Articles Posted in General Tax

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Nothing brings a new law home like some examples, let’s take a look:

1.) A single individual with a salary of $210,000, which exceeds the $200,000 threshold, could be subject to the 3.8% tax IF he also has “net investment income.”

2.) A married couple with a combined income of $275,000, which exceeds the $250,000 threshold, could be subject to the 3.8% tax IF they also have “net investment income.”

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Beginning January 1, 2013, a new 3.8% unearned Medicare income tax will be levied under IRS Section 1411(a)(1) on some “net investment income.” This tax is designed to raise an estimated $210 billion to help fund Medicare and health care reform. The tax will apply to the lesser of “net investment income” or the dollar excess of “Modified Adjusted Gross Income over the applicable threshold amount”. The 3.8% tax applies in addition to any other taxes that otherwise would apply to the associated income.

It is not true, as some frightening emails have suggested, that the new tax is a sales tax on the total sale price, nor is it true that it will affect all home sales or even most home sales. It is not true, as the emails have reported, that it would cost an additional $3,800 (3.8% x $100,000) in taxes to sell a $100,000 home.

What is Net Investment Income?

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IR-2012-65 allows Dual Citizens who Don’t Owe Tax in the US a Pain-Free Way to Become Compliant

First of all, which dual citizens don’t owe tax in the US? As a general matter, a dual citizen who have been living in a foreign country and been paying that country’s tax (as appropriate) probably does not owe much tax in the US (if any). The US taxes its citizen’s income no matter where they earn it anywhere in the world. But the US also works in cooperation with almost every country in the world (except for countries such as Cuba, Iran and Yemen…i.e., countries we have no relations with). If you are an American citizen living in France (you might also be a French citizen), and you have been paying your appropriate French tax for the money you earn in France, odds are you will not owe tax in the US. Why is this so? Most foreign countries have higher tax rates than the US. So as long as the income is of a type which we recognize (such as wages for services, or gains for stock sales, or rental income, or dividends, etc), the US will credit income earned in France by the dual French/US citizen. Thus, after the credit, the US citizen probably owes $0 US tax or very little US tax, on the amounts he earns in France. And the same goes for that US citizens with most every other country.

Now let’s not confuse the issue of whether the dual citizen owes any US tax with the obligation of the dual citizen to: (a) file US tax returns; and (b) file FBARs annually if they have bank accounts outside the US with over $10,000 at any point in the calendar year. Those obligations generally exist whether the person owes US tax or not. But for those people the new guidance is terrific. Those individuals must complet their past-due tax returns (at least 3 years) and delinquent FBARs (at least 6 years), and they’ll probably have no penalty to get compliant provided you don’t owe significant US Tax. A great deal.

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So a few months ago on this blog we informed you that the IRS offered a new FBAR amnesty program (now the 3rd program it’s offered), but that it only had released the broad stokes of the program (see our entry from February 16, 2012, for our last discussion of this topic). Since then, the IRS has established new procedures for dual citizens who have foreign bank accounts but who have paying the appropriate tax on the amounts in the those accounts in the foreign country at issue. Taxpayers with this situation can resolve it rather easily without having to go through a formal amnesty program (see our post from July 5, 2012, discussing this new option). However, that program won’t be available for everyone, and for the rest there is now the 2012 Overseas Voluntary Disclosure Program (the “OVDP”). On June 26, 2012, the IRS issued a set of Frequently Asked Questions and Answers (this is new guidance to assist taxpayers under the 2012 OVDP).

Background

Again, recall US tax citizens or residents must file a “FBAR” (a “Report of Foreign Bank and Financial Accounts”) annually, provided the US citizen or tax resident has over $10,000 in financial account(s) which are not located in the United States. The term financial account includes any savings, demand, checking, deposit, or other account maintained with a financial institution in addition to certain annuity and life insurance contracts, commodities and precious metals and safe deposit accounts. The FBAR is filed on a US Treasury Form TD F 90-22.1, by June 30 of the year after the US citizen or resident had a non-US account.

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On June 26, 2012, the IRS announced a new initiative to help US citizens living in another country (very likely dual citizens) catch up with their unfiled US tax returns and FBARs.

Background

In our law office in Palm Springs, we regularly see clients who may be Americans by birth, but who live in (and are also probably a citizen of) another country (usually Canada). While the dual American/Canadian may enjoy visiting Indian Wells three months a year, she really lives in Vancouver. But since she was born in Seattle, she has a social security number, she is a US citizen, and (whether she wants one or not) she has an obligation to file a US tax return every year (even though maybe she’s never filed one in her life). Plus, since she has bank accounts outside the US in Canada with more than $10,000 in them, she has an annual FBAR filing requirement as well.

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Let’s do some basic (and not so basic) 1031 examples. Again, before we start, remember that in addition to a rising real estate market (no sure thing the last few years, although in the Palm Springs area we might finally be turning the corner), in order to qualify for 1031 you need property either: held for (a) investment or (b) productive use in a trade or business.

Also remember vacation homes are unlikely to qualify as either: held for (a) investment or (b) productive use in a trade or business, unless the owner or the owner’s family uses the vacation house not more than 14 days a year. A property used as rental property will qualify for Section 1031 because the IRS deems rental properties as held for productive use in a trade or business.

Basic 1031 Examples

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We’re taking a break from speaking about the FBAR amnesty program (we will return to this topic shortly), but were going to continue to parallel (for now) our Canadian Snowbird Blog. So the topic at hand is how do I sell my house (we’re assuming the house has gone up in value), buy a new house, and not pay tax? Let’s assume, for the sake of discussion, that I sell a La Quinta home which has appreciated in value by $500,000 since I bought the house in 1997.

Question #1- Can I sell the house in La Quinta (for $500k more than he bought it for) and buy the Palm Desert replacement property without paying any US tax?

The general answer is yes. Internal Revenue Code Section 1031allows me to exchange, tax free, US real property for other US real property, if several requirements are met.

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We’re speaking about US citizens or residents (and US tax residents can be citizens of any country who happen to stay in the US too long in a given year, this could be citizens from any country outside of the US who may visit Palm Springs, or Rancho Mirage or Palm Desert long enough for a given year that they are deemed a US tax resident; we are also speaking of citizens of foreign countries who are US green card holders). US citizens and residents must declare to the Department of Treasury their foreign bank accounts (provided they have over $10,000 in aggregate foreign bank accounts/ assets…not a high bar). They must file these information returns (called “FBARs”) by June 30 of each year. Many US citizens and tax residents (particularly those who are current or former citizens of another country) are unaware of the FBAR requirement, which was enacted in 2003. That is why the IRS amnesty programs can be so valuable. In 2012, the IRS is again offering a FBAR amnesty program. This is the third such amnesty program. There is no guarantee there will be a fourth.

Structure of the IRS Amnesty Program

Although the IRS has yet to provide (much) specific guidance on the 2012 amnesty program, it will almost certainly follow the framework provided in the 2011 program. So it makes sense to review generally the 2011 program (the “OVDI Program”). Taxpayers who made voluntary disclosures under the 2011 OVDI Program could expect the following penalties/payments:

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In January, the Internal Revenue Service reopened the offshore voluntary disclosure program to help people hiding offshore accounts get current with their taxes. Although details of the 2012 program were not immediately available, the parameters will likely be very similar to the 2011 Offshore Voluntary Disclosure Initiative (“OVDI”). While 2011 OVDI Program seemed straight-forward, it turned out it was anything but straight-forward.

US Citizens or Tax Residents Must File a FBAR Annually

US tax citizens or residents must file a “FBAR” (a “Report of Foreign Bank and Financial Accounts”) annually, provided the US citizen or tax resident has over $10,000 in financial account(s) which are not located in the United States. The term financial account is broadly defined and includes any bank, securities derivatives, or other financial instrument accounts. It also includes any savings, demand, checking, deposit, or other account maintained with a financial institution in addition to certain annuity and life insurance contracts, commodities and precious metals and safe deposit accounts. The FBAR is filed on a US Treasury Form TD F 90-22.1. The FBAR is filed with the US Department of Treasury by June 30 of the year after the US citizen or resident had a non-US account. The FBAR requirement has been in existence since 2003.

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In January, the Internal Revenue Service reopened the offshore voluntary disclosure program to help people hiding offshore accounts get current with their taxes. Although details of the 2012 program were not immediately available, the parameters will likely be very similar to the 2011 Offshore Voluntary Disclosure Initiative (“OVDI”). While 2011 OVDI Program seemed straight-forward, it turned out it was anything but straight-forward.

Canadian Snowbirds Who Are US Citizens or Tax Residents Must File a FBAR Annually

US tax citizens or residents (i.e., Canadians who are in the US a little too much in a given year) must file a “FBAR” (a “Report of Foreign Bank and Financial Accounts”) annually, provided the US citizen or tax resident has over $10,000 in financial account(s) which are not located in the United States. The term financial account is broadly defined and includes any bank, securities derivatives, or other financial instrument accounts. It also includes any savings, demand, checking, deposit, or other account maintained with a financial institution in addition to certain annuity and life insurance contracts, commodities and precious metals and safe deposit accounts. Canadian snowbirds will likely have no shortage of these back in Canada. The FBAR is filed on a US Treasury Form TD F 90-22.1. The FBAR is filed with the US Department of Treasury by June 30 of the year after the US citizen or resident had a non-US account. The FBAR requirement has been in existence since 2003.