The payroll industry has had a lot to contend with regarding the U.S. tax reform law passed last December. And, as usual, the changes were forced upon the payroll industry with little time to prepare at the end of the year. The reprogramming for 2018 withholding changes were rushed and were frantically being implemented. Advice was given for employees to check their own withholdings to make sure they were right while they had little understanding of what they were supposed to be. What a mess!
U.S. taxpayers continue to wrap their heads around the impact of the Tax Cuts and Jobs Act (TCJA; Pub. L. 115-97), including the effect of modifications to federal tax rates, state and local deductions being limited, and the increase to the standard deduction among others. But the effect of the TCJA doesn’t stop there—it extends globally as well. Companies that have expatriates on their payroll need to understand that there are no more deductions and no more excludable reimbursements relating to relocation, thanks to the TCJA (for tax years 2018 through 2025).
Act Changes Taxability of Relocation Costs
Expatriates are an expensive group of employees. Beyond their salaries, expatriates often receive additional benefits and allowances while on temporary assignments including, for example, housing subsidies to ensure that the employee is not out of pocket for excessive rent, assistance with the higher cost of living in certain locations, and the “grossing up” of tax costs on the payment of these kinds of expenses that are in excess of their regular compensation.
For as far back as I can remember (and I have been dealing with expatriates since they were moving around on wooden boats), expenses for relocation have been mostly deductible and the reimbursements by employers for those move costs have been mostly excludable. Similarly, the costs involved with relocation are tax-efficient in most other countries around the world. TCJA ends all of this in the United States as of January 1, 2018 (through 2025). No more deductions and no more excludable relocation reimbursements. This adds up to new and potentially massive “up-front” and “back-end” costs to an assignment.
Illustration of Increased Tax Cost of Relocation Under TCJA
Let’s assume the expense for packing, shipping, and unloading a container as part of a U.S. outbound relocation is $20,000. The employer typically pays for the expense or reimburses the employee who incurred it. Under the old law, this payment/reimbursement was excludable. So, under pre-TCJA, the total household goods (HHG) cost to the employer was $20,000 net.
Under TCJA, the reimbursement is now taxable. If we assume the applicable 2018 U.S. federal tax rate in this case to be 35%, and we assume a state tax rate to be 7%, then the total cost of the HHG reimbursement is now $34,482 ($20,000, plus a tax gross up at 42%). Because of the tax-on-tax aspect of the gross up, this represents an increase of 72% to the HHG cost.
HHG is just one previously tax-efficient relocation cost. There are many others. In fact, the total cost of a single international relocation that could have easily exceeded $50,000 before the new tax law came into effect could increase the employer cost from $50,000 to more than $86,000 at the rates illustrated above. And remember, the additional tax hit comes at both ends of the assignment.
Other Side Effects of TCJA
In sum, this change could affect the overall volume of U.S. outbound and inbound assignment transfers. As employers look for ways to keep their expats on the road, they may seek to modify policies and reduce benefits, or they might try sharing certain assignment costs with the expatriates so that the overall assignment cost to the employer is reduced. But if the policies are perceived as less generous, they may be rejected by potential assignees. If the incremental employer costs are too high, new assignments may be scuttled. For this reason, the law change could have a corresponding impact on the relocation industry with potentially fewer international assignments (and domestic moves too!) - as the added tax costs might reduce the corporate appetite for relocations that will now be even more expensive than before.
There is a silver lining for the payroll professionals out there….
TCJA simplifies things for you as it relates to relocation. No more Forms W-2 Box 12 Code P reporting! But for your employer, this means new costs and a rethinking about how to accomplish international business objectives with a globally mobile workforce that may be shrinking as a direct effect of TCJA.
Dave Leboff is President, U.S. Operations for Immedis, Inc., a leading provider of global payroll services based in Dublin, Ireland, and New Jersey. He has been co-chair of the American Payroll Association’s (APA) Strategic Payroll Leadership Task Force (SPLTF) Global Issues Subcommittee since 2011. Matthew Pascual from Weichert Mobility Tax Services contributed to this report.