Archive for category: Tax Planning – Statutory Tax Benefits involving Foreign Sourced Income

The United States is one of the few large countries that taxes citizens, permanent residents and corporations on income earned anywhere in the world.

U.S. corporations have a nifty way to avoid tax on their foreign income and reduce their U.S. tax without really leaving home. It’s called tax inversion, and due to some recent high profile deals it’s becoming all the rage.

In the past year alone, at least 14 U.S. companies have announced inversion deals with foreign (mostly Irish and British) companies. Left unchecked, these deals will continue to erode the corporate tax base, leaving others like you and me to pick up the slack.

What is tax inversion?

A U.S. company reincorporates overseas by getting acquired by a smaller company in a country where the corporate tax rate is much lower than the top U.S. rate of 35%. Generally, the U.S. firm’s management and operations remain in the United States, but it is no longer taxed on income earned outside the United States. The firm will still pay taxes on income earned inside the U.S., but it gets easier to minimize that tax. For example, the U.S. subsidiary can borrow money from its foreign parent, then deduct the interest it pays on that debt, which reduces its U.S. income and taxes.

An inversion also gives companies ways to avoid U.S. tax on profits that have been piling up overseas, largely in tax havens such as Bermuda. It is estimated that U.S. companies have about $1 trillion sitting in foreign subsidiaries. They would love to bring it home and use it to pay dividends or buy back shares, which would increase their stock price. But they would have to pay U.S. tax on it.

However, if the U.S. company gets acquired by an Irish company, for example, the Irish company can borrow that cash from the Bermuda company. The Irish company can use it to buy back shares or pay dividends without paying U.S. tax. The shareholders of the former U.S. company benefit because they own most of the Irish company.

If the big corporations can do this to avoid U.S. taxes, could you or your little corporation do the same thing?

As an individual you would have to not only leave the country but also renounce your U.S. citizenship – meaning that you now must be a citizen of some other foreign country and you will never be able to attain U.S. citizenship again. You will also need to pay an “exit tax” 15% of the value of all your assets.

For your little corporation, you will not be able to accomplish the tax inversion due to special rules that the IRS has in place. These rules would classify the new foreign corporation as a Controlled Foreign Corporation (“CFC”) because you individually as a U.S. person for tax purposes would be the sole shareholder for the foreign corporation. These rules provide that regardless of whether any distributions are made by the CFC to you, you are required to report on your individual income tax return the income that the CFC earned. Big corporations would not be classified as a CFC because their stock is widely held and not concentrated to one or a few shareholders.

Does it make any sense for the taxes to be based on where the corporate “hub” is anyway? Shouldn’t it be based on WHERE they made the money?

Actually the big corporations still have to pay U.S. taxes despite accomplishing a tax inversion. Profits earned in the U.S. would still be subject to U.S. taxes; however, the U.S. federal income tax bill on repatriated profits is reduced by the amount of income taxes paid to foreign governments on the same U.S. profit reported to IRS. So, profits earned outside the U.S. would not be subject to U.S. income taxes until those profits are repatriated back to the U.S. at which time they are subject to the full U.S. statutory corporate income tax rate of 35% upon repatriation.

So as an individual or little corporation, how do you fight back?

You would be surprised of the many tax saving opportunities that are available to U.S. persons and U.S. businesses without the need to go offshore. The tax attorneys at the Law Offices Of Jeffrey B. Kahn, P.C. located in Los Angeles, San Diego, San Francisco and elsewhere in California are highly skilled in making sure that you are getting all the tax saving benefits that are legally possible.

Description: Let the tax attorneys of the Law Offices Of Jeffrey B. Kahn, P.C. evaluate your tax exposure and legally minimize the amount you need to pay.

Ordinarily, the United States taxes U.S. citizens and resident aliens on their worldwide income, even when they live and work abroad for an extended period of time. To provide some relief, a U.S. citizen or resident who meets certain requirements can elect to exclude from U.S. taxation a limited amount of foreign earned income plus a housing cost amount. A double tax benefit is not allowed, however, and a taxpayer cannot claim a credit for foreign income taxes related to excluded income.

1. Exclusion versus Credit

Because the foreign earned income exclusion is elective, an expatriate must decide whether to elect the exclusion or to rely on the foreign tax credit. A key factor in deciding which option is most advantageous is the relative amounts of U.S. and foreign taxes imposed on the foreign earned income before the exclusion or credit. The exclusion completely eliminates the U.S. income tax on the qualifying amount of foreign earned income.

This allows expatriates who work in a low-tax foreign jurisdiction or who qualify for special tax exemptions in the countries in which they work, to benefit from the lower foreign tax rates. In contrast, under the foreign tax credit option, the United States collects any residual U.S. tax on lightly taxed foreign income and the expatriate derives no benefit from the lower foreign rates.

The exclusion also eliminates the U.S. tax on the qualifying amount of foreign earned income derived by an expatriate working in a high-tax foreign jurisdiction. The credit option also achieves this result, since the higher foreign taxes are sufficient to fully offset the U.S. tax on foreign earned income.

In addition, under the credit option, the expatriate receives a potential added benefit in the form of a foreign tax credit carryover. Foreign taxes in excess of the foreign tax credit limitation can be carried back one year and forward up to ten years. Therefore, an expatriate can use these excess credits in a carryover year in which he or she has foreign-source income that attracts little or no foreign tax.

2. Qualified Individuals

The foreign earned income exclusion is available only to U.S. citizens or resident aliens who meet the following requirements:

(a) the individual is physically present in a foreign country for at least 330 full days during a 12-month period or, in the case of a U.S. citizen, is a bona fide resident of a foreign country for an uninterrupted period that includes an entire taxable year, AND

(b) the individual’s tax home is in a foreign country.

Whether a person is a bona fide foreign resident is determined by his intentions with regard to the length and nature of the stay. Factors which suggest that an expatriate is a bona fide resident include: (i) the presence of family, (ii) the acquisition of a foreign home or long-term lease, and (iii) involvement in the social life of the foreign country.

The second requirement is that the individual has a foreign tax home. An individual’s tax home is his principal or regular place of business.

3. Computing the Exclusion

The exclusion is available only for foreign-source income that was earned during the period in which the taxpayer satisfies:

(1) the foreign tax home requirement, and

(2) either (a) the bona fide foreign resident or (b) the 330-day physical presence test.

Therefore, when identifying compensation that qualifies for the exclusion, the determinative factor is whether a paycheck or taxable reimbursement is attributable to services performed during the qualifying period, not whether the expatriate actually received the compensation during that period. A deferred payment, such as a bonus, qualifies for the exclusion only if it is received before the close of the taxable year following the year in which it was earned. Pension income does not qualify for the exclusion.

Employment-related allowances, such as foreign housing and automobile allowances, also qualify for the exclusion. However, the allowance must represent compensation for services performed during the qualifying period. In this regard, any taxable reimbursement received for expenses incurred in moving from the United States to a foreign country are treated as compensation for services performed abroad. On the other hand, any taxable reimbursements received for expenses incurred in moving back to the United States are treated as U.S.-source income.

Any deductions allocable to excluded foreign earned income, such as reimbursed employee business expenses, are disallowed. Certain deductions are considered unrelated to any specific item of gross income and are always deducted in full. These include medical expenses, charitable contributions, alimony payments, IRS contributions, real estate taxes, mortgage interest on a personal residence, and personal exemptions.

4. Housing Cost Allowance

An expatriate that qualifies for the foreign earned income exclusion can also claim an exclusion for the housing cost amount. The housing cost amount equals the excess of eligible expenses incurred for the expatriate’s foreign housing over a stipulated base amount, which is prorated for the number of qualifying days in the year.

Eligible housing expenses normally include rent, utilities (other than telephone charges), real and personal property insurance, certain occupancy taxes, nonrefundable security deposits, rental of furniture and accessories, household repairs, and residential parking. Housing expenses do not include the costs of purchasing or making improvement to a house, mortgage interest and real estate taxes related to a house that the taxpayer owns, purchased furniture, pay television subscriptions, or domestic help.

5. Electing the Exclusion

The election to claim the foreign earned income exclusion and housing cost amount is made by filing Form 2555, Foreign Earned Income Exclusion, and remains in effect until revoked by the taxpayer. If uncertainties exist regarding whether to elect the exclusion, a taxpayer can file an original return without making the election, and then file an amended return at a later date electing the exclusion.

Given the complexity of this area, one would be best served by seeking tax counsel to make sure that you are getting the maximum tax benefits. Contact the Law Offices Of Jeffrey B. Kahn, P.C. with locations in Los Angeles, San Francisco and elsewhere in California.
Description: Let the tax attorneys of the Law Offices Of Jeffrey B. Kahn, P.C. resolve your IRS tax problems, get you in compliance with your FBAR filing obligations, and minimize the chance of any criminal investigation or imposition of civil penalties.

While millions of Americans were glued to their televisions to watch American athletes compete in this year’s Winter Olympics, the Internal Revenue Service was quietly getting ready to make sure that all our Olympic winners pay taxes on their victories.

It’s true. The Internal Revenue Code mandates that If you win a prize in a lucky number drawing, television or radio quiz program, beauty contest, or other event, you must include it in your income. For example, if you win a $100 prize in a marathon, you must report this income on your Form 1040. If you refuse to accept a prize, do not include its value in your income.  Prizes and awards in goods or services must be included in your income at their fair market value.

That being the case, any athlete who accepts his or her Olympic medal will have to report its value as income and pay taxes on it.  Considering that the value of each medal ranges from $10,000 to $25,000, this can be a hefty tax bill of up to $9,000. That’s true even though the competition took place in Russia and not the United States.

Contrast this to winning Olympic athletes from most other countries don’t have to worry about their medals being taxed.  This unfairness has resulted in considerable debate during each session of Congress when a Summer or Winter Olympics is held but any legislation to change the tax law has never made it out of Congress.

You would think most Americans would be in favor of the legislation but there appears to be some backlash. For example, should an Olympian who comes home with 4 medals conceivably make $100,000 tax free while millions of hard working Americans struggle to support their families on far less income yet have to pay taxes? Also consider the millions dollars from endorsements that medal winners can make as a result of winning a medal.

It’s clearly a decisive issue with arguments on both sides. But what you need to remember that even income earned outside the U.S. may be taxable. Every year, thousands of taxpayers learn that lesson the hard way. If you live, compete or work outside the United States, you must still file tax returns here.  In addition, if you win a prize or award, you must claim the value of that prize or award on your tax return as income.

Description: Let the tax attorneys of the Law Offices Of Jeffrey B. Kahn, P.C. resolve your IRS tax problems and make sure you are fully utilizing all benefits under the tax laws.

U.S. law treats U.S. persons and foreign persons differently for tax purposes. Therefore, it is important to be able to distinguish between these two types of individual taxpayers.  This area of the tax law can be quite confusing.

For an individual to be classified as ”United States person” for tax purposes means he or she is one of the following:

• A citizen of the United States
• A resident of the United States who holds a Green Card or “H1B” Visa
• A resident of the United States who meets the “Substantial Presence Test” for the calendar year

The following individuals if NOT residents or citizens of the U.S. should be treated as foreign persons:

• An individual temporarily present in the United States as a foreign government-related individual under an “A” or “G” visa.
• A teacher or trainee temporarily present in the United States under a “J” or “Q” visa, who substantially complies with the requirements of the visa.
• A student temporarily present in the United States under an “F”, “J”, “M”, or “Q” visa, who substantially complies with the requirements of the visa.
• A professional athlete temporarily in the United States to compete in a charitable sports event.

Under the “Substantial Presence Test” you will be considered a U.S. resident for tax purposes if you meet the substantial presence test for calendar year 2013. To meet this test, you must be physically present in the United States on at least:

1. 31 days during 2013, and
2. 183 days during the 3-year period that includes 2013, 2012, and 2011, counting:
   1. All the days you were present in 2013, and
   2. ¹/₃ of the days you were present in 2012, and
   3. ¹/₆ of the days you were present in 2011.

Example.

You were physically present in the United States on 120 days in each of the years 2011, 2012, and 2013. To determine if you meet the substantial presence test for 2013, count the full 120 days of presence in 2013, 40 days in 2012 (¹/₃ of 120), and 20 days in 2011 (¹/₆ of 120). Because the total for the 3-year period is 180 days, you are not considered a resident under the substantial presence test for 2013.

If you are determined to be a U.S. person, you are required to report your world-wide income on your U.S. income tax returns and annually disclose all foreign bank accounts to the U.S. Treasury where the aggregate value of those accounts exceed $10,000.00.

For those U.S. persons who have not satisfied these requirements in any of the last six calendar years, in addition to the back taxes, interest and penalties, the government may impose include a fine of not more than $500,000.00 and imprisonment of not more than five years, for failure to file a report, supply information, and for filing a false or fraudulent report.

The IRS has established the Offshore Voluntary Disclosure Initiative (OVDI) which allows U.S. persons to come forward to avoid criminal prosecution and not have to bear the full amount of penalties normally imposed by IRS.  U.S. persons who hire an experienced tax attorney in Offshore Account Voluntary Disclosures should result in avoiding any pitfalls and gaining the maximum benefits conferred by this program.