The so called Tax Reduction Act of 2006 effectively was a Tax Increase Act for U.S. citizens residing in Bermuda. This tax legislation significantly increased the U.S. Federal individual income tax for U.S. citizens residing in Bermuda. A question that many individual are asking themselves is whether the reduced U.S. tax savings makes it worthwhile to continue to work in Bermuda. This column explores that question.
How Much Tax Would I Pay If I Stayed In the United States?
Our hypothetical example is a married couple, no children, who have briefly lived and work in Boston, Massachusetts. They rent an apartment in downtown Boston at a cost of $2,000 a month. The working spouse’s current compensation is $250,000, and the employer has asked them to relocate to Bermuda on January 1, 2006 where the employee will receive a $6,000 a month housing allowance. At the end of December, 2005 their accountant provides them with the following tax comparison:
United States Bermuda
Federal income tax $58,100 $29,500
State income tax 12,900 0
Social Security tax 5,700
Medicare tax 3,600
Bermuda payroll tax 11,100
Bermuda social insurance 1,350
Total $80,300 $41,950
The $38,350 tax savings is supplemented by the fact that the couple does not have to pay rent of $24,000, so the cash savings is over $62,000. Next stop, Bermuda.
New Tax Law
The new tax law, retroactive to January 1, 2006, will drastically change this couple’s tax position, as follows:
United States Bermuda
Federal income tax $58,100 $55,200
State income tax 12,900 0
Social Security tax 5,700
Medicare tax 3,600
Bermuda payroll tax 11,100
Bermuda social insurance 1,350
Total $80,300 $67,600
The $38,350 projected tax savings that prompted this couple to relocate to Bermuda has been reduced by the new tax law to a $12,700 tax savings. While the couple still does not have to pay rent of $24,000, they argue that the additional cost of living in Bermuda, and the cost of frequent trips back to Massachusetts for weddings and birthdays, almost offsets the rental saving.
So they are struggling with the question “does a cash flow savings of $12,000+ a year offset being away from family, friends, and other business opportunities?”
Commuters
The problem becomes more acute for the dozens of Americans who live and work in Bermuda, but whose families have remained in Massachusetts because one spouse is unable to obtain a Bermuda work permit, medical needs, special education needs or a number of other reasons. Their situation is as follows:
United States Bermuda
Federal income tax $58,100 $29,500
State income tax 12,900 16,700
Social Security tax 5,700
Medicare tax 3,600
Bermuda payroll tax 11,100
Bermuda social insurance 1,350
Total $80,300 $58,650
The tax savings to this couple is $21,650 under the old tax law.
Under the new tax law the impact is as follows:
United States Bermuda
Federal income tax $58,100 $55,200
State income tax 12,900 16,700
Social Security tax 5,700
Medicare tax 3,600
Bermuda payroll tax 11,100
Bermuda social insurance 1,350
Total $80,300 $84,300
Thus, under the new tax law, the U.S. tax benefit of one spouse living and working in Bermuda disappears for this couple.
Is It Possible To Pay More Taxes While I Live and Work in Bermuda Than I Would Have Paid in the United States?
Yes. We will go back to the first example and instead of Massachusetts as their home state, we will make it New Hampshire, where there is no income tax on salary, and we will raise the housing allowance to $120,000 a year. Under the new tax law, the comparison is as follows:
United States Bermuda
Federal income tax $58,100 $72,950
Social Security tax 5,700
Medicare tax 3,600
Bermuda payroll tax 11,100
Bermuda social insurance 1,350
Total $67,400 $85,400
Thus, it will cost this couple $18,000 more in income taxes to relocate to Bermuda.
Your tax benefit, if any, will depend in part on what State you come from, the rate of tax in that State, and whether you are required to continue paying income tax to that State while you work and live in Bermuda.
The other factor is the taxable amount of your housing allowance. With the maximum foreign housing exclusion being $11,536 in 2006, the employee now will bear the U.S. income tax on the remainder of the housing allowance, at the highest tax rates.
What Are Bermuda Employer’s Doing to Offset the Increased U.S. Income Tax?
While all local employers have been forced to address the issue, as of the date this article is written, we are only aware of one local employer who has agreed to reimburse U.S. employees the U.S. tax increase. However, the employer did not agree to gross up the tax reimbursement, which still leaves the employees with a reduced cash flow.
The tax advice given by this column is, by necessity, general in nature. You should, of course, check with your own U.S. tax consultant as to how specific transactions affect you since tax advice varies with individual circumstances. |