Many former American citizens who live outside the U.S are not aware that they still may owe U.S. taxes. To remedy this situation and collect back taxes, the IRS released the Relief Procedures for Certain Former Citizens in September 2019. It provides certain expats with relief for back taxes and the chance to comply with their U.S. tax and filing obligations.
No matter where American citizens live, they are liable for paying U.S. taxes. If living and working abroad, these individuals may be eligible for credits on tax payments made to foreign governments, but taxes are still owed to the U.S. government. Even if individuals decide to relinquish their U.S. citizenship, they still may have tax obligations to meet.
There are various reasons why expatriated citizens may be confused about their U.S. tax status and liability. The 14th Amendment to the U.S. Constitution specifies that all individuals born in the U.S. automatically attain U.S. citizenship at birth. This includes those who were born overseas to American parents and continued living abroad, and those born in the U.S. but who have lived elsewhere for most of their lives. These individuals are often considered “accidental Americans” and because they have lived outside the U.S. for all or most of their lives, they are not aware of their U.S. tax obligations.
Others who may qualify are those who have unofficially renounced their citizenship by taking up residency abroad and mistakenly assume they no longer owe taxes. The IRS warns that individuals who relinquish U.S. citizenship without complying with their U.S. tax obligations may face significant tax consequences.
New Procedures Ease Compliance
Highlights of the tax compliance program include:
- Eligible individuals are those who relinquished their U.S. citizenship after March 18, 2010 and have not filed tax returns as a U.S. citizen or resident.
- The net worth of eligible individuals must be less than $2 million at the time of their expatriation and when making their submission under these procedures.
- Individuals must file outstanding tax returns with all required schedules and information returns for the year of their expatriation and for the five years preceding it.
- If the total tax liability for the six-year period does not exceed $25,000, individuals are relieved of paying U.S. taxes.
- Individuals who qualify for these procedures will not be required to pay penalties and interest.
- The procedures are available only to those individuals who failed to file tax returns and pay taxes and penalties for the pertinent period due to “non-willful conduct” such as negligence, oversight or a good faith misunderstanding of their U.S. tax obligations.
- The program is only available to individuals and cannot be used by estates, trusts, partnerships, corporations or other entities.
The IRS notes that these procedures are available for a limited time and it will announce a closing date prior to the end of the grace period. Expatriated individuals are advised to consult with a tax advisor if they are considering using these procedures to comply with their U.S. tax and filing obligations.
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The Tax Cuts and Jobs Act (TCJA) of 2017 reduced tax rates for most individuals, introduced a new deduction for owners of sole proprietorships and pass-through entities, increased the standard deduction and, among other things, significantly increased the Alternative Minimum Tax (AMT) exemption and either limited or eliminated many other tax deductions. While the IRS continues to release guidance and update forms to reflect the changes, we offer the following tax planning guide that includes significant opportunities to minimize individual tax obligations.
Income from an investment held for more than one year is generally taxed at preferential capital gains rates. For 2019, the long-term capital gain and qualified dividend rates remain unchanged at 0%, 15% or 20%, based on statutory income brackets and adjusted for inflation. For example, the 20% rate applies when taxable income exceeds $488,850 (married filing joint), $461,700 (head of household) or $434,550 (others).
- Consider holding capital assets for at least 12 months, as short-term capital gains are taxed at ordinary income rates.
- Consider gifting appreciated stock or mutual fund shares to relatives in a lower income tax bracket (such as children or grandchildren), who will pay less or no tax on the long-term capital gains when the shares are sold.
- Consider selling unrealized loss positions in your investment portfolio to offset capital gains recognized earlier in the year.
- Consider investments in Qualified Opportunity Funds, which allow investors to defer gain recognition.
NET INVESTMENT INCOME TAX (NIIT)
In addition to income tax, individual taxpayers with modified adjusted gross income (MAGI) of more than $200,000 per year ($250,000 if married filing joint; $125,000 if married filing separately) may be subject to net investment income tax. NIIT equals 3.8% of the lesser of (a) net investment income or (b) the amount by which MAGI exceeds the applicable threshold. Net investment income includes interest, dividends, capital gains, rental income (unless derived from ordinary business activities) and passive activities, less deductions properly allocated to net investment income.
- Consider electing installment sale treatment so that gains are spread over a number of years. By spreading the income over multiple years, current year net investment income and MAGI may be reduced to minimize or eliminate the 3.8% tax for the current and future tax years.
- Consider selling unrealized loss positions in your investment portfolio to offset capital gains recognized earlier in the year.
- Tax-exempt income is not subject to the 3.8% tax. Consider switching investments to tax-exempt investments if it makes sense for your portfolio. State taxation of such investments should also be considered.
SMALL BUSINESS OWNERS
If you own a business, consider the following strategies to minimize taxes:
- Defer income – If your business uses the cash method of accounting, you can defer billing and collections for products until year-end. If you use the accrual method, you can delay shipping products or delivering services.
- Accelerate Expenses – If you are a cash basis taxpayer, consider accelerating expenses by paying for business expenses by year-end. Credit card payments are deductible in the year charged rather than paid.
- Employ Your Child – If you are self-employed, consider employing your child to work in the family business. The child will be taxed at their rate on earnings (earnings are not subject to Kiddie Tax). Wages paid by sole proprietors to children age 17 or younger are exempt from Social Security, Medicare and federal unemployment taxes. Make sure wages paid are reasonable given the child’s age and work skills.
- Home Office Deduction – The TCJA suspended the home office deduction for employees who work from home. However, this deduction still applies if you are self-employed and have a home office that is used primarily for business activities.
- Acquire Assets – Acquiring business assets may be a good tax-planning strategy depending on your business situation. For assets with a useful life of more than one year, you generally must depreciate the cost over a period of years, depending on asset type. As a part of TCJA, the following favorable provisions were revised and made available for depreciating fixed assets, maximizing deductions:
- Section 179 Expensing Election – This election allows you to deduct 100% of the cost of qualifying assets rather than recovering them through depreciation. The maximum amount that can be expensed for 2019 is $1.02 million. This amount is reduced (but not below zero) by the amount by which the cost of total qualifying property exceeds $2.55 million.
- Bonus Depreciation – The TCJA establishes a 100% first-year deduction for qualified assets placed into service through December 31, 2022, with a recovery period of 20 years or less. This provision applies to both new and used property and was expanded to include qualified film, television and live theatrical productions. (For the period January 1, 2023 – December 31, 2026, bonus depreciation is scheduled to be gradually reduced.)
For 2019, medical expenses can be deducted to the extent the expenses exceed 10% of adjusted gross income (increased from 7.5% in 2018). Eligible expenses include health insurance premiums (if not deducted elsewhere on your income tax return), long-term care insurance premiums (subject to limitations), medical and dental services and prescription drugs. You may also deduct expenses paid for medical care of a child for whom you provide more than half of total support.
- Since individuals generally use cash basis accounting, medical expenses must be paid in the year incurred in order to be deductible. Credit card payments are deductible in the year charged, rather than paid. Be aware, however, that prepayment of medical services in advance of the year services are actually rendered may not accelerate the deduction.
- If possible, consider bunching elective medical procedures into alternating years (for services and purchases for which timing is within your control, without negatively impacting your or your family’s health) if it will help you exceed the 10% floor and if you have enough total itemized deductions to benefit from itemizing.
For tax years 2018-2025, the TCJA reduces the limit on mortgage debt incurred after December 15, 2017, from $1 million to $750,000. Interest on debt incurred prior to December 15, 2017, but refinanced later, is deductible to the extent the new debt does not exceed the original debt. The TCJA also suspends the prior provision that allowed up to $100,000 of interest on home equity debt to be treated as deductible qualified residence interest.
- Keep track of how and when you spend proceeds of a loan. For example, if you used a portion of your mortgage debt to acquire business assets, that portion is deductible as trade or business interest or as investment interest expense.
- Elect out of treatment of debt secured by a qualified residence. This election allows you to characterize interest expense on home equity debt under the specified interest tracing rules and to preserve an otherwise nondeductible expense.
Year-end is a great time to make donations to qualified charities. Generally, cash donations to public charities are fully deductible up to 60% of adjusted gross income (AGI), and gifts of appreciated property or gifts for use by public charities are deductible up to 30% of AGI. This benefit only applies if you itemize deductions. For donations made during the year, be sure to get acknowledgment letters from the qualified charities for both cash and property (including stock donations) over $250. If you are not certain if a particular charity is qualified, you can consult the IRS website at http://apps.irs.gov/app/eos/ to search for the organization in question.
- Consider bunching donations into alternating years if your total itemized deductions on those years would surpass your standard deduction. A donor-advised fund allows donors to make a charitable contribution, receive an immediate tax deduction and then recommend grants from the fund over time.
- Donate appreciated stock to charity to avoid paying capital gains tax and get a fair market value deduction for stocks held for more than one year.
- Sell depreciated stock and donate the cash proceeds to charity. You will receive a charitable deduction as well as a capital loss benefit on the sale of stock. Capital losses offset capital gains, and any resulting net loss in future years offsets a maximum of $3,000 in ordinary income for a married filing joint taxpayer ($1,500 for all other taxpayers).
401(k) AND SEP CONTRIBUTIONS
Contributions to a traditional employer-sponsored defined contribution plan are typically pretax, therefore reducing taxable income. If you are an employee and your company offers a 401(k) plan, you should try to maximize your contribution to boost your retirement savings and save current year taxes. The maximum contribution to a 401(k) plan increased to $19,000 in 2019 (from $18,500 in 2018) and is scheduled to increase to $19,500 for 2020. Employees age 50 or older can also make an additional “catch-up” contribution of up to $6,000 (scheduled to increase to $6,500 in 2020.)
If you are self-employed, consider setting up a self-employed retirement plan (SEP) or some other type of retirement plan in order to maximize the allowable contribution each year.
QUALIFIED CHARITABLE DISTRIBUTIONS (QCD)
Taxpayers who have reached age 70½ can donate up to $100,000 of traditional and Roth IRA distributions directly to qualified charities. The donation satisfies the minimum distribution requirement and is excluded from taxable income. A charitable deduction cannot be claimed for the contribution.
HEALTH SAVINGS ACCOUNT (HSA)
If you are covered by a qualified high-deductible health plan, you can either contribute pretax income to an employer-sponsored Health Savings Account (HSA) or make deductible contributions to an HSA you set up yourself. For 2019, the maximum contributions are $3,500 for single taxpayers (increased from $3,450 in 2018) and $7,100 for family coverage (increased from $7,000 in 2018). Taxpayers aged 55 or older as of the end of the tax year can contribute an additional $1,000. (This means HSA holders can contribute and reduce income by $9,000 if both spouses are over 55.) There is no “use it or lose it” provision with HSAs, as you can carry over unused balances from year to year. Consider paying for qualified out-of-pocket medical expenses with personal funds rather than HSA funds. You can leave funds invested in your HSA to grow on a tax-deferred basis creating a pool of money to use for medical expenses later in life.
FLEXIBLE SPENDING ACCOUNT (FSA)
Amounts contributed to a healthcare Flexible Spending Account (FSA) are not subject to federal income, Social Security or Medicare taxes. For 2019, the maximum contribution is limited to $2,700 (increased from $2,650 in 2018). Historically, the “use it or lose it” provision applied to amounts contributed to a flexible spending account. However, there is a carryover provision which allows participating employees to carryover up to $500 of unused funds to the following year if your employer offers this option. Some employers may offer a grace period to incur eligible medical expenses, generally two-and-a-half months after year-end. Check with your employer for the rules on the established FSA plan.
If you wish to discuss tax planning strategy for the new rules that are generally going into effect for the 2019 tax year, please call the State and Local Tax team at 716.847.2651 to schedule a complimentary Tax Situation Review. Or, click on the button, give us your contact information, and a member of our staff will connect with you to schedule a discussion.View full article
Some U.S. taxpayers have used foreign accounts to hide income subject to U.S. taxes. As a result all U.S. taxpayers, and many non-U.S. financial institutions, must comply with information reporting and withholding rules related to accounts outside of the States.
Ronald Reagan was known for quoting a Russian proverb to the Soviet leader: “Doveryai, no proveryai.” In English, “Trust, but verify.” The U.S. Treasury and the IRS have taken a similar approach when it comes to taxpayers holding accounts and transacting business outside of the United States. Those who hold accounts or send money out of the U.S. need to know about the related reporting and withholding rules or risk encountering an enforcement “bear in the woods.”
This discussion requires serving a large bowl of abbreviation alphabet soup, so we’ll make that the appetizer before we get to the main course.
FBAR: Refers to the “Report of Foreign Bank and Financial Accounts” that U.S. taxpayers file to identify financial accounts held outside of the States.
FATCA: Stands for “Foreign Account Tax Compliance Act.” Enacted in 2010, fully effective in 2014, this law expands the types of foreign assets and related income that U.S. taxpayers have to report. Through a series of inter-governmental agreements (IGAs), this law also requires financial institutions in many other countries to provide information to the IRS about accounts and assets held abroad by U.S. taxpayers.
FDAP: This stands for “fixed, determinable, annual or periodic” income, which, if you think about it, is pretty much all income. It applies primarily to foreign persons and businesses earning income in the U.S. Reports that relate to FDAP are used to track payments that leave the U.S. for reasons other than investment or deposit in foreign countries.
In short, FBAR, FATCA and FDAP reporting requirements form the backbone of the “trust” end of the equation. Each of these concepts includes at least some element of self-reporting by U.S. taxpayers on payments made and corresponding withholding, amounts held in foreign accounts and income earned outside of the country. (For more information on FBAR, please see Susan Steblein’s post from July 2015.) (For more information on FDAP, please see my post from March 2015.)
Of the three, FATCA holds down the “verify” side of the equation. Through a network of intergovernmental agreements, the U.S. has actually managed to place reporting requirements on foreign financial institutions. While those financial institutions may not be wild about the idea, they comply because they value the opportunity to do business with the U.S. and its taxpayers. As a result, many foreign financial institutions now regularly report information about assets of U.S. taxpayers that they hold. In some instances, the agreements require foreign institutions to withhold 30% of payments made to U.S.-held accounts if circumstances warrant. The IRS has gone so far as to levy penalties against some covered institutions that have failed to comply with the rules. In addition, financial institutions are now sending account holders reports with detailed account information that they have supplied to the IRS, giving a reality check to the process.
The IRS estimates that the U.S. loses approximately $450 billion per year in taxes on assets held and income generated overseas by U.S. taxpayers. With that kind of money in play, it seems pretty reasonable to expect that enforcement in this area is a high priority for the Service now and for the foreseeable future. The good news is that if you are a U.S. taxpayer who has failed to comply, there are opportunities to mitigate potential penalties by coming forward voluntarily. These voluntary disclosure programs will not last forever, and taxpayers who are audited by the IRS lose the opportunity to reduce penalties if they don’t initiate the process on their own.
If you have tax obligations in the U.S. and hold accounts or conduct business outside of the country, it’s important to make sure that you are in compliance with these rules. For help in figuring out what obligations you might have, please contact us.View full article
It’s important to understand the basics before you or your business crosses borders
In today’s economy, many businesses wind up crossing international borders much sooner than they expected—often without even realizing it. It’s not uncommon for growth-oriented entrepreneurs to charge ahead believing that it’s easier to ask for forgiveness than permission, but that philosophy can lead to fines, penalties and taxes that could have been avoided when it comes to international taxes. If you understand these basic concepts about income tax treaties, you’ll be better equipped to understand when to ask permission and how to do it.
- Tax Treaties Have 2 Main Goals: In short, tax treaties provide guidance regarding potential tax benefits and reporting requirements when residing or doing business in a foreign country.
- Avoiding Double Taxation: This may be hard to believe, but not every government thinks it’s entitled to tax all of your income. Nations negotiate tax treaties in order to determine where income should be taxed and to make sure that the same income is not taxed both at home and abroad.
- Avoiding Tax Evasion: This goal sounds more like what you expect from governments. While treaties may ease a tax burden by preventing double taxation, they will almost always assign some sort of information reporting obligation to an individual or business when in a foreign country. A treaty also typically includes protocols that govern the sharing of tax information between governments.
- Residency: Step 1 when it comes to figuring out where you have to report information or file taxes is figuring out where you are a resident. Spoiler alert— For individuals, it’s not always where you live.
- Individuals: Most treaties determine if an individual is a resident for tax purposes by counting the number of days spent in the country. At the same time, a treaty can also describe specific exceptions that allow someone to live abroad and maintain tax residency in the country that they think of as home. For example, Canadians who spend significant time in Florida may become U.S. residents for tax purposes, but the treaty between the countries will allow for a “closer connection” exception if one follows certain rules and files certain forms.
- Businesses: Corporations and other types of businesses typically follow a more incremental process toward tax residency. Many enterprises first cross a border when they ship a product or deliver a service electronically into another country. Others might send a salesperson to a trade show in another country where that person closes deals on site. This can be followed by warehousing product in the second country, employing citizens of the country to manage operations there, and eventually opening an office or outlet that might establish tax residency for the business in the foreign country. A treaty can detail the obligations of the business at each of these stages.
- Immigration: Corporations rarely face immigration issues applicable to the business, but they almost always face immigration issues when employees work in other countries. A tax treaty can spell out what special visas and work permits may be needed in order for an employee to work in the host country. As for acquiring those visas and permits, an attorney who focuses on immigration issues may be the best resource for a business sending workers into another country.
The United States currently has tax treaties with about 60 countries. If you are a businessperson in the U.S. or one of those countries, it’s critical to understand the requirements of the relevant treaty before doing business that crosses the border. If you have operations in a country without a U.S. treaty, it’s important to understand how the Internal Revenue Code will treat the income you generate--both in the U.S. and abroad. As noted above, this is an area where engaging professionals before you start can save you money and hassles, while seeking forgiveness after the fact can lead to significant fines and penalties in addition to taxes. A consultation with an international tax professional is a must for any business with plans to operate across borders.
What you have to report and what you have to pay all depends on if and when you take the plunge.
International tax issues can sometimes be categorized by how differently people frolic at the beach. Here are some examples:“Treaty Filing:” Just the toes.
Lots of the folks at the beach never go in any deeper than getting their feet wet. Could be a kid who sticks a toe in and gets freaked out by the waves, or a more mature person who wanders to the water’s edge to cool off just a bit then heads back to the comfort of a beach chair.
These folks are like businesses that may ship products or sell services into another country without ever establishing a more permanent presence. The obligations of the business in the country where the products or services are used will be governed by a tax treaty, if one exists, between its home government and the destination country. For businesses selling into the U.S., these activities typically will generate an information-reporting obligation at the federal level. Those businesses also need to be aware of potential state tax obligations that may be triggered by their activities, if sales cross certain thresholds.
“Branch Filer:” Wading in a bit deeper.
Other people will wade in about waist- or chest-deep and go no farther. Maybe they don’t want to get their hair wet, or they don’t want water in their ears. It could be that salt water stings their eyes too much. Whatever the reason, they know their limits and stay within them.
These swimmers are similar to businesses that might lease or build some type of warehouse or other permanent structure in the U.S. or have some other type of significant presence in the states (such as an office or employees), but not create a separate legal entity in the country. They would treat the operations in the U.S. as a “branch” for tax purposes. Branch treatment typically isn’t the ideal situation for most businesses. When it does make sense, the key is to plan from the outset to treat U.S. operations as a branch and operate accordingly going forward. This operation will usually face tax obligations at the federal and state level in the U.S.
“U.S. Legal Entity:” Taking the plunge.
Most folks who head for the water eventually get comfortable enough to take the plunge and dive in. For many who enjoy the beach, the plunge is the whole reason for going.
Top 100 CPA firm Freed Maxick assists international businesses as they expand into the U.S. Contact us to learn about how we can help you avoid the pitfalls and realize the benefits of doing business in the U.S.Most businesses that are growing across borders are best served by planning for the plunge from the start and executing on that strategy as operations ramp up. For a non-U.S. business establishing a presence in the U.S., there are 3 main reasons why forming a U.S. entity beats operating a U.S. branch. First, a U.S. entity is better positioned to handle U.S. employment issues. Second, a U.S. entity can often manage legal liability more effectively than a branch. And lastly, the tax rules for U.S. entities are somewhat less complicated than those that apply to branch operations.