Simply Junior

President Obama is tagging your Foreign Earned Income Exemption to help pay for huge federal budget deficits. He thinks to hide this motive behind recent White House announcements about U.S. companies, providing smokescreens such as: “I want to see our companies remain the most competitive in the world,” and “…the way to make sure that happens is not to reward our companies for moving jobs off our shores or transferring profits to overseas tax havens.”

The reality is that with tax gaps estimated in the $400 billion range, this administration is hard-pressed to come up with new sources of revenues to fill the deficit. It is estimated that offshore tax abuses cause the United States to lose approximately $100 billion each year in tax revenues. Recovering these funds represent a substantial portion of the annual U.S. tax gap, which is why President Obama has authorized an additional $128 million for the 2010 IRS budget, which includes the addition of 800 new IRS agents. Do not be fooled, they have declared war on YOU and are coming after YOUR money.

First, they are going after the companies you work for because they see companies operating abroad as a viable source of additional revenues. Currently, companies with overseas operations pay U.S. taxes only if they bring the profits back to the United States. They can defer paying U.S. taxes indefinitely if they keep the profits offshore. Obama’s plan, which would take effect in 2011, cracks down on these loopholes so that companies would no longer be able to write off domestic expenses for generating profits abroad. It is estimated that this change alone would generate $210 billion in new taxes over the next 10 years, making a modest dent in the forecasted $1.8 trillion federal deficit. Rest assured, this administration will encourage any possible avenue to be able to bring these monies back into the U.S.

And, they are coming after YOU. The recently released IRS report on the 2006 tax year indicates that the Foreign Earned Income Exclusion might be another modest source for helping to fill the tax gap. In tax year 2006, about U.S. taxpayers living abroad reported approximately $36.7 billion in foreign-earned income and claimed nearly $18.4 billion in income exclusions. And that was three years ago. There are more Americans living and working abroad now than ever. Can’t you just see the wheels turning in the minds of our government leaders? Removing the Foreign Earned Income Exclusion could add billions to U.S. tax coffers.

Perhaps you think they won’t find YOU. The historic legal struggle that has cracked Switzerland’s renowned reputation for banking secrecy is part of an on-going IRS quest to identify nearly 52,000 suspect offshore bank accounts. When the IRS increases their workforce by 800 new agents, they won’t be hiring new college recruits. They have announced that they will be hiring the fancy attorneys and investment advisors that have helped hide those assets offshore. Now, multiply the number of suspected offshore accounts by the $10,000 or possibly $20,000 in allowable fines for non-reporting, and you come up with another modest number toward the filling of the U.S. tax gap. If you have been one of those ‘tax evaders’ thinking they can hide assets in offshore bank accounts, think again. The IRS is already searching for you, cracking the international bank privacy policies and gearing up to hire professionals to find you.

All of these items add up to making the American Expatriate look like a great big piggy bank to the current administration. While there will likely be a huge fight in Congress regarding closing the corporate loopholes, it is even more likely that the tax benefits associated with your Foreign Earned Income Exclusion will be taken from you. Fines for unreported bank accounts will soon become automatic bills. This means that for you, the individual American Expatriate, the stakes are high and getting higher if you seek to hide your income off-shore or evade paying U.S. taxes on that income.

What action do you need to take as an expatriate? Stay abreast of the latest information that develops about the foreign earned income exclusion. The best way to accomplish this is to work with a reputable advisor who will focus on keeping you out of the scrutiny of the IRS by keeping your activities well above board and within the law. Your advisor must be well-versed in the nuances of expatriate tax law, so check with your advisor about his/her expertise in this arena and be ensure you’ve chosen your advisor wisely.

Copyright (c) 2009 Nick Hodges

Passage of the Health Care and Education Reconciliation Act of 2010 (“Reconciliation Act”) amending the Patient Protection and Affordable Care Act of 2010 (together the “Health Care Reform Package”), which President Obama signed on March 23 created many tax changes. Many of these tax changes are discussed below.

Additional Medicare Payroll Tax

Beginning in the 2013 taxable year, the Reconciliation Act imposes a 3.8 percent “unearned income Medicare contribution” tax on the lesser of the taxpayer’s net investment income or modified adjusted gross income (“AGI”) in excess of $200,000 for singles and $250,000 for joint filers.

Net investment income includes interests, dividends, annuities, royalties, rents, gain from disposing of property from a passive activity, income earned from a trade or business that is a passive activity, and income earned from a trade or business of trading financial instruments of commodities as defined by existing mark-to-market tax rules for dealers of commodities. Income on an investment of working capital is also taxed. In determining net investment income, investment income is reduced by deductions properly allocable to that income. Some income is exempt from the tax, including income from the disposition of certain active partnerships and S corporations, distributions from qualified retirement plans, and any item taken into account in determining self-employment income. The tax does not apply to nonresident aliens or trusts for which all of the unexpired interests are devoted to charitable purposes.

The provision defines modified adjusted gross income as AGI increased by any income excluded by the foreign earned income exclusion over the amount of any deductions and exclusions disallowed with respect to that income.

Estates and trusts are also subject to a 3.8 percent unearned income Medicare contribution tax on the lesser of the undistributed net investment income for the tax year or the excess of adjusted gross income over the dollar amount at which the 39.6 percent tax bracket for trusts and estates begin.

Small Business Tax Credit

Beginning in 2010, many small businesses and tax-exempt organizations that provide health insurance coverage to their employees now qualify for a special tax credit.

The credit is designed to encourage small employers to offer health coverage for the first time or to maintain health coverage they already have.

An employer generally qualifies for this credit if the business has no more than 25 full-time equivalent (“FTE”) employees paying wages averaging less than $50,000 per employee per year. Because the eligibility formula is based in part on the number of FTEs, not the number of employees, many businesses will qualify even if they employ more than 25 individual workers. The qualified small employer must contribute at least one-half of the cost of health insurance premiums for coverage of its participating employees.

In 2010 through 2013, qualified small employers may qualify for a tax credit of up to 35 percent of their contribution toward the employee’s health insurance premium. After 2013, small employers that purchase coverage through an insurance exchange may qualify for a credit for two years of up to 50 percent of their contribution and 35 percent of premiums paid by eligible employers that are tax-exempt organizations.

The maximum credit goes to smaller employers with 10 or fewer FTEs paying annual average wages of $25,000 or less.

Eligible small businesses can claim the credit as part the general business credit starting with the 2010 income tax return they file in 2011. The IRS will provide further information on how to claim the credit for tax-exempt employers.

Excise Tax on “Cadillac” Health Plans

Beginning in 2018, the Health Care Reform Package will impose a 40 percent nondeductible tax on insurance companies or plan administrators for any health insurance plan with an annual premium in excess of an inflation-adjusted $10,200 for individuals and an inflation-adjusted $27,500 for families. There is a higher premium level for employers in certain high-risk professions: $11,850 for individual coverage and $30,950 for family coverage. Non-Medicare retirees age 55 and older are also eligible for higher thresholds.

Dental and vision plans are not included when calculating the total benefit value.

Corporate Estimated Taxes

The Reconciliation Act includes a one-time increase of 15.75 percentage points for estimated taxes of corporations with assets of at least $1 billion dollars for payments made during July, August, and September of 2014. Payments will be decreased by a corresponding amount during the following quarter.

Individual Mandate

Pursuant to the Health Care Reform Package most individuals who fail to maintain essential minimum universal coverage are liable for penalties. The penalty is based on the greater of a flat-dollar amount or a percentage of household income. The Reconciliation Act exempts income below the filing threshold, lowers the flat payments required from $495 to $325 in 2015 and from $750 to $695 in 2016 and increases the percent-of-income thresholds.

The employer-provided health coverage gross income exclusion extends to coverage for adult children up to age 26 as of the end of the tax year. Self-employed individuals are allowed a deduction for the premiums paid on the dependent care coverage for adult children up to age 26.

Employer Responsibility

The Health Care Reform Package generally does not require employers to provide health insurance coverage. However, beginning in 2014, a fee is imposed on firms with 50 or more employees that do not provide coverage. The fee is calculated based on the number of full-time employees.

The Reconciliation Act modifies that provision by excluding the first 30 employees from the payment calculation.

Indoor Tanning Tax

The Health Care Reform Package imposes a 10 percent tax on qualified indoor tanning services effective for services provide on or after July 1, 2010.

Codification of the Economic Substance

The Reconciliation Act adds a revenue raiser that codifies the economic substance doctrine. Economic substance is a common law doctrine under which the tax benefits of a transaction are not permitted if the transaction does not have economic substance or lacks a business purpose. The provision in the Reconciliation Act requires a conjunctive analysis of economic substance under which taxpayers must show that (1) the transaction changes in a meaningful way their economic position apart from federal income tax effects and (2) they had a substantial purpose apart from federal income tax effects for entering into the transaction.

A 40 percent penalty applies to tax understatements attributable to undisclosed noneconomic substance transactions. The penalty is 20 percent if the transaction is adequately disclosed. The Reconciliation Act also renders the ability to obtain relief from accuracy-related penalties under the reasonable-cause exception inapplicable to noneconomic substance transactions.

The Joint Committee on Taxation projects that this provision will generate $4.5 billion over 10 years.

The courts have relied on the economic substance doctrine to distinguish abusive transactions from legitimate ones. The application of the doctrine is heavily dependent upon the facts and circumstances of a particular transaction. The codification of the economic substance doctrine adds some clarity but what remains to be seen is whether the codification will be more or less favorable to a transaction than the doctrine as historically applied

Disclaimer Required by IRS Rules of Practice: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.

This publication is intended for general information purposes. It does not constitute legal advice. The reader should consult with knowledgeable legal counsel to determine how applicable laws apply to specific situations. Articles in this publication are based on the most current information available at the time they were written. Since it is possible that the law and other circumstances may have changed since this publication, please call us to discuss any actions you may be considering as a result of reading an article.

© 2010 Law Office of Michael G. Lapidus.  All rights reserved.

Because of a partnership between the Internal Revenue Service (IRS) and 19 Free File partners, including Turbo Tax Online, many taxpayers are now eligible for free online income tax filing.

If you qualify, you can use Turbo Tax Online, or any other of the 19 Free File partners, to prepare and file your income tax return online for free. This program is known as the IRS Free File Alliance.

This free tax filing program is designed for lower income taxpayers with simple tax situations and includes IRS and State tax forms and schedules. However, it is not designed for more complex tax situations such as investments, rentals, royalties, farming, foreign earned income, partnerships, s corporations, estates or trusts.

In addition, twenty-one states have also created free file programs based on the Federal free tax filing program. This means you may also qualify to file your State taxes for free with the Freedom Edition tax software.

Free File differs from conventional tax filing in that Free File is an electronic tax program. You must use a computer and have Internet access to use the free tax filing service. Users enter their income tax data online and tax calculations are made by the online tax software. Completed tax returns are then sent to the Internal Revenue Service (IRS) through the efile system.

Using the (IRS) e-file system allows you to get your tax refund back in as little as 10 days. If it ends up that you owe money, you can have it deducted from your bank account on the last day of tax filing season.