2018 but will cease to apply after December 31, 2025.  As a result of the change in ordinary income tax rates as well as the changes to itemized deductions, the standard deduction, and the elimination of personal exemptions, which will be discussed below, program managers should consider updating U.S. hypothetical withholdings, where applicable, and budgeted cost estimates to ensure there are no surprises for the individual assignee and the domestic relocation and/or global mobility budgets.


Itemized Deductions

While many itemized deductions are still allowed, the new tax legislation significantly limits the amount an individual can claim. 

  • State and local income taxes, state and local property taxes, and sales taxes are limited to $10,000 in the aggregate.  This cap does not apply to personal or real property taxes incurred in carrying on a trade or business or otherwise incurred in or for the production of income. 
  • Foreign real property taxes are no longer deductible unless they are incurred in carrying on a trade or business. 
  • The deduction for home equity indebtedness, Home Equity Line of Credit, is eliminated.  Home acquisition indebtedness incurred on or after December 15, 2017, is limited to $750,000.  Debt incurred before December 15, 2017, is “grandfathered” so the maximum mortgage interest debt threshold remains at $1 million. 
  • Miscellaneous itemized deductions subject to the two percent of Adjusted Gross Income limitation are eliminated.  This includes many of the common deductions for investment fees, tax preparation fees, and unreimbursed employee business expenses to name a few. 
  • The overall limitations on itemized deductions (the “Pease” limitation) has been suspended. 

Standard Deduction

The new law significantly increases the standard deduction to $24,000 for married couples filing a joint return and $12,000 for a taxpayer filing as single or married filing separately.  The standard deduction will be adjusted for inflation in tax years beginning after December 31, 2018.


Personal Exemptions

The new law suspends the personal exemption for tax years 2018 through 2025. 
As a result of the significant limits on itemized deductions, the increase in the standard deduction, and the elimination of personal exemptions, program managers should consider updating U.S. hypothetical withholding calculations since more individuals may be claiming the standard deduction.  In addition, given the broad impact of the tax law changes, now is an appropriate time to review tax equalization, domestic relocation, and global mobility policies and policy documents since many of these may make reference(s) to items that are no longer applicable and/or need to be revised or updated as a result of the tax law changes.


Moving Expense Deduction and Exclusion

Individuals were previously allowed to claim an above the line deduction for qualified moving expenses paid or incurred in connection with starting work in a new location if specific distance and length of service requirements were met.  The qualified moving expenses included the cost of travel from the old location to the new location, the cost of shipping the taxpayer’s goods, as well as certain storage expenses.  In addition, if an employer paid qualified moving expenses on behalf of an employee for a domestic and/or international move, these costs (i.e., the qualified moving expenses) were excluded from the employee’s taxable income and disclosed on the Form W-2 (Wage and Tax Statement).  The new tax law eliminates both the moving expense deduction and the exclusion from taxable income for tax years 2018 through 2025. 
As a result of this change, companies will see a significant increase in their domestic and international relocation costs.  Companies will need to consider what, if any, changes should be made to their domestic and international relocation policies and budget for the increase in costs.  Since the cost of the former qualified moving expenses must now be included in the taxable income of the employee the tax cost of providing the appropriate tax gross-up (i.e., federal, State and Local, Social Security and Medicare, if applicable) must also be accounted for in department budgets and program cost estimates.  The appropriate communication to employees regarding any changes to current programs and policies must be carefully considered, since companies that look to expand their business both at home in the United States and abroad will need to ensure employees view relocations as a positive experience instead of a nightmare as a result of cost-reduction efforts.  While there has been discussion about some companies providing a higher lump sum that is grossed-up to employees in an effort to self-direct their move to a new location, it is critical to consider the opportunity cost of this type of arrangement.  Employers expect their employees to be productive and contribute to the success of the organization.  If an employee is scheduling meetings to interview movers or taking time to pack and move their household goods themselves, they are not focused on the business of the organization.  Relocation programs that were in place on December 31, 2017, may still apply in 2018 and beyond, which means the cost of these moving expenses now are taxable elements of compensation that attract tax liabilities as a result of the tax law changes, and are expected to increase taxable benefits relating to a relocation by potentially over 50 percent, with a potential 60-70 percent tax gross-up needed to keep an employee whole under most former policies.  Employers need to consider what message is being communicated, both intentionally and unintentionally, to their employees regarding any change in policy they might choose to make with respect to their domestic or international relocation policies.


Supplemental Withholding Rate

The supplemental withholding rate that must be applied to wage payments made to an employee that aren’t regular wages (i.e., bonuses, commissions, severance pay, payments for nondeductible moving expenses, etc.) has been reduced to 22 percent effective January 1, 2018, from the previous 25 percent.  If an employee receives supplemental wages in excess of $1 million during calendar year 2018 the amount over $1 million must be withheld at the highest rate of income tax for the year which is 37 percent for 2018.  The 2017 supplemental withholding rate for supplemental wage payments in excess of $1 million was 39.6 percent.
Companies are required to withhold using the supplemental withholding rates when making supplemental wage payments to their employees.  It is important to remember that if an element of compensation is being grossed-up to ensure the employee does not bear any tax cost with respect to the element of compensation, these gross-up calculations should be reviewed before year-end or the payroll cutoff, whichever is earlier, to ensure that any true-up that may be required is addressed. Otherwise, companies may have to make up for any short fall in income tax liabilities in the subsequent year.


Sale of Principal Residence

The new tax law did not change the rules with respect to excluding the gain on the sale of a principal residence. Therefore as long as the taxpayers can demonstrate that they have owned and lived in the home for two years out of five years prior to sale, they can exclude $250,000 of gain for single taxpayers and $500,000 of gain if married filing a joint return.  The ability to prorate the exclusion remains available with respect to employment-related moves.


Alternative Minimum Tax (AMT)

While the new law did not eliminate AMT for individual taxpayers, the AMT exemption amounts and the phase-out thresholds have been increased.  For single taxpayers, the AMT exemption amount is $70,300 and the phase-out threshold increases to $500,000.  For married taxpayers filing a joint return, the AMT exemption amount is $109,400 and the phase-out threshold increases to $1 million.
The new Tax Reform legislation provides an excellent opportunity for program managers of domestic relocation and global mobility programs to step back and consider how these changes will impact their program(s), their company, and their assignees.  As the saying goes, “no one likes surprises,” so it would be prudent to consider the tax law changes in light of your particular program(s), and make the appropriate adjustments to hypothetical tax calculations, assignment cost estimates, budgets and accruals, gross-ups, as well as review your current policies and procedures to determine how the tax law changes impact your bottom-line.  The sooner the analysis is performed, and the appropriate changes are made and communicated to your assignees and stakeholders, the better.