Christian Reeves

U.S. Tax for Business Owners & Self Employed

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This section is an introduction to the benefits of an offshore corporation for U.S. citizens living and working abroad. It is not meant for those living abroad on their pension (retirees) or those with passive investment income.

Most Expats know that the U.S. taxes its citizens on their worldwide income and that all U.S. citizens must file a U.S. tax return every year. What most do not know is that a foreign corporation, in a zero tax jurisdiction, can legally and legitimately be used to reduce, defer or eliminate U.S. tax on their business income.

As discussed in Section one, your first line of defense is the Foreign Earned Income Exclusion (FEIE or exclusion). This exclusion was covered in detail in Section One, and can be summarized for our purpose here as follows: The FEIE excludes from your U.S. income tax the first $95,100 for 2012 of wage or self-employment income earned by a U.S. citizen who is a “resident” of another country or who was outside of the U.S. for at least 330 of any 365 day period.

The FEIE can be used to reduce or eliminate U.S. Federal income tax on wages paid to you by a U.S. corporation or a foreign corporation. It does not matter if you are the owner of the corporation…the FEIE still applies as long as you are an employee of that company drawing a salary.

The exclusion can also be used to reduce federal income tax on self-employment income paid to you while you are living and working abroad. “Self-employed” generally refers to someone operating a small business without the protection of a corporation.

Now, that you have become an expert on the FEIE by reading this book, let’s look at the practical applications to the employee and the self-employed person.

Employess

Let’s say you are the employee of a U.S. corporation and live outside of the U.S. You receive a Form W-2, and may have had reduced withholding of your federal income tax, or will file a claim for a refund with the IRS because of the exclusion. However, the exclusion only applies to income tax, thus you still get to pay Medicare, Social Security, and FICA tax…which, for our purposes, I will estimate at about 7.5%, or $6,855 on a salary of $95,100. In addition, your employer is required to match your Medicare, Social Security and FICA contributions, which is a cost to him of about 7.5%. Therefore, the total cost is about 15%. Again, these numbers are rounded off for this example.

Now, let’s say you are an employee of foreign corporation, rather than a U.S. corporation. This foreign corporation can be owned by you, or be a subsidiary of your U.S. employer. In that case, you would not have a Form W-2 sent to the IRS, might not have any U.S. withholding, and may not be required to contribute to the U.S. Medicare, Social Security, or FICA programs (unless the foreign corporation opted in to the U.S. system).

In addition to the benefits to the employee, the employer incorporated offshore is not required to pay in to these U.S. programs, thereby resulting in a total savings of about 15%.

Please note that I have assumed that the foreign entity is incorporated in an offshore jurisdiction that will not tax its income or levy a Social Security tax. Also note that I assume it is a corporation, and not a partnership or Limited Liability Company.

Self-Employed

Now for the self-employed person operating without a corporation: The IRS and the entrepreneur will (or should) receive a Form 1099 from each payment over $500 done for a U.S. company or person. Presumably, there will be no report for work done for non-US businesses, though this does not impact your tax obligations. You then report your business income and expenses on Schedule C and use the foreign earned income exclusion to reduce your federal income tax…and that is where things go horribly wrong.

First, the FEIE does not reduce self-employment tax, which is about 15%, similar to the tax charged to the employee and employer above. Unfortunately for the self-employed person, he must pay the entire tax, rather than only half, as he would as an employee.

Second, the exclusion is reduced in proportion to your Schedule C business expenses. This roughly means that, if your gross income is $182,800, and your business expenses are $95,100, your exclusion is reduced by about 50% to $45,700. Thus you are paying federal income tax on $45,700, or about 50% of your net business income, in addition to paying 15% self-employment tax on $95,100.

Ok, so that is rough, but the IRS is not done with you yet! Since January 1, 2006, when the Tax Increase Prevention and Reconciliation Act of 2005 came into effect, taxpayers claiming the foreign earned income exclusion have been paying tax at the tax rates that would apply had they not claimed the exclusion. That means, instead of having your income taxed starting at the 10% rate, most expatriates are taxed starting at the 25% tax bracket.

Therefore, if you have a Schedule C business operating at a 50% net profit margin with sales of $182,800 your tax bill might be $24,835 ($91,400 x 15% + $45,700 x 25%). This is a very rough, back of the envelope, example, but you get the idea.

If a husband and wife both operate the same business, and sales are doubled, with the same 50% margin, the cost of reporting the business on Schedule C, rather than through a properly structured offshore corporation, could be around $49,000.

Tax Benefits of Incorporating

If you are self-employed and living and working abroad you do have options.

For example, had the same self-employed person above operated through a properly domiciled and structured offshore corporation, he or she may have eliminated just about all of the tax on net active business profits of $95,100…to say nothing of the benefits of limited liability. This is accomplished as follows:

First, form an offshore corporation in a zero tax jurisdiction, open a foreign bank account, and resister that company with the IRS.

Second, draw a salary of up to $95,100 for 2012 from that foreign corporation. As long as you qualify for the FEIE and the company’s income is derived from active, not passive business, there will be no federal income tax on this income.

Third, the properly registered and domiciled foreign corporation is not responsible for Medicare, Social Security, or FICA taxes.

Fourth, you are not considered self-employed; you are an employee of your offshore corporation, and not subject to self-employment tax.

Fifth, the expenses of the offshore corporation do not reduce your foreign earned income exclusion.

Sixth, you might be able to retain some or all of the offshore corporation’s earnings in excess of the exclusion. Careful planning in this area might allow the deferral of U.S. income tax on active business income inside the corporation.

Therefore, the use of an offshore corporation by an international business with net profits of $95,100 and one employee saves about $24,000 in U.S. taxes. If the corporation’s net profits are $190,200, and there are two employees, such as a husband and wife, the total savings might be as high as $48,000.

When planning an international business, be it large or small, you should consult with a qualified U.S. licensed tax attorney experienced in forming and advising international businesses.

 

OVERSEAS TAX FAQ #1: How can an offshore corporation be used to reduce U.S. taxation?

If you live in the United States while you do your work, you will pay U.S. tax on the income you earn. Using a foreign corporation while you are physically present in the U.S. does not affect your U.S. tax situation.

If you retire to a foreign country and your only income is from a pension, investments, Social Security, etc., you will continue to pay tax in the States. There is no tax benefit to retiring abroad.

If you live abroad, work for either a U.S. company or a foreign employer, and meet the foreign earned income exclusion requirements, up to US$95,100 in wage income (for 2012; the amount is adjusted upward each year) will be free of U.S. federal income tax.

If you run a business or are self-employed, live and work abroad, meet the foreign earned income exclusion requirements, and operate through an offshore corporation, you could be able to reduce or even eliminate all U.S. tax on your ordinary income.

If you operate a business from and reside in a country that does not tax foreign-source income, and your clients are outside that country, you could be able to operate free of tax in that country as well, meaning it could be possible for you to live completely income tax free.

OVERSEAS TAX FAQ #2: What if I set up an offshore corporation but continue living in the United States? Could I have foreign clients wire money to my offshore corporation, then pay U.S. tax on that income only when it is brought into the States?

No. This is one of the most common types of tax fraud…a strategy for going to prison.

If you are present in the United States while you work, all income you earn is taxable in the United States when received. When money is sent to an offshore corporation that you own or control, it is deemed received. It does not matter if you use nominee directors or add some other layer of complexity.

Of course, there are legitimate benefits to incorporating offshore. For example, you could have access to better or more diverse investment options, you could enjoy better asset protection than available in a domestic vehicle, and your customers could prefer to do business with a non-U.S. entity.

I am asked this question all the time by people seeking tax advice. Typically, they are looking for honest counsel and have no intention of breaking the law. However, you must understand that, when you call an offshore attorney or an online incorporator, you often receive no guidance and often can be given misleading information.

OVERSEAS TAX FAQ #3: If I retire overseas, will I owe income on my retirement or pension income?

U.S. retirement and pension income was earned while you were working in the United States. In many cases, you were allowed to defer income on the pension component of your wages.

Now that you are ready to take that income, it is taxable in the country where it was earned. The foreign earned income excision and other international tax tools do not apply.

The same is true of most types of investment income. Income from stocks sold, dividends received, rental income, and bank interest does not qualify for the foreign earned income exclusion and is taxed as if you were living in the United States.

OVERSEAS TAX FAQ #4: Living overseas, must I still pay Social Security, Medicare, and FICA?

If you live abroad but work for a U.S. corporation, you qualify for the foreign earned income exclusion and can exclude up to US$95,100 in wage income (for 2012) from federal income tax.

However, you still must pay Social Security, Medicare, and FICA. This usually amounts to 7.5% paid by you and 7.5% paid by your employer. For the purposes of this conversation, I’m ignoring Social Security treaties, which are country-specific.

Also, you could still be required to pay state tax if your spouse is living in the United States while you are working abroad. For example, if your spouse lives in California, which does not have the foreign earned income exclusion, the state would tax 50% of your income under a community property tax rule.

If you are employed by a non-U.S. corporation, the foreign earned income exclusion rules are as I’ve described, but you do not pay U.S. Social Security, Medicare, or FICA taxes. This is the case even if the foreign corporation is a subsidiary of a U.S. company (unless that subsidiary elects into the U.S. social tax system, which is extremely rare).

OVERSEAS TAX FAQ #5: What is my U.S. tax obligation operating a business or being self-employed outside the States?

If you are self-employed or operate a business outside the United States and qualify for the foreign earned income exclusion, you can use that exclusion to reduce the amount of federal income tax you owe. If you operate your business without a corporation or through a single-member LLC that does not file an election with the IRS, you must pay U.S. self-employment tax on your income. This amounts to about 15% tax of your income.

Making things worse, your business is reported to the IRS on the “Schedule C” form, and your business expenses proportionately reduce your foreign earned income exclusion. For example, if your total sales for 2012 were US$300,000 and your expenses were US$150,000, your foreign earned income exclusion is reduced by 50%. Thus, you can reduce your income for the purposes of figuring the tax you owe by only US$95,100 divided by 2, or US$47,550.

Adding insult to injury, you must pay U.S. income tax on the amount over the allowed foreign earned income exclusion. In our example, that is US$150,000 of net income, minus the remaining FEIE of US$47,550 equals US$102,450 of taxable income.

All three of these problems can be managed by operating your business through a foreign corporation.

First, operating this way, you are a non-U.S. corporation and not required to pay Social Security, Medicare, or FICA taxes.

Second, you can draw a salary from your corporation of US$95,100, avoiding the issue of a reduced exclusion because of business expenses.

Third, you may be able to retain net profits in excess of the foreign earned income exclusion and pay U.S. income tax on that money only when you take it out of the corporation.

OVERSEAS TAX FAQ #6: If I operate a business in a foreign jurisdiction (such as Panama), what is my local tax obligation?

Several countries, including Panama, do not tax foreign source income. These jurisdictions tax only domestic income (profits you make by selling to people in that country).

Therefore, you can mitigate income tax in your country of residence if you sell to people or businesses outside that nation. For example, from a base in Panama, you could offer products or services over the Internet to clients in the United States. If you don’t take orders from people in Panama, this is foreign-source income in Panama and not taxable by that country.

Note: Selling to customers in the United States does not affect your foreign earned income exclusion or your ability to retain earnings in your corporation. These tax rules require only that you live outside the United States and otherwise qualify for the foreign earned income exclusion.

As discussed above, you must take a salary from your foreign corporation to maximize the benefits of living and operating a business abroad. If you draw a salary from your Panama corporation while you are living in Panama, you could be subject to Panama’s various income, payroll, and social taxes.

You can comply with your U.S. obligations by selling through a second foreign corporation, such as one incorporated in Cayman or Nevis, drawing a salary from that entity, and then passing funds sufficient to pay business expenses in Panama up to your Panama company.

In this way, you mitigate tax in Panama on your salary, and your domestic (Panamanian) entity breaks even for domestic tax purposes.

As long as you report both entities and all non-U.S. bank accounts to the U.S. government, you remain in compliance with your U.S. tax obligations. If you take a salary less than or equal to the foreign earned income exclusion, and retain the balance in your offshore structure, you could eliminate or defer U.S. tax on up to 100% of your revenues.

Where to Incorporate

Once you have decided to incorporate your business offshore, the next big issue is where. Here are my suggestions.

The first step in the process is to decide if you want to focus on privacy, transparency, or on a country that will make a good impression on those who contract with your business. There are several good choices available for each of these three focal points, but I tend to limit my formations to countries where I have experience, have personal relationships, and where I have spent time researching and debating their business, tax, and privacy laws.

With that said, if the primary component is privacy, I typically suggest a Nevis or Cook Islands corporation or limited liability company (LLC). Both of these countries have exceptional privacy laws, well tested legal systems, and a long history in the asset protection industry. Again, there are other jurisdictions, but these two work well, so I do not see a need to search further.

I expect most readers are familiar with Nevis, so I will say a few words about the Cook Islands (CI). The CI have long been a leader in international asset protection trusts, and just recently passed the “The Cook Islands International Limited Liability Companies Act 2008.” This Act, modeled after Nevis, integrates CI’s long standing trust and creditor laws, and their corresponding lack of a bankruptcy statute, into an LLC statute which maximizes both privacy and asset protection.

Other clients, especially those who are officers or directors of large U.S. based businesses, or who will operate an offshore hedge fund with U.S. investments, require a country that is fully compliant with the U.S. Fyi…compliant generally means that the IRS and SEC can easily find the beneficial owner and gain access the company’s books, records, and foreign bank accounts.

Where transparency is required, I prefer Cayman Islands corporations and licensed hedge funds. This jurisdiction is more expensive than its competitor, the British Virgin Islands, but I believe that the availability of quality legal and accounting professionals on Grand Cayman is worth the cost. Since most clients seeking such transparency are operating significant businesses or investment portfolios, cost should not be a primary factor.

The third category, a country that will make a good impression on those who contract with your business, is harder to define. After all, beauty is in the eye of the beholder. With that in mind, here are three suggestions:

If money is no object, and image is everything, I suggest a Swiss holding company with Cayman or BVI subsidiaries. This generally allows you to operate from Switzerland, hold yourself out as a Swiss company, and contract through offshore subsidiaries, without incurring Swiss tax on international (holding company) profits.

Unfortunately, operating in Switzerland can be expensive. The typical annual maintenance of a Swiss holding company, including a Swiss director, is $10,000+, compared to about $850 for a Nevis IBC or LLC without a foreign director. In addition, a lot of planning and complex structuring is required to work through the dividend withholding section of the Swiss tax code.

For those on a budget, I recommend Hong Kong or Panama. Hong Kong is an excellent place for a holding company, has a wealth of qualified legal and accounting professionals, balances privacy and business image well, allows for nominee directors, and most banks are comfortable with corporations domiciled in Hong Kong.

The drawbacks of Hong Kong are that the directors monitor the company’s activities closely, which results in higher than average annual bills, the time difference with the U.S. often delays communications and transactions by about 24 hours, and you must travel to Honk Kong in order to open a bank account there. If you prefer not to travel, an account can be opened in the Isle of Man. Also, while the directors are active, they are typically well qualified and handle your business in a professional manner.

Finally, I believe Panama is the best jurisdiction for someone who will operate a business outside of the U.S. with employees, an office, and business assets. The Panamanian economy is strong, qualified labor is relatively inexpensive, the costs of firing an employee are minimal compared to Europe, telephone and internet services are cost effective and of a high quality (certainly superior to all Caribbean islands and most Latin American countries), several local banks provide reasonable service and do not have branches in the United States, and Panama’s primary currency is the U.S. dollar, so your Panamanian bank can accept checks from U.S. clients.

In addition to the business benefits above, from a privacy standpoint, Panama allows for nominee directors and shareholders. Also, the shares in a Panama company can be held by a Panama foundation, thereby maximizing asset protection.

Shelf Companies

I am frequently asked about the use of offshore “shelf” corporations in international business. Some claim they are useless, while others market them as the greatest invention since the numbered bank account. I would like to take this opportunity to put my two cents worth in to the debate.

Bottom Line: I believe offshore shelf corporations can be helpful if you are marketing a business because they improve your image. Since this can be accomplished without backdating any documents, or doing anything improper, I support shelf companies.

First, what is a shelf company? It is a corporation formed months or years ago that has been sitting on the incorporator’s shelf, unused. Because it has no history of operation, no bank account, and no creditors, there should be no risk in purchasing a shelf company.

The legitimate benefits of an offshore shelf corporation are:

  1. The company is ready to use off the shelf. You do not need to wait for the company to be formed, the name to be approved, or for the directors to be assigned.
  2. You can market the name and age of the shelf company. For example, your letterhead and marketing materials can refer to “International Marketing Services (Panama), S.A., Established 2006,” if you bought a corporation by that name formed in Panama in October of 2006.

Of course, the abuses of shelf companies are well documented. Many purchase these entities and then ask the director to sign back dated documents. While you can find some less scrupulous directors who are willing to provide this service, such a practice is obviously improper.

Because of the nature of the industry, it is difficult to find a shelf company older than about 14 months. This is because these companies are usually formed by the incorporator on behalf of a particular client. The client does not pay the incorporation fee, so the entity sits on the shelf to be sold to someone else. After 12 months, the annual dues must be paid, which the incorporator is not willing to do. Around the 14th to 16th month, the company is closed by the government registrar.

The only significant exception that I have found is in Switzerland. There, it is possible to purchase a company formed many years ago, revive that company in the government registry, let it sit on the shelf for about 2 years to eliminate any potential creditors and then file for a tax clearance. The result is a clean shell with the original incorporation date attached.

So, while a shelf company may help in marketing your business, it has no tax benefit.

International Foundations

Many offshore promoters are pushing Liechtenstein Foundations on the very wealthy and Panamanian Foundations on the rest of us.

Note: Foundations are more commonly used in asset protection, but some operate offshore businesses under them, thus their inclusion in this book.

Many are taken in by the term “foundation,” hoping or believing that it makes the structure a charitable foundation which is tax exempt. This is simply not true. For an entity to be tax exempt, it must be registered with the IRS as such, under IRC §501(c)(3)., and this applies to both foreign and domestic entities.

Tax tip: Only donations to charities licensed by the U.S. are deductable on your personal tax return. You can donate money to any charity or group around the world, but, if they do not have the IRS’s blessing, you are not entitled to a deduction.

Adding to the confusion, Foundations typically have multiple levels of nominee directors and boards which allegedly control the Foundation’s assets. Some promoters’ claim that, because you gave up control of your assets, you are not taxed on the interest, dividends, and earnings of the foundation. Again, this is not true. You remain the beneficial owner and have indirect control, which equals ownership in the U.S. tax code.

Most accept that a simple foreign corporation with a nominee director, or an offshore trust with a foreign trustee, does not reduce U.S. tax on earnings. But, change the ending from Inc. to foundation; add a few layers of directors, and many are willing to believe the impossible.

Taking it one step further, some foreign attorneys will issue an option stating that the Foundation is not a grantor trust under the U.S. rules. I do not see anything inherently incorrect in this statement. It seems possible that the Foundation can be classified as something other than a grantor trust. However, these statements are often used to confuse and mislead the U.S. client in to believing that there is some tax benefit to such a classification.

All of the opinions I have read say something like this: “The design and structure of the Foundation is to achieve an entity classification as other than a trust such as a partnership, corporation or disregarded entity for U.S. tax purposes.”

Keeping in mind that the U.S. citizen is taxed on his or her worldwide income, and if we agree that the foundation is not some magical tax exempt structure, the classification does not make a tax difference. Under all options, income to the foundation will be taxed in the U.S. as earned, transfers to the entity will be reportable events, and (most) transfers of appreciated property will be deemed sales.

Some opinions also have the following clause: “Furthermore, there is the option of seeking a private letter ruling from the Internal Revenue Service confirming the proper entity classification of the Foundation.” Such a statement should cause alarm…it means that the IRS has not classified the Panamanian or Lichtenstein Foundation and that U.S. citizens have no certainty regarding when, what, and how to file returns for a foundation.

What would happen if you assumed the foundation was a corporation, filed foreign corporate returns, and then it was classified as a trust? I have no idea, but I would not want to find out! In my opinion, Panamanian and Lichtenstein Foundations are potential options and competitors of the offshore Asset Protection Trust. However, I will not recommend them until the IRS provides some clarity on their status and filing requirements.

I am a big fan of Panama as a country in which to operate an international business and I hope these issues are resolved, and that promoters take a more realistic view of U.S. taxation, so that Panamanian Foundations can become legitimate Asset Protection tools.

Christian Reeves

Taxation of Foreign Real Estate Investments

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EDITORS NOTE: This article was published in 2010 and has some valuable information. For a more recent and detailed article on this same site, click here.

 

When it comes to investing in property overseas, there is often little difference than if you were investing in U.S. property. Three situations bear investigation:

1. The first is the purchase of raw land or a building for speculation. In this scenario, the investor buys a property overseas and plans on holding it for a period of time to later sell for a profit. The result is a capital gain taxed by both the U.S. government and, in some cases, the state of domicile of the taxpayer. The U.S. has favorable tax rates (currently 15%) if the holding period is over one year. There may also be a capital gains tax in the country that the property is located in. If this is the case, a credit can be used to offset U.S. taxes.

In this situation, there is no difference in how the U.S. taxes the sale of an investment property in the U.S. and one outside of the U.S.

2. Let’s look at the same scenario, except this time, instead of selling the property outright you want to exchange it into another property. This can be accomplished by using the provisions of section 1031 of the IRS code. Under this section, you can defer some or all of the gain from the sale of one property by simultaneously purchasing another property of “like kind.” Here again, there is no difference in the taxation of property inside the U.S. and outside the U.S.

What we must look at in this situation is the exact definition of “like kind.” When dealing with real property, the government gives quite a bit of latitude in what is considered “like kind.” Examples are raw land, a single family house, a condo, an apartment building, a restraint, etc. As long as you’re selling real estate to buy real estate, you will generally be allowed to perform a 1031 exchange.

The main thing to be aware of is that foreign real property and U.S. real property is not considered to be like kind. For instance, you cannot exchange a rental property in California into a rental property in France or to raw land in Costa Rica (or vice versa).You could however exchange the rental property in France into raw land in Costa Rica. What this boils down to for you, the investor, is that, if you want to move an investment back into the U.S. you will have to pay taxes on any gains you made.

If a property qualifies as “like kind” then you must also qualify the exchange. There are complexities involved with this type of transaction, and you should hire a tax consultant to facilitate the transaction and make sure that you don’t do anything to disqualify the non-recognition of gain. Another critical point is that your new property needs to be more expensive and have a larger note on it. Otherwise a portion of the gain will be recognized and taxable. For more information, see the “Nontaxable Exchanges” section of IRS Publication 544 Sale or Other Dispositions of Assets available at www.irs.gov/pub/irs-pdf/p544.pdf.

3. The third consideration is when you have a rental property overseas. In this case, it is much the same as a rental situation within the U.S. The main consideration is that rental activities are considered passive. This means that losses from your passive rental activities can only offset income from other passive sources. If you do not have any other passive income, the losses are suspended until such time that you have passive income or you sell the property—at which time the losses are released and can offset other types of income.

An exception to this rule applies to active participants in the management of real property. As an “active participant,” you must share in the management decisions for the property, arranging for others to provide services like repairs, etc. Owning property in a foreign country makes it more difficult, but not impossible, to qualify as an active participant. If you meet this requirement, you can deduct the losses from your rental property against your other income (like wages, self-employment, interest, and dividends).

Besides the need to qualify as an active participant you must also meet these additional requirements:

  • You must own more than 10% of the property.
  • You cannot be a limited partner.
  • You must be an active participant in the year of the loss and the year that the loss is deducted. The benefit phases out at an adjusted gross income of between $100,000 and $150,000.

Finally, you will only be allowed straight line depreciation on property outside of the U.S. You are not eligible for the various accelerated depreciation methods.

Implications of Your “Tax Home”

If you only have one tax home regardless of whether you reside in the U.S. or overseas, there are few, if any, complications.

For people with multiple homes or multiple business ventures at which they spend varying amounts of time, it gets trickier. These situations are decided on a case-by-case basis, according to individual circumstances. Some of the facts that will be looked at are:

  • Total business time spent at the different locations.
  • The amount of business activity that is carried on at each location.
  • The significance of the business activity to the taxpayer’s return (where is more money made and what percentage of the total income does it represent?)

Let’s look at some examples of how the tax home concept can affect the taxes of the international real estate investor.

Example 1—Bob and Jane live in the United States and work close to their home. They own some real estate outside the U.S.

In this case, their tax home is their residence and all expenses they incur when visiting their realestate (whether rental property or investment property) are deductible against the income fromthat property.

Example 2—Bob and Jane live in the United States and work close to their home. They spend part of the year at their foreign property—a small house in France with a vineyard.

In this case, whether they can deduct all their living expenses (travel, meals, utilities, incidentals) as “away-from-home” expenses in pursuit of a business is dependent on the facts. Which home do they spend more time at? Where do they make more of their money? How much of their time at the foreign home is devoted to the vineyard business?

If it is determined that more time is spent at the foreign location, the deductions will not be allowed. This is exactly what happened in the case of Bowles v. United States. The taxpayers claimed away-from-home expenses for their grape-growing business, but the IRS and then the courts ruled that, since more of the couple’s time was spent at the vineyard, the vineyard was their tax home and the deductions weren’t allowed.

Example 3—Bob and Jane live in the United States and work close to their home. They own a seasonal B&B in Europe, which they spend the summer operating.

In this case, if Bob and Jane can prove that their tax home is in the United States, all of their living expenses can be deducted as away-from-home expenses (in any case the direct expenses of operating the business are allowed).

What is important to note is that you need to plan your actions beforehand. If you are going to operate a business, or own real estate overseas, and you want to deduct your overseas living expenses as away-from-home expenses, you need to make sure that you create a fact pattern consistent with a tax home in the U.S. Direct expenses of the business or investment are always deductible and are not dependent on where your tax home is.

Note: There is an important distinction in the concept of “tax home” for purposes of deducting away-from-home expenses and qualifying for the foreign earned income exclusion. Multiple homes may cause the loss of the away-from-home expenses but, as long as they are all overseas, you may still qualify for the earned income exclusion and the housing exclusion.

 

EDITORS NOTE: This article was published in 2010 and has some valuable information. For a more recent and detailed article on this same site, click here.

 

Christian Reeves

Expatriation – The Final Solution

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Each month I get one or two inquiries from U.S. citizens who have had enough and want to give up their U.S. citizenship. While it is rare for someone to take such drastic steps, especially after they learn how to manage their U.S. tax obligations while living abroad, it is an important subject. Here are the facts:

Individuals who give up their U.S. citizenship, or long-term residents who give up their residency status after June 16, 2008 are subject to a mark-to-market tax regime under which they are taxed on the unrealized gain in their property to the extent it exceeds $651,000 for 2012.

To calculate gain, the IRS assumes the all of your assets were sold at fair market value on the day before you expatriated. If the net gain from these deemed sales exceed $651,000, you pay tax on that difference.

These rules apply to any U.S. citizen who relinquishes citizenship or any long-term resident who ceases to be a lawful permanent resident of the United States, and the individual who has:

  1. An average annual net income tax liability for the five preceding years of more than $145,000,
  2. A net worth of $2 million or more on the expatriation date, or
  3. Fails to certify under penalty of perjury that he or she has complied with all U.S. tax obligations for the preceding five years or fails to submit evidence of compliance required by the IRS.

Of course, paying tax on assets you do not sell can cause a problem, for which the IRS has graciously made allowances: You may elect to defer this tax so long as you provide adequate security, as required by the IRS, to ensure payment and you give up any treaty rights that would preclude assessment or collection of the tax in the future.

In addition to any other requirement, an expatriate must also file an information return on Form 8854 in each tax year they are subject to the rules above. This form can be found at http://www.irs.gov/pub/irs-pdf/f8854.pdf

There are a lot of contingencies and complexities to the rules above. For example, special rules apply to deferred compensation items, interests in non-grantor trusts, special gift and inheritance rules, etc. Anyone considering expatriation should consult a tax expert.

U.S. licensed tax and expatriation experts are available to speak with you. Feel free to phone us at (619) 483-1708 or send an email to info@premieroffshore.com for a confidential consultation.

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The Rules for Americans Overseas

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Foreign Income Must be Reported

As an American citizen overseas—regardless of where you live or work—you are generally required to file a U.S. tax return, reporting any income generated abroad, in addition to your earnings on the U.S. side.

You are also subject to the same filing requirements that apply to U.S. citizens or residents living in the U.S. As long as you meet the gross income requirement, there’s no escaping the IRS.

You are also eligible for just about all of the deductions. You can choose to take the standard deduction, or itemize on Schedule A. If you itemize, you may deduct mortgage interest, property tax, investment interest, etc. The only major issue is charitable contributions made to a non-U.S. church or organization.

In order for a charitable contribution to be deductible, it must be made to an IRS approved organization. In other words, the charity must qualify under Code Section 501(c)(3). Only the largest of international charities have gone through this approval process, thus, it is unlikely that a contribution to your local non-U.S. church or group is deductible on your U.S. tax return.

Certain deductions may also be reduced by the foreign housing exclusion for the foreign earned income exclusion. However, this is rare and you will need to consult with a tax professional for further guidance.

Even if you determine that your federal tax obligation is zero, you must still complete and file the forms. The IRS changes the filing thresholds slightly each year. In general, once you have the following gross income amounts for 2012, the law requires you to file a federal tax return with the IRS:

Single . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $9,500

— 65 or older . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $10,950

Head of household . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $12,200

— 65 or older . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $13,650

Married filing jointly . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $19,000

— One spouse 65 or older . . . . . . . . . . . . . . . . . . . . . . . . . $20,150

— Both spouses 65 or older . . . . . . . . . . . . . . . . . . . . . . . . $21,300

Married filing separately . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,700

Qualifying widower . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $15,300

— 65 or older . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $16,450

To determine if you meet the gross income requirement for filing purposes, you must include all income you receive from foreign sources as well as your U.S. income.

This is true even if:

• The income is paid in foreign money.

• The foreign country imposes an income tax on that income.

• The income is excludable under the foreign earned income exclusion.

If you are self-employed, and generate more than $400 of net self-employment earnings in a single year, you must file a U.S. income tax return, regardless of your age. Net earnings from self-employment include the income earned both in a foreign country and in the U.S.

You must pay self-employment tax on your net self-employment income, even if it is earned in a foreign country and is excludable as foreign earned income in figuring your income tax. This is an important point worth repeating: the foreign earned income exclusion helps reduce the income tax—not the self-employment tax. The only way to reduce self-employment tax is with ordinary business expenses incurred in the self-employment activity or to operate the business through a foreign corporation.

The Standard Deductions for tax year 2012 are as follows:

Married, Filing Joint Return. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $11,900

Head of Household. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ………. $8,700

Unmarried (not S.S. or H.H.) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $5,950

Married, Filing Separate Return. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $5,950

Tax Advantages for Americans Overseas

The good news is that you may be able to exclude from your income some or all of your foreign earned income. Earned income includes salary, wages, and self-employment earnings. You may also be able either to exclude or to deduct from gross income a “housing amount.” And—depending on your situation—you may qualify for a foreign tax credit or deduction for the local taxes paid to a foreign country. Based on your own particular circumstances, these advantages may reduce—or sometimes eliminate—your federal tax liability.

While exclusions and credits can reduce your tax liability to Uncle Sam, the United States has concluded tax treaties—and other international agreements—with many foreign countries which may help reduce your foreign tax liability, as well.

In theory, the foreign earned income exclusion, the credit or deduction for foreign income taxes, and the application of tax treaty provisions are designed to prevent overseas Americans from paying taxes to both the U.S. and a foreign country on the same income. In other words, they are designed to avoid double taxation. If you are fortunate enough to live in a foreign country that—for one reason or another—doesn’t tax your income, and your salary while abroad is less than or equal to the foreign earned income exclusion amount, this exclusion may allow you to escape income taxes altogether

Foreign Earned Income Exclusion

The most important tool in the expat’s U.S. tax toolbox is the Foreign Earned Income Exclusion (FEIE or Exclusion). If you qualify, you can exclude up to $95,100 in 2012 of foreign earned income free from U.S. Federal income tax. If you are married, and both spouses qualify for the exclusion, your total exclusion may be $182,800.

Foreign Earned Income

As I said above, only income that is both foreign and earned can be excluded from Federal income tax. Income that is foreign is that which is earned while you are physically present outside of the United States. Income that is earned is wages, salaries, professional fees and other amounts received as compensation for personal services actually rendered when your tax home was located in a foreign country and you meet either the bona fide residence or physical presence test. Wages can come from a U.S. corporation or a foreign corporation, including an offshore corporation, and it does not matter that you are also a shareholder or owner of that corporation.

Earned Income does not include interest, dividends, or other investment or passive income.

To qualify for the exclusion, you must first prove that your “tax home” is outside of the United States. Second, you must meet the requirements of either the residency or 330 day tests.

Your tax home is where your principal place of business is located, regardless of where you maintain your residence. In most cases, if you live and work outside of the United States, your tax home is located there.

The concept of a tax home can become complicated in a few, specific instances, such as when someone works in Mexico and lives in the U.S. (ie. commutes from the U.S. to Mexico each day). In that circumstance, your tax home is the U.S. and the FEIE is not available.

In the vast majority of cases, one’s tax home is not a major consideration, therefore, I will not go in to more detail here. For more information, contact a tax professional or see Code Section 911(d)(3) and the related regulations and examples.

Once you have established that your tax home is outside of the United States, you must meet the requirements of either the 330 day test or the residency test.

1. 330 Day Test: You must be outside of the United States for 330 out of any 365 day period. It does not matter if the 330 days is over two calendar years (example: between November 1, 2011 to October 31, 2012) and a special extension to file your tax return is available to give you time to meet this requirement.

2. Bona Fide Residency Test: Residency is achieved by moving to another country and making it your “home.” You can intend to return to the United States in the future, but you must move to the foreign country for an “indefinite” or “extended” period of time, which must include one entire calendar year. This is discussed in detail below.

As you can see, the 330 day test is fact based, while the residency test turns on your intentions and is therefore more difficult to use and prove. I often recommend relying on the 330 day test in the first year you claim the Exclusion, and then moving to the residency test after applying for or gaining residency in your new home.

Also, the exclusion is computed on a daily basis. Therefore, the maximum limit must be reduced for each day during the calendar year that you do not qualify. The exclusion is also limited to the excess of your foreign earned income for the year over your foreign housing exclusion.

Bona Fide Residency Test

The bona fide residency test is one of the most misunderstood and misused sections of the tax code by those working and living abroad…especially by contractors on “temporary” assignments and those in combat zones.

You are a bona fide resident if you move to a foreign country and make it your home. You do this by filing and paying taxes in that country, moving there and planning to stay indefinitely, and generally becoming part of the local community.

The perfect example of a resident is someone who moves to a foreign country, does not intend to return to the U.S., files and pays taxes in that country, is on a long term visa that allows them to work in that country, applies for residency and/or citizenship if possible, sell their U.S. home and buys one in the foreign country, and if they are married or have children, those family members relocate with them.

The problem with the residency test is that very few cases are perfect. For example, a husband might move to France to work indefinitely, leaving his family in California, where he returns to visit for 40 days per year. He also plans on returning to California when it is financially possible. This taxpayer must use the residency test and convince the IRS that his tax home is in France, while his wife’s tax home is in the U.S. This can be a challenging tax issue.

Also, being out of the U.S. for one calendar year does not make you a resident of a foreign country. For example, if you go to a foreign country to work on a particular construction job for a specified period of time, say 14 months, you ordinarily will not be regarded as a bona fide resident of that country even though you work there for one tax year or longer. The length of your stay and the nature of your job are only some of the factors to be considered in determining whether you meet the bona fide residence test.

If the residency test is so complex, why use it? Because qualifying under this test, rather than physical presence, allows you to return to the U.S. for a few months each year rather than only 35 days. Second, once you qualify as a resident of a foreign country, you will remain a resident of that country for U.S. tax purposes until you give up your residency. With the 330 day test, you must be out of the country for 330 of each 365 day period.

Finally, with the residency test, you can qualify for all or part of a year. Here is an example:

Andy is a U.S. citizen who qualifies for the FEIE using the physical presence test by living in Costa Rica for all of 2011. He spent no days working in the United States and received $78,000 in salary. Assuming he claimed no foreign housing exclusion, Andy is able to exclude all of this salary from his gross income because it is less than the Foreign Earned Income Exclusion amount for 2011 of $92,900. Andy continues to work in Costa Rica until October 31, 2012, when his employer permanently reassigns him to the United States. During this time, Andy received a salary of $95,000 for his work in Costa Rica in 2012. Assuming he claimed no foreign housing exclusion, the maximum amount of foreign earned income he can exclude from his gross income in 2012 is $79,467 ($95,100 multiplied by ratio of the number of days he was working in Costa Rica (305/365)).

Perpetual Traveler

One major issue I see time and time again, especially with retiree’s living abroad, is the “perpetual traveler.” This is someone who is never in any one place long enough to lay down roots. They travel from place to place, possibly residing in one city for a few days, or a few months.

As stated above, the residency test is based on your intent to move to a particular place and make it your home. If you have no home base, or are not a part of any community in particular, you may not be eligible to use the residency test.

In my opinion, the perpetual traveler is forced to use the 330 day test. Therefore, they must be outside of the U.S. for 330 out of each 365 day period. This may limit the perpetual traveler’s ability to visit family or vacation in the States.

Simply gaining residency in a nation, such as Belize that only requires you to be in their country a few months each year, will not suffice for U.S. tax purposes. The residency test is based on a number of facts and circumstances, and having a residency permit is only one factor.

However, once you establish residency in one place, you will not lose that status in the U.S. tax system, until you give it up (also stated above). Therefore, if you move to a foreign country for a year or two, with the intent of making it your home, and then become a perpetual traveler, you should maintain your foreign residency status.

Travel Days

Since about 2008, it has been the IRS’s position that travel days, and time spent in international waters or airspace are not days outside of the U.S. for the purposes of the FEIE. This argument has been supported by a few U.S. tax court cases.

What does this mean to you? If you are using the 330 day test, you must count days traveling to and from the U.S., as days in the U.S., and not foreign days.

If you are in a business, such as a ship captain or airline pilot, that requires you to spend time in international waters, then you have a problem. If you have no residency, and are required to use the 330 day test, you may not be eligible for the FEIE. If this applies to you, you should contact a tax professional.

Forced Out

Relief from either the residency or the 330 day test is available if you are forced to flee a foreign country because of civil unrest, war, or other adverse conditions. To qualify, you must have been a bona fide resident of, or present in, the foreign country on or before the date the IRS determines that adverse conditions exist. In addition, you must establish that you could reasonably be expected to have satisfied the residency requirements had the adverse conditions not arisen. The IRS publishes the names of countries for which this waiver is available annually.

I note that the adverse conditions must arise after you moved to the country in question. Each year I have contractors working in war zones ask if they can use this clause to get out of their contracts and still use the FEIE. Of course, the answer is no. Anyone who travels to a country on the list is on notice and the exception is not available.

Use it or Lose It

In a perfect world, all U.S. citizens file their U.S. tax returns on April 15 and make use of all the proper exclusions and deductions. Of course, that is not the case. In fact, the majority of returns I prepare for those living abroad are delinquent.

This can be extremely costly for those using the foreign earned income exclusion. If you file late, and you are audited by the IRS, you might lose the foreign earned income exclusion, and pay tax on 100% of your foreign earned income!

Generally, a qualifying individual’s initial choice of the foreign earned income exclusion must be made with one of the following income tax returns:

  • A return filed by the due date (including any extensions),
  • A return amending a timely-filed return. Amended returns generally must be filed by the later of 3 years after the filing date of the original return or 2 years after the tax is paid, or
  • A return filed within 1 year from the original due date of the return (determined without regard to any extensions)

An exception to this rule will be made provided that:

  • You owe no federal tax after accounting for the exclusion, or
  • Prior to the IRS discovering you failed to elect/utilize the exclusion.

If you owe tax after taking the FEIE into account, and the IRS discovers your failure to use the FEIE, then you may request relief by requesting a private letter ruling under Income Tax Regulation 301.9100-3 and Revenue Procedure 2009-1.

Having handled several of these cases, I can tell you that negotiating a settlement, or securing a letter ruling, will be a very costly and time consuming battle. It is possible to have about $1 million in untaxed income at issue, where a husband and wife failed to file a return for 6 or 7 tax years and would have been eligible for the full FEIE.

What if I am not overseas for a full tax year?

If during a tax year, you are overseas for only part of one tax year, but not long enough to qualify for the exclusion based on either physical presence or bona fide residence, you have four options:

1. If you paid foreign income tax, claim the foreign tax credit if it means you can avoid paying any U.S. income tax. In general, this applies when the tax rate of your foreign country is higher than, or equal to the U.S. tax rate.

(Caution: This option should be made only with the advice of a tax professional. It is not entirely clear at this time whether claiming a foreign tax credit when you could have chosen the foreign earned income exclusion will automatically revoke your election to take the exclusion for the following five years without the approval of the IRS.)

2. File your tax return for the year without claiming the exclusion. Then, once the physical presence or bona fide residence qualifying period is reached in the following year, you can file an amended return to claim a pro-rated exclusion for the part-year.

3. Those who were overseas for the last three months of the year (let’s say in 2010 for this example) and expect to be overseas for the first nine months of the following year, can file an IRS Form 4868 and if necessary the applicable state return filing extension request for automatic extensions to October 15. This will allow time to meet the 12 month physical presence test before the extended due dates of the returns. Once the 12 month period is reached, the 2010 tax returns can be filed claiming the partial exclusion for the time spent overseas in 2010.

4. File a Form 2350—a further application for extension of time to file beyond October 15. This allows you sufficient time to qualify under either of the two time requirements, plus 30 days to file the return for the year in which you qualified for only the part-year exclusion. In choosing your strategy, you need to consider the consequences involved. If financial concerns are paramount, then you should seek advice from a tax professional. If you have a considerable amount to pay on the original return—most of which you will recover on an amended return—you may prefer to wait out the qualification period and file one return.

HOUSING EXCLUSION OR DEDUCTION

If your tax home is in a foreign country—and you meet either the bona fide residence test or the physical presence test—you may be able to claim an exclusion or deduction from gross income for housing provided by your employer. Employees claim an exclusion, whereas a deduction is claimed by those who are self-employed.

For the exclusion, foreign housing is provided by an employer if any amount is paid or incurred by the employer on your behalf and included in your foreign earned income (for example, housing allowance or reimbursement).

A housing amount is determined as the excess, if any, of your allowable housing expenses for the tax year over a base amount which increases each year. For 2012 the qualifying daily rate is $36.47 or $13,314 for an entire year of qualifying days (this is 16% of the total FEIE). Allowable housing expenses are the “reasonable” expenses incurred by you and your family such as:

  • Rent paid on your foreign property.
  • Utility charges incurred (other than telephone charges).
  • Real and personal property insurance for foreign housing.

Items that are not considered “allowable housing expenses” include:

    • The cost of home purchase or other capital items.
    • Wages of domestic servants.(Note: Under certain circumstances, such wages may qualify as “childcare expenses.”)
    • Deductible interest and taxes.

You can also include the allowable housing expenses of a second foreign household for your spouse and dependents if they did not live with you because of adverse living conditions at your tax home.

The base amount is figured on a daily basis. Your allowable housing amount is the IRS-determined base amount times the number of days during the year that you meet the bona fide residence or physical presence test. The base amount, which changes each year, is shown on each year’s Form 2555. It is found on line 32 of the Form 2555 for 2011.

Determining your housing

You can exclude or deduct (within the lower and upper limits) your entire housing amount from income if it is considered paid for with employer-provided amounts. Employer-provided amounts are any amounts paid to you—or on your behalf—by your employer, including salary, housing reimbursements, and the fair market value of pay given in the form of goods and services.

If you have no self-employment income, your entire housing amount is considered paid for with employer-provided amounts. If you claim the exclusion, you cannot claim any credits or deductions related to excluded income, including a credit or deduction for any foreign income tax paid on the excluded income.

If you are self-employed—and your housing amount is not provided by an employer—you can deduct the housing amount to arrive at your adjusted gross income.

However, the deduction cannot be more than your foreign earned income for the tax year, minus the total of your excluded foreign earned income and the foreign housing deduction amounts.

If you are an overseas employee who also carries on an overseas self-employment activity, the rules are more complicated. To determine the net self-employment income for both income and self-employment tax purposes, you should consult a tax professional.

Second foreign household

Ordinarily, if you maintain two foreign households, your reasonable foreign housing expenses include only costs for the household that bears the closer relationship (not necessarily geographic) to your tax home. However, if you maintain a second, separate household outside the United States for your spouse or dependents because living conditions near your tax home are dangerous, unhealthful, or otherwise adverse, include the expenses for the second household in your reasonable foreign housing expenses.

You cannot include expenses for more than one second foreign household at the same time. If you maintain two households and you exclude the value of one because it is provided by your employer, you can still include the expenses for the second household in figuring a foreign housing exclusion or deduction.

Adverse living conditions include:

  • A state of warfare or civil insurrection in the general area of your tax home.
  • Conditions under which it is not feasible to provide family housing—for example, if you must live on a construction site or drilling rig.

WHAT EXCLUSION WILL I TAKE?

You make separate choices to exclude foreign earned income and/or to exclude or deduct your foreign housing amount. If you choose to take both the foreign housing exclusion and the foreign earned income exclusion, you must figure your foreign housing exclusion first.

Your foreign earned income exclusion is then limited to the smaller of (a) your annual exclusion limit, or (b) the excess of your foreign earned income over your foreign housing exclusion. This limitation is automatically computed on the Form 2555.

It is often difficult to follow the interplay of the lines on tax forms because forms are generally designed by mathematicians whereas the rules are most often written by lawyers. A simpler way of looking at it is that your combined earned income exclusion and housing exclusion cannot exceed your total overseas earnings.

Once you choose to exclude your foreign earned income and/or housing amount, that choice remains in effect for that year and all future years unless you revoke it. You can revoke your choice for any tax year. However, if you revoke your choice in one tax year, you cannot claim the exclusion again for your next five tax years without the approval of the IRS. For more information on revoking the exclusion, see (1) Effect of Choosing the Exclusion and (2) Revoking the Exclusion, both of which are found on page 20 of the 2012 Publication 54.

After reading these two sections, you may reach the conclusion that simply taking a foreign tax credit when you could have chosen the exclusion will automatically disqualify you from claiming the exclusion for the next five years without the approval of the IRS.

If, in your case, a foreign tax credit would be far more beneficial than claiming the exclusion, you should discuss your situation with a tax professional.

For a consultation, you can reach a us at (619) 483-1708 or by email to info@premieroffshore.com.

FORM 2555 OR FORM 2555EZ?

The Form 2555EZ is a shorter, simpler version of the Form 2555 but may be used only if you meet all of the following requirements:

  • Total foreign earned income is $91,400 or less.
  • The return being filed is for a full calendar year.
  • You have no self-employment income.
  • You have no business or moving expenses.
  • You are not claiming the foreign housing exclusion or deduction.

There is no need to memorize the above conditions. They are printed on the top of page one of the Form 2555EZ.

MARRIED COUPLES CLAIMING EXCLUSIONS

If both you and your spouse are eligible for either the foreign earned income or housing exclusion, you can file separate Form 2555s (or 2555EZs) and claim separate exclusion amounts. For further details on married couples filing separate 2555s, see Chapter Four of Publication 54.

If you are married and residing either in a foreign country with community property laws or a domiciliary of a U.S state with community property laws, you need to consult a tax expert.

WAIVER OF TIME REQUIREMENTS

Disruption of the qualifying time period because of war, civil unrest, or similar adverse conditions in the foreign country would not preclude you from claiming at least part of the exclusion. However, there are special rules to determining a reduced amount of the exclusion. Here again, you should refer to Publication 593 or Publication 54, or consult with a tax professional.

EXCLUSION OF EMPLOYER – PROVIDED MEALS AND LODGING

If your work requires you to live in a camp in a foreign country that is provided by or for your employer, you can exclude the value of any meals and lodging furnished to you, your spouse, and your dependents. For more details, see Publication 593 or Publication 54.

Withholding income tax and social security tax

If you are an employee of a U.S. company overseas, your employer may withhold income and social security taxes from your pay. In certain circumstances, it may be to your advantage to have your employer discontinue withholding income tax from all or part of your wages. You might do this if you expect to qualify for the income exclusions under either the bona fide residence test or the physical presence test. See Publication 54 for more information on withholding income tax.

See the U.S. security taxes section below for the requirements for employer withholding of social security taxes.

If a U.S. employer does not withhold income taxes from your foreign wages—or if not enough tax is withheld—you may have to pay estimated tax. Your estimated tax is the total of your estimated income tax and self-employment tax for the year, minus your expected withholding for the year.

When estimating gross income, do not include the income that you expect to exclude. In figuring your estimated tax liability, you can subtract from income your estimated housing exclusion or deduction. However, if the actual exclusion or deduction is less than you expected, you may be subject to a penalty for underpayment. You can use Form 1040-ES (Estimated Tax for Individuals) to estimate your tax due for the year. The requirements for filing and paying estimated tax are generally the same as those you would follow if you were in the U.S.

WITHHOLDING FROM  PENSION PAYMENTS

U.S. payers of benefits from employer deferred compensation plans (such as employer pensions, annuities, or profit-sharing plans), individual retirement plans, and commercial annuities are generally required to withhold income tax from these payments or distributions. This will apply unless you choose an exemption from withholding.

To qualify for this withholding exemption, you must provide the payer of the benefits with a residence address in the U.S. (or U.S. possession), or certify to the payer that you are not a U.S. citizen, resident alien, or someone who left the United States with the principal purpose of avoiding U.S tax.

For rules that apply to non-periodic distributions from qualified employer plans and tax-sheltered annuity plans, refer to Publication 575 (“Pension and Annuity Income”).

Although the U.S. Social Security Administration (SSA) is not required to withhold federal income tax on benefit payments to American recipients residing in the U.S. or overseas, benefit recipients may request voluntary income tax withholding. Based on rules too complicated to discuss here, some of the benefit payments may be subject to U.S. income tax and the recipients may prefer to have the income tax withheld. You should check with a tax expert to determine if any of your benefit payments will be subject to U.S. income tax and whether or not it is advisable to have the tax withheld by the SSA.

Note: Some foreign countries may tax your benefit payments in spite of the fact the payments are also subject to U.S. tax. Although the many U.S. income tax treaties provide for taxation of certain income by the U.S. alone, you will need to be familiar with the laws of the foreign country in which you reside.

U.S. SOCIAL SECURITY TAXES

Under certain circumstances, you may be required to pay social security taxes to both the U.S. and a foreign country on the same income. For example, when Bob, an employee of a U.S. company, moves overseas on a foreign assignment, the employer is liable for the employer’s share and Bob is liable for his share of U.S. social security taxes on his wages. At the same time, the foreign tax laws may require that Bob’s employer pay the foreign social security taxes on the wages paid to Bob while he is living in that country.

Unless certain arrangements are made with the SSA, the same situation would occur if the U.S. company assigns Bob to work for a foreign subsidiary of which the American company is a principal owner.

The SSA is responsible for administering “totalization agreements,” which are similar to the U.S. tax treaties.

At time of writing, the U.S. has totalization agreements with the following nations: Australia, Austria, Belgium, Canada, Chile, Finland, France, Germany, Greece, Ireland, Italy, Japan, Korea (South), Luxembourg, Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, and the United Kingdom.

An agreement is under discussion with Poland. Agreements with the Czech Republic, Denmark, and Mexico have been signed but have not yet come into force. (See Appendix C for full details.)

On the other hand, if you have the option of working overseas for employers other than U.S. companies—or principally owned foreign subsidiaries of U.S. companies—you will avoid any double taxation on the social security side because you will no longer be liable for the U.S. social security taxes.

If you or your employer needs more information, contact the Social Security Administration online at www.ssa.gov. Its welcome page has a “Contact Us” link that provides a variety of means of getting in touch with a representative.

Credits and Deductions on Foreign Income Taxes

In filing your U.S. returns, you can take either a credit or a deduction for income taxes imposed on you by a foreign country. Taken as a deduction, foreign income taxes reduce your taxable income. Taken as a credit, foreign income taxes reduce your tax liability.

There is no rule to determine which approach is better. Generally, it is to your advantage to take the credit, which is subtracted directly from your U.S. tax liability. Your credit cannot be more than the part of your U.S. income tax liability allocable to taxable foreign income. In other words, if you have no U.S. income tax liability, or if all your foreign income is excludable, you will not be able to claim a foreign tax credit.

If foreign income taxes were imposed at a high rate, and the proportion of foreign income to U.S. income is small, a lower final tax may result from taking the foreign income tax deduction. You must treat all foreign income taxes in the same way—you generally cannot deduct some taxes and take a credit for others.

If you choose to credit foreign taxes against your tax liability, you will need to complete Form 1116 (unless you meet the requirements outlined below), and attach it to your U.S. income tax return.

Caution: Do not include the foreign taxes paid or accrued as withheld taxes on the second page of the 2012 Form 1040 at line 63.

If the foreign taxes you paid or incurred during the year exceed the limit on your credit for the current year, you can carry back the unused foreign taxes as credits to the two previous tax years, and then carry forward any remaining unused foreign taxes to the next five tax years.

You will not be subject to this limit, and may be able to claim the credit without using Form 1116, if the following requirements are met:

  1. You are filing as an individual.
  2. Your only foreign source income for the tax year is passive income coming from sources such as dividends, interest, and royalties, which are reported to you on a payee statement such as a Form 1099-DIV or 1099-INT.
  3. Your qualified foreign taxes for the tax year are not more than $300 ($600 if filing a joint return) and are reported on a payee statement.
  4. You elect this procedure for the tax year. (If you make this election, you cannot carry back or carry over any unused foreign tax to or from this tax year.)

If you choose to deduct all foreign income taxes on your U.S. income tax return, you need to itemize the deduction on Form 1040 Schedule A.

The foreign tax credit and deduction, their limits, and the carry back and carry over provisions are discussed in detail in IRS Publication 514.

Foreign Currency: The foreign income, expenses, and credits must be converted from foreign currency using an appropriate exchange rate and reported on the U.S. return in U.S. dollars.

CLAIMING A DEDUCTION FOR RELOCATION EXPENSES

If you incur expenses when relocating overseas, you may qualify for a deduction of “reasonable” moving expenses. Keep in mind that moving expenses relate to the income earned after the move and you cannot claim expenses attributed to excluded income. For example, if you are an employee and move overseas, your unreimbursed moving expenses are generally deductible. However, if you are able to exclude all of your overseas earnings in the year of the move, the following year you cannot claim any of the unreimbursed moving expenses regardless of whether or not they are reasonable. See Publication 54 for more details.

AVOIDING DOUBLE TAXATION

If you have paid foreign taxes on the earnings that qualify for the earned income exclusion, you will have to make a choice of taking the exclusion, taking the tax credit/deduction, or taking a combination of the two.

A good tax software program should allow you to prepare a complete return claiming the income exclusion, housing exclusion/deduction, and the foreign tax credit. Once the return is prepared, the program should allow you to easily produce two duplicate computer copies. These can be produced individually using the other two options for comparison to figure out which option produces the best results. As mentioned earlier, you need to do the math.

If you claim the exclusion, you cannot claim any credits or deductions that are related to the excluded income—the concept being that you can’t get a double benefit. Nor can you claim the earned income credit, which is to benefit low income earners. In other words, someone who earned $100,000 overseas and excluded $91,400 is not the same as an individual whose total earnings are only $8,600.

Also, for Individual Retirement Account (IRA) purposes, the excluded income is not considered compensation and, for figuring deductible contributions when you are covered by an employer retirement plan, the excluded income is included in your modified adjusted gross income.

DOUBLE TAXATION TREATIES

If a “double taxation” treaty exists between the United States and the country in which a U.S. citizen resides, then the tax treaty supersedes the Internal Revenue Code (IRC), and the language of the treaty governs. As a general rule, tax treaties allow you to offset foreign tax paid against what your federal tax liability would have been.

This means that if your foreign taxes are higher than your U.S. federal tax, no U.S. tax is due. If your foreign taxes are lower, then the difference would generally still be due to Uncle Sam, unless it was exempted under the rules for foreign earned income exclusion.

Treaties generally provide U.S. students, teachers, and trainees with special exemptions from the foreign treaty country’s income tax.

Publication 901 contains detailed information on tax treaties and tells you where you can get copies of them. Click here for additional information: http://www.irs.gov/publications/p901/index.html

Foreign Bank Accounts Must be Reported

If you had any financial interest in, or signature or other authority over a bank account, securities account, or other financial account in a foreign country at any time during the tax year, you may have to complete Form 90-22.1 and file it with the Department of the Treasury. You need not file this form if the combined assets in the account(s) are $10,000 or less during the entire year, or if the assets are with a U.S. military banking facility operated by a U.S. financial institution. The deadline for filing is June 30 of each calendar year.

There are no extensions and an extension to file the federal income tax return does not extend the deadline for filing the Form 90-22.1. If you have a foreign account, you must also file a Form 1040 Schedule B and complete Part III regarding foreign bank accounts—regardless of whether you are required to file a Form 90-22.1, or have any interest or dividend income to report on the Schedule B.

This requirement to report your foreign bank account is one of the most important obligations you have as a U.S. citizen living abroad. The law imposes a civil penalty for not disclosing an offshore bank account or offshore credit card up to $25,000 or the greatest of 50% of the balance in the account at the time of the violation or $100,000. Criminal penalties for willful failure to file an FBAR can also apply in certain situations. Note that these penalties can be imposed for each year.

In addition to the FBAR penalties above, intentionally failing to check the box on Schedule B to report a foreign account is a Felony. It is possible for a single violation to result in 6 to 12 months in prison!

I have personally handled many FBAR and Schedule B related cases and can tell you with certainly that the IRS is very aggressive in prosecuting these matters. For example, in one case in 2010 a client plead guilty to a single count of failing to check the box on Schedule B, and was given 6 months of confinement. In addition to the criminal case, the IRS initiated a civil audit which, when taxes, fines, interest and penalties were calculated, the client was wiped out financially. Finally, to add insult to injury, the State of California came in with their taxes, interest, and penalties.

The Schedule B rules and the FBAR are no joke, and they are not just used against money launders and drug dealers. Prosecutions and civil fines have become a major revenue sources for the IRS.

Filing Deadlines, Extensions, and Penalties

If your tax year is the calendar year, the due date for filing your income tax return is April 15 of the following year—unless that date falls on a weekend day or holiday, which would allow you an additional day or two.

AUTOMATIC TWO – MONTH EXTENSION FOR AMERICANS

The good news is that overseas Americans are automatically granted a two-month extension to June 15 to file (and pay their tax).You don’t have to request this extension in advance. When the time comes to file, simply attach a statement to your return explaining that you were either:

1) Living outside the U.S. and Puerto Rico and that your main place of business or post of duty was outside the U.S. and Puerto Rico; or

2) In the military or naval service on duty outside the U.S. or Puerto Rico.

Note: If you are filing electronically (I’ll discuss this later), you will need to check your software instructions or check with your software provider on how to electronically file the extension form or to add the required statement to the return.

What to do if you need more time

Better still is the Form 4868 (“Application for Automatic Extension of Time to File U.S. Individual Income Tax Return”). This form will get you a full six-month extension.

No signature and no reason will be required for the six-month extension to October 15 (or the alternate date under the weekend and holiday rule).

TIME TO PAY TAX DUE ON A RETURN

With the exception of the automatic two-month extension for overseas Americans, an extension of time to file does not mean an extension of time to pay the tax. Although you will be required to pay interest on any payment made after April 15, you will not be required to pay the late payment penalty (see below) for the period April 15 to June 15.

WHERE TO FILE

If you claim the foreign earned income exclusion or the foreign housing exclusion or deduction on a paper tax return, you should file your return with the Internal Revenue Service, Austin, Texas 73301-0215.

Electronic filing has its own set of filing rules that are not treated here. A good software program with the electronic filing feature allows you to send the federal and, if applicable, the state income tax return to the relevant processing center.

ELECTRONIC FILINGS IS THE WAY TO GO

If you have the option, paperless filing is the way to go. All you need is a computer, tax preparation software with the electronic filing feature, and Internet access. You complete your return (and with some software programs the Form 4868 as well), send it over the wires, and await confirmation from the IRS or a state tax department that your return was accepted. If rejected, you should receive an error message that either tells how to correct the error(s) for resubmission or a statement of why the return cannot be accepted for electronic filing. The deadline for electronic filing is April 15, or October 15 (or the alternate date under the weekend and holiday rule) if you file an extension. You may not file a late return electronically.

The rules that relate to formatting, what information must be included on the return, and what forms or schedules if included in the return forms will disqualify the return from electronic filing, are mind-boggling. However, as with any good software program, the computer does most of the analytical work. And, if you mess up, the programs are generally designed to alert you to your mistakes or provide other reminders to help you through the process.

Most software programs allow you to complete the state tax return along with the federal return, saving time spent on duplicating data entries. The state return in most cases is produced automatically as an offshoot of the 1040. Part-year return (or even a non-resident return), if your situation warrants one, takes a little extra time because there are additional data entry steps. You will be required to allocate the annual income taxable on the federal return to the lesser amount taxable by a state for part-year residency or non-residency.

An additional benefit of tax preparation software is that, once you go through the process for the first year, most of the routine—and often tedious—data entries that apply year after year are carried forward to save you time in future years.

You’ll find a variety of good tax preparation software programs on the market. Two of the most popular are TurboTax and TaxCut.

I’d recommend that you do some research on the Internet to compare prices and availability. And make sure that whichever software program you purchase has the electronic filing capability. There are also some companies offering to prepare your taxes online, through their website, without your downloading and installing their programs. These include Intuit and H&R Block.

FOREIGN POST MARKS AND ELECTRONIC FILING

Generally, the IRS treats payments made—and tax returns filed—as received by the IRS on the date they are received by the U.S. Postal Service or a domestic courier service. Penalties could be applied by the IRS on late payments and, if applicable, late filed returns under certain circumstances including those received from overseas.

Consult a tax professional if sending tax documents from countries whose mail or courier systems are subject to lengthy delays. You should keep in mind that electronic filing is one means of avoiding mailing delays and possible penalties resulting from such delays. I generally recommend the electronic filing method to my clients overseas.

INTEREST AND PENALTIES

If you are late in filing your taxes, avoid filing altogether, or underpay taxes—whether intentionally or unintentionally—the IRS may impose a penalty. If the 1040 has no tax due, there are generally no penalties whether you filed or did not file.

Even if there are penalties, the IRS may waive them if the delay is due to “reasonable cause.” The IRS doesn’t like to pin itself down by trying to define the term reasonable cause—you have to write in with an explanation and hope for the best! The instructions for requesting elimination of a penalty for reasonable cause are found in Notice 433 on the IRS website.

The two more common penalties are the late filing and the late payment penalties. The penalty for late filing (or failing to file) a tax return is a percentage of the tax due but unpaid, unless the reason for the late filing or failure to file is due to reasonable cause. The penalty is 5% of the underpayment per month, or any part of the month, up to the maximum of 25%. If the return is not filed within 60 days of the due date (considering extensions), there is a minimum penalty which is the lesser of $100 or the tax due on the return. There is an interaction of the late filing penalty and the late payment penalty discussed below.

The late payment penalty is 0.5% for each month, or any part of a month, the tax due on a return remains unpaid. The maximum penalty is 25%.

The interaction between these two penalties in effect limits both penalties combined to the 25% maximum. For each month that both penalties apply, the late filing penalty is reduced to 4.5%.

Consequently, a return filed four months and one day late is subject to the late filing penalty of 4.5% times 5 (22.5%), and a late payment penalty of 0.5% times 5 (2.5%), for a total of 25% (the maximum).

However, if the return is filed on time but there is tax due, the late payment penalty is 0.5 per month of any fraction thereof until paid. These penalties are in addition to the interest charged for unpaid taxes. The IRS is required to determine the interest rate quarterly. For the latest information on interest rates, check with the IRS or a tax professional.

U.S. State Taxation of Foreign Income

If you have a choice of where to live and work overseas, it is important to understand how your last state of residency, the U.S., and your new home country will tax your income. High state or foreign tax rates, or lack of tax exemptions for income earned inside and outside of a new home country, can easily negate any tax advantages provided to overseas Americans under the U.S. federal tax laws.

Before we delve into state income taxes, it is important to understand the distinction between residency and domicile—although most states use these terms interchangeably. For tax purposes, your residence is generally where you currently live and work. Your domicile on the other hand may be the place you presently live, or previously lived and have a definite intention to return after living elsewhere.

Your domicile may also be a state in which you formerly lived, but failed to fulfill the conditions to abandon domicile when you moved elsewhere. For most of us, we are residents and domicile of the same state regardless of whether that state is a U.S. state or a foreign country.

Residence and domicile are important distinctions for those states that subject both their residents and their domiciliaries to state income tax. For example you may have moved to another state and established residency in that new state, but still have to file tax returns in your former state (where you are officially domiciled).

DIFFERENT STATES…DIFFERENTS RULES

Liability for state income taxes is a complicated matter. There are 51 jurisdictions including the 50 states and the District of Columbia and consequently 51 different sets of rules.

If you move from one of the more popular non-taxing states such as Florida and Texas, you needn’t ordinarily worry about liability for state income taxes while living overseas.

Other states such as Oregon, New York, and Missouri to name a few will not tax an individual who is otherwise considered a domiciliary of the state, but maintains a permanent residence elsewhere (in the U.S. or overseas) and spends less than 30 days a year in the state. Also, New Hampshire and Tennessee only tax interest and dividend income.

Then there are those states desperate for money, like California. This state has no foreign earned income exclusion, is aggressive in determining “residency” for those abroad, and, when one spouse is abroad and one is in California, this state will tax the international spouse’s income under a “community property” argument. If you live in an aggressive state, and you can first move to a non-taxing state, and then move abroad, I strongly recommend you do so.

Finding a complete listing of states who do not tax domiciliaries living outside the state is beyond the purpose of this guide. A good starting point is a very comprehensive website for finding all kinds of information on taxation. Try www.taxsites.com and click on “state links” in the tax column to check out your state of interest.

Don’t be misled by the advice that you can make a quick trip to one of the non-taxing states, set up a local address, get a driver’s license, and register to vote thereby establishing residency and domicile in that state. It doesn’t work that way. The fact that many have done exactly that without being questioned is a matter of inadequate enforcement by state tax authorities, rather than a good faith compliance with the rules for establishing and abandoning state residency.

If you think you may be taxed by a former state as a domiciliary, you need to be aware of what elements that state will look at to determine your liability for its income taxes. Some of the most important are as follows:

  • Where you live.
  • Where and how you vote.
  • What state driver’s license you carry.
  • Where your bank accounts are located.
  • The location of any real property you own.
  • Where your family is living if not with you.
  • Whether or not you have a fixed intention of returning to a particular state if you are living elsewhere at the present time.

There is no magic formula for determining what combination of the above listed items will prompt your former state to subject your income to taxation. Some combinations are more important than others. Where you live; whether you vote in national but not state elections; which driver’s license you carry; and where your real property (if any) is located are often very critical elements. However, the most important and critical is the final point. A fixed intention to return to a particular state will always subject you to that state’s income taxes, in those states that tax as residents not only those who physically reside within the state but also its domiciliaries.

WHAT IF I DON’T KNOW WHICH U.S. STATE I WILL RETURN TO?

Unlike in foreign countries, there is no such thing as a national U.S. residency or domicile. Residency and domicile apply to states only. So, if you don’t have the fixed or definite intention to return to a particular state, but do have a fixed or definite intention to return to the U.S., you may still be able to abandon domicile in a particular state.

This is an important distinction when it comes to voting in U.S. elections. However, the Overseas Citizens Voting Rights Act allows U.S. citizens living outside the country who are presently not residents or domiciliaries of any U.S. state to vote in the federal elections (see U.S. Code 42, 1973ff).

To obtain the specific instructions and to download the form to request an absentee ballot, go to www.fvap.gov. On the opening web page you will see a large white block with the heading The Basic Absentee Voting Process. Just follow the simple instructions.

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INTRODUCTION

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The biggest challenge facing Americans living and/or working abroad is the United States Internal Revenue Service. The U.S. is one of the few countries that tax its citizens abroad, and the only one that regularly locks up its people up in prison cells for violations of the tax code.

The Service’s hostility to foreign tax planning and attacks on international business has become legendary over the last five years. Criminal penalties aside, the financial risks for failing to file a report or form on time are extraordinary…some include penalties of up to $50,000 per year, per form. For this reason, many Americans are afraid to hold funds or assets abroad.

Even after determining what forms are required, an ever moving target, figuring your tax liability is like learning a foreign language. “IRS speak” is unique and convoluted…and a distant cousin to the business English you speak every day.

And, once you learn the lingo, applying that language to your situation requires advanced training in accounting and finance.

How much time will it take an average business person to learn the language, organize the accounting, and prepare the forms for a standard foreign corporation return? The IRS estimates you should spend 174 hours to complete Form 5471 and its schedules! That’s about 22 days, working 8 hours per day, while completely ignoring your business, employees, and other obligations.

Note: Time estimates are contained in the instructions for each form. For Form 5471, see page 14 of 17 at http://www.irs.gov/pub/irs-pdf/i5471.pdf

As few international entrepreneurs have the time or energy required to learn this language, some give up and stay onshore and others hand the entire mess over to their accountants and hope for the best. Those who really like to gamble, place their bets on off the shelf software costing anywhere from $25 to $150, with the expectation that the software will guide them through the maze and costly traps safely.

Think about that. Spending $25 to protect themselves from risks of $50,000+ is quite a gamble. Would you do that in any other area of your life or business?

Note: The tax attorneys and enrolled agents at Premier Offshore, Inc. have decades of combined experience in international taxation and we spend about $5,000 per year for professional level tax software.

With that in mind, the objectives of this tax guide are to

1) give you the tools to maximize profits and minimize taxes while working and living abroad,

2) provide a road map to the U.S. forms and reporting requirements, and

3) to point out the landmines of international taxation – costs and risks of failing to keep up with tax compliance.

Armed with this manual, you will be able to structure your business and plan your life abroad to your advantage…and those advantages can be significant. For example, a business owner may be able to reduce or completely eliminate U.S. income tax on his ordinary income while taking a salary tax free of up to $97,600 for 2013.  This means no Federal income taxes, no State income taxes, and no employment taxes (payroll, FICA, etc., which add up to 15% in the U.S.).

While you might not become a U.S. tax expert by the end of this guide, you will be better prepared to deal with your tax attorney, CPA or accountant. You will have an understanding of the options available, the forms required, and the questions that must be asked. You will be able to determine if your current preparer is capable of handling your new and more complex tax reporting and, by being better prepared, you should cut down on the time—and fees—spent with your advisor.

In addition to this guide, there are resources available on the IRS website at www.irs.gov.

For example, IRS Publications 593 and 54 should be reviewed by all U.S. ExPats (anyone living and/or working outside of their home country).

Publication 54 is a lengthy document, which goes into the nitty-gritty of overseas taxation—for a summary of the highlights, use Publication 593. Publication 593 can be viewed athttp://www.irs.gov/publications/p593/index.html and Publication 54 is at http://www.irs.gov/publications/p54/index.html.

If you have been living abroad, or had an offshore account, for several years and not been filing your U.S. forms, this guide can help you get in to compliance. However, a complete analysis of your situation should be undertaken by a qualified tax attorney before you file any amended or delinquent tax returns or forms. I suggest you start with the section of this report entitled “2012 IRS Offshore Compliance Program,” then review the IRS website at http://www.irs.gov/uac/2012-Offshore-Voluntary-Disclosure-Program for any new information. After you understand your options, read the rest of this guide to become familiar with your filing obligations and future planning options.

Finally, this guide is focused on your U.S. Federal Taxation issues. It is not meant to help you with

(1) liability for state income taxes;

(2) estate and probate matters;

(3) local taxes of a foreign country; or

(4) the community property laws of the U.S. states or foreign countries.

Other
Christian Reeves

Hiding Money in the U. S. of A.

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Want to hide money from the tax man? Come to America – Hiding Money is big big business.

“…the U.S. system welcomes foreigners with arms wide open and eyes wide shut.”

A few days ago, I met with the president of a large international investment bank in Panama. We’ve been friends for a number of years and went to one of my favorite places for dinner, Chalet Suizo – 1985, in El Cangrejo. After a few drinks, we got to talking about money laundering and the U.S.’s attempts to “stop the evil and protect us from terrorists.”

My friend’s view was that the vast majority of money laundering is done in the United States by American banks. He believes that 80% to 90% of the money hidden from international tax authorities is invested in the United States, and that there is nothing these foreign governments can do to get to it. Most of this money is from Europe, but a great deal comes from Mexico, Venezuela, Colombia, and other parts of Latin America.

Every international banker I’ve ever met will agree with this assessment, as do a number of scholarly studies. In fact, some estimate the amount of money hidden in the U.S. in the billions of dollars. It represents a very significant portion of fund held in U.S. dollars, and the liquid capital of many prominent banks.

While the Department of Justice is aggressively going after its citizens for not paying up, the government is making it easier to bring in untaxed money and protecting foreigners from discovery. While it is near impossible for a U.S. citizen to get an account abroad, anyone can open an account in the United States with no questions asked.

Don’t believe me? Here is how the system really works:

Let’s say you, an upstanding U.S. citizen, want to open an account in Panama. First, you might not be able to find an institution willing to take your money…about 90% of the banks are closed to Americans. Second, if you manage to talk your way past the front door, you will have a battle on your hands to get an account approved. You will be required to travel to Panama for an interview where you must:

1. explain why you need the account,

2. prove where the money came from (source of your savings),

3. where the money that will go through the account will come from (prove your business model),

4. provide two forms of ID,

5. provide two professional reference letters (these will be verified),

6. provide statements and a letter from your U.S. bank saying how long you’ve been a client, that your account is in good standing, and how much money you usually have at the bank,

7. pass a WorldCheck screening,

8. undergo a due diligence investigation by the bank’s compliance department that will take weeks, and

9. if this is a corporate account, the above is required for all shareholders and directors, not just those who are signors on the account.

If you manage to get an account open and operating, each time you write a check or send a wire, the bank will want to know why you are sending the money and to whom. Recipients of any significant wire transfers will also need to go through a WorldCheck screening before the wire will be initiated.

And these rules apply to all foreigners, not just Americans. Are you a Colombian or Venezuelan working in Panama? You must go through all the same due diligence. In fact, I know of only one bank in Panama that will accept smaller accounts from Colombians, compared to 3 or 4 banks that accept Americans.

Want to open an account in the U.S. with your Panama corporation? Good luck! While my well-healed clients (those with $250,000+ at a bank with long standing relationships with a private banker) have been able to open these accounts, average Americans are being told to pound sand. I’ve even seen some Americans with foreign entities at Wells Fargo and Bank of America kicked to the curb after the account was opened and compliance had time to review the file.

Now, let’s say you are a Mexican citizen and you want to open an account in the United States. Just walk in to any branch with your “passport” or other ID and you’ll have an account within 15 minutes. There are no questions asked, no references required, and no background checks. In fact, the bank does not even bother to verify the passport or ID document in any way. The only due diligence the bank will undertake is to run the name on the account through their database to see if you’ve bounced a check or had problems under that name at other banks.

Well, what if you are an undocumented worker or illegal immigrant in the U.S. and want an account? No problem. Just show up with some sort of ID and get an account. No verification required. This is not a secret…institutions like Union Bank and Bank of America have marketed these services to undocumented workers and let them know in advance that no questions will be asked.

Note: Back in 2007, bank accounts for illegals were a hot political topic and got a lot of press. For an example, see: http://articles.latimes.com/2007/feb/14/business/fi-credit14. These days, they are common practice and no one cares.

What’s the catch? If you have a checking or savings account and are not a U.S. citizen, or can’t be bothered to fake a Social Security card, you won’t earn interest on your account. Yes, the bank makes their money…they just don’t give you a cut.

Now, here’s the story that really got me thinking and initiated this article:

A friend in Panama called me this morning and told me about opening a corporate account at a large bank in the United States by email with no questions asked. She is 28 years old, Panamanian with no ties to the U.S., and has had a small savings account at this bank in America for about 6 months. She sent an email to her representative basically saying:

“Hey, I have a small CD and savings account at your bank and I want a corporate account for my new business. I will form a corporation in Panama and want to know what is required to open a checking account at your bank.”

The banker wrote back (I summarize): “Dear Senorita, We will be happy to take your money and we don’t need nothing. Just let me know the name of the company you will form and I’ll will have your account ready today. We don’t want to know anything about the shareholders, source of funds, or business, and we don’t need a copy of the company documents. By the way, we have a special on a combo checking, savings, and corporate CD, which will save you money on fees…I suggest we open all 3 accounts today.”

After battling for so many clients to open accounts abroad, stories like this really hurt. Basically, the bank was willing to open the account under any corporate name, with no due diligence or hassle. She did not even need to form the corporation…just provide a name…any name…and the account will be ready.

While the IRS is locking up Americans with unreported income, the U.S. system welcomes foreigners with arms wide open and eyes wide shut. My friend has no intentions of doing anything illegal, but her experience proves how easy it would be for non-nationals to hide and launder funds in the U. S. of A.

Keep in mind that it is the United States who is pushing for “compliance” worldwide and forcing banks in countries like Panama to put up so many barriers to new clients. This means that citizens have very few options abroad, which may force them to return their funds to U.S. banks. At the same time, it pushes foreign money out of smaller countries and in to the American system (path of least resistance), where accounts are easy and no one gives a damn where the money came from.

Essentially, America gets its cake ($5 billion+ and counting in taxes and penalties raised on the backs of Americans with international accounts) and to eat it too (billions in the banking system and in U.S. dollars from undisclosed and unreported sources).

Convert to a Roth 401k
Christian Reeves

Fiscal Cliff Tax Break for Your 401(k)

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Good news for the millions of Americans with 401(k) plans – you can convert to a Roth 401(k) at any time. Buried in the Fiscal Cliff bill was a big break – you can now convert your 401(k), 403(b) and other defined contribution plans to a Roth at any time.

In previous years, you could convert your 401(k) to a Roth only if you changed jobs, retired, or turned 59 ½. Now, you can convert to a Roth at any time on the same terms as an IRA. In other words, 401(k)s and IRAs are on a level playing field when converting to Roth tax status.

The tax differences between a 401(k) and a Roth 401(k) are simple enough. With a traditional 401(k) you deduct contributions as they are made and pay taxes when you take distributions (tax deferred). With a Roth 401(k) you do not get a deduction when you make the contribution and your 401(k) grows tax free (tax exempt). Note that tax free principal and growth in a Roth 401(k) still requires that the funds be invested for at least 5 years and can’t be withdrawn until you reach age 59½.

The other major differences between a 401(k) and a Roth 401(k) are the contribution levels. For 2013, those under 50 can contribute $17,000 and those 50 and over can contribute $22,500 to a 401(k). The most you can place in a Roth 401(k) is $5,000 if you are under 50 and $6,000 if you are 50+. Additionally, Roth IRA contributions are prohibited when taxpayers earn a Modified Adjusted Gross Income of more than $110,000, ($160,000 for married filing jointly). For other issues, such as catch-up contributions, click here for the IRS website.

Employers are permitted to make matching contributions on their employees’ designated Roth 401(k). However, these contributions do not receive the Roth tax treatment. The matching contributions are allocated to a pre-tax account, just as matching contributions to a traditional 401(k). So, employer contributions are tax deferred, not tax exempt.

Here are a few other considerations when converting to a Roth 401(k):

  • Roth 401(k) contributions are irrevocable. Once money is invested into a Roth 401(k) account, it cannot be moved to a traditional 401(k) account. This means there are no mulligans when you convert to a Roth 401(k). The Fiscal Cliff legislation does not allow for an in-plan recharacterization – the ability to undue the conversion. If you convert and lose your job, or the bottom falls out of the market, you are stuck paying the taxes.
  • Employees may roll their Roth 401(k) contributions over to a Roth IRA account upon changing jobs or retiring.
  • Not all employers offer the Roth 401(k). Many smaller companies may feel that the added administrative burden is just too costly.
  • Unlike Roth IRAs, owners of Roth 401(k) accounts must begin distributions upon reaching age 70 ½, similar to required minimum distributions for IRA and other retirement plans.

So, now that you can convert, should you? For a related article, please see my comments on why Expats should convert to a Roth ASAP. I note this was written in 2012 when tax rates were guaranteed to go up (5% short term capital gains increase, etc.).

A Roth 401(k) plan will probably be most advantageous to those who might otherwise choose a Roth IRA – for example, younger workers who are currently taxed in a lower tax bracket, but expect to be taxed in a higher bracket upon reaching retirement age. Higher-income workers near the Roth IRA income limits may prefer a traditional 401(k).

Another consideration is your views on the future of income tax rates in the U.S. If you believe taxes will continue to rise, then paying taxes now through a Roth 401(k) may be preferred. If you are an optimist, and hope tax rates will go down, then deferring taxation through a traditional 401(k) might be your bet. As I wrote in 2012, if you believe tax rates will go up, then convert to a Roth ASAP.

The same holds true for your investment methodology. If you are in “preservation” mode, holding U.S. treasuries and following the recommendations of your broker, then the tax free growth of a Roth 401(k) is of little benefit. If, on the other hand, you are actively diversifying out of the United States, using offshore self-directed LLCs and related strategies to grow your wealth, and investing with an eye towards maximum growth, a Roth 401(k) may result is significant tax savings in the long run.

Here are some of the other situations where a Roth conversion may make sense:

  • You want to leave a tax-free inheritance to your heirs, regardless of the cost, or your tax rate is significantly lower than your beneficiaries.
  • You are at the lower end of the tax-rate scale now and will likely be at a much higher tax-rate during retirement.
  • You have enough deductions and tax credits to offset the tax bill that would be due on the Roth conversion.
  • When will you need to access your retirement money? If very soon, say in the next 8 to 10 years, then a Roth conversion may not make sense.
  • Can you afford to pay the taxes on the conversion? If you are under age 59 ½ and need to take money from your retirement account to pay the taxes, it almost never makes sense to convert. If you are over 59 ½, and the 10% penalty will not apply, then payment of taxes from your retirement account may be advisable.

In conclusion, I note that the optimal strategy may include both Roth and traditional accounts. This will give you the most flexibility when navigating the sea of tax law changes in the years to come. For example, you might be able to avoid increased taxation of your Social Security benefits, or increased Medicare premiums and Obama-care costs by using tax-free Roth withdrawals to keep taxable income below a given threshold.

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Unfiled Tax Returns

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First Things First: Taking Care of Unfiled Tax Returns

The first step in dealing with the IRS is to file your delinquent federal personal income tax returns. Until these tax returns are submitted, the IRS can’t set up an Installment Agreement or accept an Offer in Compromise.

Clients often come in missing two, five or even ten years of returns. Our computer system and the workflow we set up are designed to quickly and efficiently prepare multiple years of delinquent tax returns while minimizing the taxes due.

When multiple years of tax returns are needed, it is common for records to be missing or incomplete. Our licensed tax attorneys and enrolled agents will access your IRS archives and get a report of income for each year. This data, along with your records, will be used to prepare your delinquent tax returns.

Premier Tax & Corporate, Inc., LLC can prepare both your federal and state returns, regardless of where you live. We can also prepare multi-state returns for those who have moved, or those who work in one state and live in another.

You can submit your tax data to us by mail, fax, or by uploading it to our secure server. You can also download one of our questionnaires to help you get started.

We have decades of tax preparation experience, clients in over 15 different countries, and we are qualified to prepare tax returns for all 50 states.

Whether you have a

  • 1040 – Individual Tax Return;
  • 1065 – Partnership Tax Return;
  • 1120 – Corporate Income Tax Return;
  • 1120S – Corporate Income Tax Return for an S Corporation; or
  • Informational returns for Foreign/Offshore Corporations (Form 5471) and Trusts (Forms 3520 and 3520-A),

we can help you save money and get compliant.

Preparation Fees:

  • Basic personal tax return with W-2 wages: US$225 per year.
  • Basic personal tax return with W-2 wages and itemized deductions, such as mortgage interest: US$325 per year
  • Personal tax returns with wages, itemized deductions, and Partnership or S-Corporation Income (Form K-1): US$425 per year and up, depending on complexity.
  • Personal return with small business (Schedule C/self-employment income): starting at US$325 per year (total fee will depend upon completeness of your income and expense records).
  • Personal returns with Foreign Earned Income Exclusion, Form 2555: US$325 per year.
  • U.S. Corporation and Partnership returns with less than US$250,000 in assets or sales: starting at US$625.
  • U.S. Corporation and Partnership returns with more than US$250,000 in assets or sales, requiring a balance sheet: starting at US$750.


Please contact us for a free quote. Click here to send an e-mail or call us at (800) 581-6716/(213) 985-1876.

Note: Because everyone’s tax preparation needs are unique, sign-up and payment must be made by phone, e-mail, fax, or regular mail.

Online Resources

You can submit all of your tax information to us through our secure web interface.

First, fill in the Tax Organizer with your income, expense, and other data. This form will help you get organized and will guide you through most tax situations. You can access your form as many times as you need, or create multiple forms to cover several tax years.

  • Click hereto download a standard questionnaire.

  • Click here to download a questionnaire for U.S. citizens living abroad.

  • Click here to download an additional form for self-employed persons.

  • Click here to download an additional form for rental real estate.

  • Click here to download a questionnaire for corporations.

Next, you can fax your supporting documents to us at (213) 260-8371, or upload them through the Document Upload Tool on our website. Using the online system will get your confidential information and documents to us in the most secure way possible.

 

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IRS Wage Garnishments

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The IRS Wage Garnishment: How It Works, How to Stop It

When you owe money to the IRS and you do not contact the government to set up monthly payments or file an Offer in Compromise, they can levy your paycheck, and this course of action is referred to as an IRS wage garnishment or IRS wage levy.

It is important to note that the only obligation the IRS has is to send a series of letters to your last known address. Once these have been sent, and 30 days have passed, the government can take most of your paycheck, as well as levy your bank account. There is no requirement that they make any real effort to find you, verify your address, or even make a phone call before attacking.

In a wage garnishment or wage levy, the IRS can take about 75% of your salary, leaving you with a subsistence wage…enough to pay for food, but that’s about it. The exact amount of a wage garnishment will depend on your salary, number of dependents, and other factors, but 75% is a good rule of thumb.

A wage garnishment is often more difficult to deal with than a bank levy. When the IRS takes 100% of your available assets with a bank levy, it may be easy to demonstrate that this created an unreasonable hardship. By comparison, when the IRS takes 75% of just one paycheck, it may be harder to show you are suffering. They then take 75% of the next paycheck, the next, and so on, until your debt is paid or other arrangements are made. On occasion, the IRS leaves a wage levy on your account to force you to get your financial statement and supporting documents together more quickly.

Time is of the essence when dealing with an IRS wage garnishment/wage levy. Allowing the IRS to drag out the process makes your financial situation more precarious with each paycheck.

The best way to avoid an IRS wage levy or wage garnishment is to be proactive. Contact the IRS and make payment arrangements. If you can’t afford to make monthly payments, submit an Offer in Compromise or request to be considered “temporarily uncollectable.” What you can’t do is ignore the problem.

You should not wait for someone to knock on your door, as this generally happens only after your bank accounts have been taken or a wage levy/wage garnishment is in place. It is up to you to be proactive and contact the IRS to resolve your debt.

By submitting a complete, accurate, and well-planned financial statement to the IRS you can stop a wage garnishment from happening, negotiate the release of a wage garnishment, as well as minimize an Offer in Compromise payoff amount or an Installment Agreement payment amount.

Premier Tax & Corporate, Inc., LLC will analyze your case, determine your best course of action, prepare your forms, review your supporting documents, send you a completed package reviewed by a tax attorney and an enrolled agent, and prepare a custom-made, detailed letter of instruction. We will also support you throughout the process by phone and online chat.

Put our decades of IRS experience to work for you and get great results. Click here to get started now, here to send an e-mail inquiry, or phone us at (800) 581-6716/(213) 985-1876 with any questions.

Christian Reeves

IRS Tax Liens

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IRS’s Enforced Collection Measures and What to Do About It

If you owe money to the IRS, the government will usually file a Federal Tax Lien. A tax lien is a negative mark on your credit report and “attaches” to any real estate you own. It is typically filed with your country recorder’s office.

By recording a lien with the credit-reporting agencies, the IRS is putting your other current and future creditors on notice that you owe money to the Federal Government.

By filing the lien with your country recorder, the IRS is attaching your personal income tax debt to any real estate you own. This places them in line as one of the creditors on your home.

For example, let’s say your home is worth US$300,000 and that you have a first mortgage for US$100,000, a second mortgage for US$50,000, and a Federal Tax Lien for US$50,000. When you sell your home, your first and second mortgages get paid, as does the IRS, leaving you with US$100,000.

Same example, but let’s say you owe the IRS US$500,000. When you sell your home, your first and second mortgages get paid in full, and the IRS taxes the balance of US$150,000…leaving you with nothing but a remaining IRS debt of US$350,000.

Same example where you owe the IRS US$500,000, but a lender foolishly lends you US$100,000 against your home after the IRS files its lien. When you sell your home, your first and second mortgages get paid in full, and the IRS takes the remaining US$150,000 of equity, leaving the new lender with nothing.

If you file an Offer in Compromise that is accepted by the IRS and you pay in full, the tax lien will be removed from your home and reported as satisfied to the credit agencies. However, your Offer in Compromise must include 80% of the equity available in your home.

Using the same example as above, where you have US$150,000 of equity in your home, if you file an Offer in Compromise, your offer amount must include 80% of that US$150,000, plus any extra income you have over your allowed expenses.

Therefore, if you are a retired person, living on a Social Security pension, and your only asset is your home, then you may be able to settle your IRS debt of US$500,000 for 80% of US$150,000, or US$120,000.

Note: The 20% non-refundable deposit must include your available equity and therefore you need to come up with the US$150 filing fee plus 20% of US$120,000, or US$24,000, to file the OIC above.

If you are working and your income is US$2,000 per month over your allowed expenses, then you may be able to settle for US$120,000 + (US$2,000 x 48) = US$216,000. In this case, your 20% non-refundable deposit is 20% of US$216,000, or US$43,200.

Because the value of your home is used in determining the 20% deposit, as well as the offer amount, a proper valuation of the home is a key component to a successful Offer in Compromise. Also, proper planning and documentation of the OIC prior to filing may reduce the value of any assets, minimize the 20% deposit, and ensure you get the best deal available from the IRS.

Premier Tax & Corporate, Inc., LLC will analyze your case, determine your best course of action, prepare your forms, review your supporting documents, send you a completed package reviewed by a tax attorney and an enrolled agent, and prepare a custom-made, detailed letter of instruction. We will also support you throughout the process by phone and online chat.

Put our decades of IRS experience to work for you and get great results. Click here to get started now, here to send an e-mail inquiry, or phone us at (800) 581-6716/(213) 985-1876 with any questions.

Christian Reeves

IRS Offer in Compromise

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What to Do When You Owe the IRS: The Offer in Compromise

The IRS Offer in Compromise (OIC) program is the most misunderstood, misrepresented, and abused tax debt resolution program in history. It reached nearly mythic status with late-night television ads promising to settle your tax debt for pennies on the dollar, and then crashing to earth when the government stepped in to shut down companies they alleged were “scams.”

The purpose of this web page is to separate myth from reality and explain the IRS Offer in Compromise program in a simple and straightforward way.

The Basics

The IRS Offer in Compromise program allows you to settle your IRS tax debt for less than the full amount if 1) you can’t afford to pay the debt in full; 2) your assets are significantly less than the debt; and 3) you convince the IRS that they can’t collect the debt in full in the future.

The intent of the program is that you offer something to the IRS that they could not otherwise take from you. For example, you might borrow money from a family member to settle your tax debt. Offers will not be considered if the liability can be paid in full as a lump sum or under an Installment Agreement.

First, it is said that you can’t afford to pay the debt in full when you do not have the money to pay all at once, and can’t make monthly payments over the statute of limitations, that will satisfy the debt. Your ability to pay is based on your income when compared to your allowed expenses, as well as cash in any bank accounts, retirement accounts, cash-value life insurance policies, money in investment/brokerage accounts, etc.

Note: The IRS has about 10 years to collect from you once you file your returns or the tax debt is “assessed” (usually as result of an audit). Once this period has expired, most tax debt is eliminated. This 10-year period is called the “statute of limitations.”

Second, your assets must be significantly less that the debt you owe to the IRS. These assets include the equity in real estate, automobiles, boats, etc. Basically, your assets are said to be less than your tax debt if, in the case you sold/liquidated everything you own, you still wouldn’t be close to paying off the IRS.

Finally, you must convince the IRS that they will not be able to collect from you in the future. This means that you must show that your income will not increase and that other circumstances will remain the same, making it impossible for you to pay the debt.

For example, if you are unemployed you do not qualify for an Offer in Compromise. The IRS will simply wait until you find employment and then make a determination on how much, if any, they can take from you.

Another common example in today’s tough economic times is someone who made good money in prior years, but whose salary has decreased significantly. In most cases, the IRS will wait a year or two to see if your situation improves before granting an Offer in Compromise. In other words, you may need two or three years of similar income before an OIC will be granted.

The Offer in Compromise Program is summarized in the following IRS policy statement:

“The Service will accept an Offer in Comprise when it is unlikely that the tax liability can be collected in full and the amount offered reasonably reflects collection potential. An Offer in Compromise is a legitimate alternative to declaring a case as currently not collectable or to a protracted Installment Agreement. The goal is to achieve collection of what is potentially collectable at the earliest possible time and at the least cost to the government.”

Approval Rates

Most people do not have the skills or knowledge of the IRS collection process to prepare and document an Offer in Compromise that is in their best interest. Informal IRS estimates in Southern California for 2010 indicate that 75% of Offers in Compromise are returned due to forms being filled out incorrectly and that, of the 25% that are processed, approximately 50% of them are rejected.

The keys to a successful IRS Offer in Compromise are 1) a proper analysis of your tax situation, including a review of your income, expenses, and financial documents, and 2) a complete and accurate Offer in Compromise package.

Note: A proper analysis often shows that you do not qualify for an Offer in Compromise. Therefore, forms and instructions are produced to set up an Installment Agreement or to list you as “temporarily uncollectable.”

The Process

There were approximately 52,000 Offers in Compromise processed in 2009, and about 11,000, or 26%, of those were accepted. This compares to the height of the Offer in Compromise boom in 2004, when approximately 100,000 OICs were filed.

There are hundreds of IRS agents assigned to work these thousands of Offers in Compromise, and they must treat all taxpayers the same. This means that the Offer in Compromise program is very mechanical,with agents following strict guidelines and mathematical formulas to determine acceptance or rejection.

In most cases, an IRS agent receives the OIC package, researches the accuracy of the information provided, looks at prior-year income history, potential future earnings, and accepts or rejects the Offer in Compromise. Almost zero negotiation goes into this process. The only communication one is likely to get from the IRS during an OIC is a request for additional information or documents.

A typical Offer in Compromise requires:

  • IRS Form 656 – Offer in Compromise Booklet and Form;
  • Form 433-A – Collection Information Statement for Wage Earners and Self-Employed Individuals;
  • Form 433-B – Collection Information Statement for Businesses;
  • Supporting documentation: You will need three months of documentation on just about every expense and income you have. These amounts include pay stubs, credit card statements, mortgage or rent statements, investments, transportation, W-2s, tax returns, etc.

By preparing these documents correctly and properly researching the Offer prior to submission you are guaranteed of the best possible result.

What If I Don’t Qualify for an Offer in Compromise?

Most clients who contact us for tax relief do not qualify for an Offer in Compromise. Therefore, we assist them to set up an Installment Agreement, to be listed as “temporarily uncollectable,” or with one of the many other solutions available.

All forms of tax relief require the same steps and documentation:

  1. Filing all tax returns;
  2. A proper analysis of your tax situation to determine the best course of action;
  3. Planning and accounting in order to prepare an IRS financial statement, Form 433-A and/or 433-B when applicable;
  4. A complete and accurate IRS financial statement, Form 433-A and/or 433-B; and
  5. Supporting documents which match the information reported on the IRS financial statement(s).

Therefore, the key to successfully dealing with the IRS is to submit a complete, well-planned, and detailed package of information. This, combined with our unlimited phone and Internet support, guarantees you the best result possible.

Conclusion

Once you understand the intent and structured nature of the IRS Offer in Compromise program, as well as all other forms of tax relief, dealing with the IRS becomes much less scary, and it is easier to move forward toward resolving your IRS tax debt.

Keep in mind that the IRS’s objectives for the Offer in Compromise program are:

  • To effect collection of what would reasonably be collected at the earliest time possible and at the least cost to the government;
  • To resolve accounts receivable in the best interest of both the taxpayer and the government;
  • To give taxpayers a fresh start to enable them to voluntarily comply with all filing and paying requirements;
  • To collect funds which may not be collected through any other means.

If you qualify for an Offer in Compromise, you will eliminate your debt permanently and gain a fresh start with the Internal Revenue Service. If you do not qualify, you will prevent levies and other hostile actions from the IRS by dealing with the situation head-on through the Installment Agreement program, or one of the many other options or variations available.

Premier Tax & Corporate, Inc., LLC will analyze your case, determine your best course of action, prepare your forms, review your supporting documents, send you a completed package reviewed by a tax attorney and an enrolled agent, and prepare a custom-made, detailed letter of instruction. We will also support you throughout the process by phone and online chat.

Put our decades of IRS experience to work for you and get great results. Pleaseclick here to get started now, call one of our experienced and licensed tax professionals at (800) 581-6715/(213) 985-1876 to discuss your case, or click here to send us an e-mail.

Christian Reeves

IRS Bank Levies

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When Your Hard-earned Money Is at Risk—The IRS Bank Levies

If the IRS has levied your account, you have only 21 days to submit all the necessary documents and secure a release before the money is gone. Time is of the essence, so please contact us immediately!

One of the most powerful and vicious collection tools in the IRS toolbox is the bank levy. It allows the government to take all of the cash in your account up to the amount of your debt.

In other words, if you owe the IRS US$10,000 and you have US$12,000 in your bank account, a levy will take US$10,000 and leave you with US$2,000. If you have US$8,000 in your account, the IRS will take all the money, leaving you with nothing.

Making matters tougher on the taxpayer, the IRS does not need to get a court order, or make any real effort to collect from you, before draining your bank account. All the government is required to do is send a series of letters to your last known address. Whether you receive them, respond to them, or whether the address on file is current is of no consequence.

Once the IRS has your money, it is challenging to get it back. The burden is on you to prove that the levy created an unreasonable hardship, such as resulting in your being evicted from your home, for example.

The best way to prevent a bank levy is to face your tax issues head-on, providing the IRS a completed financial statement, Form 433-A, and all of the supporting documents. As a part of this process, you may need to file missing or delinquent tax returns.

Do not wait for someone to knock on your door, as this generally happens only after your bank accounts have been taken. It is up to you to be proactive and contact the IRS to resolve your debt.

If your account has been levied, you will need a completed financial statement and supporting documents to prove the levy created a hardship and that it should be released.

You should also note that a bank levy is a one-time event. For example, let’s say your bank received a levy on Monday. They will pay all items that posted that day and then execute the levy, depleting your account. If you make a deposit on Tuesday, the IRS has no right to that money…the levy only applied to your balance at the end of the day on Monday. Of course, the IRS can send a second levy to get additional deposits.

If you are concerned that the IRS may levy your account, you have several options:

  1. Move your account to a new bank.
  1. Keep a minimal amount of money in your personal bank accounts. Make your deposit and immediately pay all bills.
  1. The IRS can levy any personal bank account in your name. If you have a joint account, remove your name to protect the other party.

For example, a son is a signatory on his elderly father’s account, for estate-planning reasons. The IRS can take all of the money from this account, up to the amount of the debt. The son’s name should be removed from this account until his tax issues are resolved, either by an Offer in Compromise, an Installment Agreement, or by paying in full.

  1. If you have a business, keep money in your corporate or LLC account, and not in your personal account. However, never pay personal bills from your corporate or LLC account.
  1. Keep money in your retirement accounts, as it is very rare for the IRS to levy such an account.
  1. In the case where one spouse has a tax debt and the other doesn’t, the bank account may be held in the name of the innocent spouse.

For example, a husband owes money to the IRS from unpaid payroll taxes. This debt doesn’t include his wife, who should be the only signer on the household bank account.

Never deposit a husband’s paycheck in his wife’s account. Keep all transactions separate.

Note:Taxes that are the result of a business, such as payroll and sales taxes, generally only affect the spouse involved in the business. The spouse not involved in the company is referred to as the “innocent spouse.”

  1. Request an Installment Agreement or file an Offer in Compromise. While you are working towards a resolution of your tax issues, the IRS can’t levy your bank account…just be sure not to miss a deadline to provide documents, or your accounts may be depleted!

By submitting a complete, accurate, and well-planned financial statement to the IRS, you can stop a bank levy from happening, negotiate its release, as well as minimize an Offer in Compromise payoff amount or an Installment Agreement payment amount.

Premier Tax & Corporate, Inc., LLC will analyze your case, determine your best course of action, prepare your forms, review your supporting documents, send you a completed package reviewed by a tax attorney and an enrolled agent, and prepare a custom-made, detailed letter of instruction. We will also support you throughout the process by phone and online chat.

Put our decades of IRS experience to work for you and get great results. Click here to get started now, here to send an e-mail inquiry, or phone us at (800) 581-6716/(213) 985-1876 with any questions.

 

Christian Reeves

IRS FAQs

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Frequently Asked Questions (FAQs)—IRS Tax Problems and IRS Tax Debt Relief. The IRS Offer in Compromise Program Defined

1. What is an IRS Offer in Compromise?

In most cases, an IRS Offer in Compromise is a way to settle your IRS debt for less than the balance due, because you are unable to pay the full amount. You are basically offering the IRS something they could not take from you…something over and above what they could collect.

2. Do I qualify for an IRS Offer in Compromise?

If you can afford to pay your IRS debt in full, either over time or all at once, then you do not qualify for an Offer in Compromise.

If your assets, such as equity in real estate, retirement accounts, etc., are more than your IRS debt, then you do not qualify for an Offer in Compromise.

If you can’t afford to pay your IRS debt and your assets are significantly less than your IRS debt then you may qualify for an Offer in Compromise.

3. What are the “allowed expenses?”

You are allowed to spend up to certain amounts for your personal expenses such as food, clothing, housing, utilities, automobile, etc.

Some of these amounts, food and clothing for example, are regulated by the National Standards, which means that everyone in the U.S. is allowed the same expense.

Other expenses, such as housing and utilities, are based on where you live.

For example, a family of three living in Bailey County, Texas, is allowed only US$830 in housing and utilities. However, if that same family lives in New York County, New York, they are allowed up to US$4,976 in housing and utilities.

The logic of the IRS here is that you should not be allowed to make payments on your mansion and Ferrari, and not pay the government.

One of the most important tasks when filing an Offer in Compromise is to understand the interplay between the various allowed expenses to ensure you get the best deal available.

4. If I do not qualify for an IRS Offer in Compromise, what alternatives do I have?

If you can’t settle your IRS tax debt with an Offer in Compromise, you have two options:

  1. Set up an Installment Agreement. With this, you must pay the IRS each month until the applicable statute of limitations has expired. When the statute of limitations has run out, any remaining debt is eliminated.
  1. Request to be considered “temporarily uncollectable.” If you do not qualify for an IRS Offer in Compromise and you can’t afford to make monthly payments, then you can request that your account be placed on hold until your situation improves. The IRS will review your income and expenses each year and require you to make payments when you can afford to do so.

5. What is a “statute of limitations?”

In the case of an IRS Offer in Compromise, a statute of limitations is the length of time the IRS has at its disposal to collect taxes from you.

The IRS has 10 years to collect once you have filed your tax return or after your IRS tax debt has been assessed. “Assessed tax debt” generally refers to debt which is the result of an IRS audit.

Once the statute of limitations runs out, your IRS tax debt is eliminated.

For example, you file your 2009 federal personal income tax return on April 15, 2010, and owe US$100,000. The IRS has until about April 15, 2020 to collect that amount from you. If you made monthly payments totaling US$25,000 over 10 years, the remaining US$75,000 of debt is eliminated and you get a fresh start.

6. I am unemployed. Do I qualify for an IRS Offer in Compromise?

In general, if you are unemployed you do not qualify for an Offer in Compromise. The IRS will wait until you’ve been employed for around six months and then determine your ability to make monthly payments.

While you are unemployed, you should qualify to be listed as “temporarily uncollectable” (see above). When your income has stabilized, you might submit an Offer in Compromise.

Note:“Unemployed” means that you are capable of work and under age 65. Someone over age 65, or disabled and unable to work, is considered retired and may qualify for an Offer in Compromise.

7. If my IRS Offer in Compromise is rejected, what will happen?

In most cases, the IRS person working your Offer in Compromise will set up an Installment Agreement or list you as “temporarily uncollectable” if you do not qualify for an Offer in Compromise.

If you disagree with the rejection of your Offer in Compromise you can file an appeal, which will move your case to a more senior IRS person in your region. This person may have more authority to consider your unique circumstances.

8. How long does an Offer in Compromise take to complete?

It generally takes four to 12 months for your Offer in Compromise to be assigned to an IRS agent to work on. Then, it may require two to three months for the case to be completed. The precise time will depend on the amount of the debt and the complexity of your situation.

If your Offer in Compromise is rejected and you file an appeal, this may take another six months or so.

9. Can the IRS collect from me while I am in the Offer in Compromise program?

The IRS is prohibited from collecting from you while your Offer in Compromise is pending. Also, the applicable statute of limitations is on hold while your Offer in Compromise is being considered.

For example, if your debt would expire on April 15, 2020, and your Offer in Compromise takes 12 months before it is rejected, then the IRS has until April 15, 2021 to collect from you.

10. Is it expensive to have a professional help with an Offer in Compromise filing?

Legal fees for an Offer in Compromise typically range from US$3,500 to US$25,000. Complex cases cost more, and these fees do not include the IRS US$150 filing fee or the 20% non-refundable deposit. We estimate the average cost of a case to be US$4,500.

11. What forms do I need for an Offer in Compromise?

Planning and preparing the documents for an Offer in Compromise are complicated and require lots of experience. We believe that 90% of the work for an Offer in Compromise is done prior to filing.

A typical Offer in Compromise requires:

  • IRS Form 656 – Offer in Compromise Booklet and Form;
  • Form 433-A – Collection Information Statement for Wage Earners and Self-Employed Individuals;
  • Form 433-B – Collection Information Statement for Businesses;
  • Supporting documentation: You will need three months of documentation on just about every expense and income you have. These amounts include pay stubs, credit card statements, mortgage or rent statements, investments, transportation, W-2s, tax returns, etc.

12. What forms are required for an Installment Agreement or a request to be considered “temporarily uncollectable?”

Just like in the case of an Offer in Compromise, you will need Form 433-A and/or Form 433-B, along with the supporting documentation.

13. After the forms are complete and the Offer in Compromise filed do I need a tax attorney to negotiate the best deal? Will a tax attorney get me a better deal than I could get on my own?

The IRS Offer in Compromise program is very structured, with hundreds of different IRS agents handling thousands of cases. These agents receive a case, investigate whether the information provided is complete and accurate, apply the National and Local Standards, look for exceptions, and then accept or reject the Offer.

Because very little negotiation occurs and the IRS agent has almost no ability to diverge from the allowed standards, an expensive tax attorney is not required in most cases.

This means that most work is done before filing the Offer in Compromise, and an experienced professional adds the most value in planning, preparing, and documenting the Offer. Also, just as important, a professional can determine if you qualify for an Offer in Compromise prior to its being filed, saving you thousands of dollars and months of time.

14. I have not filed all of my federal personal income tax returns. Can I still submit an Offer in Compromise?

No, all of your tax returns must be filed before you submit an Offer in Compromise or set up an Installment Agreement. Basically, the IRS will not deal with you until all of your tax returns are filed.

We are experienced in preparing delinquent returns of all types and will be happy to assist you.

15. Is the IRS required to give me an Offer in Compromise if I qualify?

No, the IRS is not required to grant you an Offer in Compromise simply because you qualify. If the IRS believes your income will increase, they are likely to deny your Offer in Compromise and list you as “temporarily uncollectable.”

For example, a real estate agent made US$150,000 in 2008, US$125,000 in 2009, US$45,000 in 2010, and files an Offer in Compromise in 2010 for back taxes owed. The IRS is likely to wait a year or two to see if the taxpayer’s income increases significantly. If it doesn’t, they may grant an Offer in Compromise in 2011 or 2012.

16. What about all of the TV and radio ads promising to settle my IRS debt for 10 cents on the dollar?

Any firm that files a large number of Offers in Compromise will have success stories. However, these are the exception, not the rule.

For example, one of our clients owed US$250,000 to the IRS and settled his Offer in Compromise for US$7,500, or three cents on the dollar. This is the type of case we could use in our advertising.

Well…this client was 71 years of age, was living on Social Security and Disability income, and had no assets. I suspect that this more-detailed description fits very few of those of you reading these FAQs.

Therefore, every case and set of circumstance is different, and careful planning, preparation, and documentation of an Offer in Compromise are the keys to success.

17. Why are there so many websites promising to settle my IRS debt for less?

In fact there are only a few national firms marketing IRS tax debt settlement services. Also, there are many small local law firms and CPA offices offering this service.

However, there are hundreds of marketing websites. These are small companies, oftentimes guys in their basements, who put up a website to generate marketing leads on their spare time. They then sell these leads to an Offer in Compromise mill, or a tax person just starting out and who is not able to get business on his own. Our research indicates that the majority of sites on the Web are marketing sites.

18. How much does it cost to file an IRS Offer in Compromise?

The filing fee for an IRS Offer in Compromise is US$150. Also, you must submit a non-refundable deposit of 20% of your Offer amount.

For example, if you owe US$100,000 and offer to settle your debt for US$10,000, your filing fee is US$150, and your deposit is US$2,000 (20% of US$10,000).

19. What does the IRS say about the national Offer in Compromise mills?

Since 2004, the IRS has continually informed the public about unscrupulous promoters who prepare and file Offers in Compromise they know will be rejected, just to make the fee. IR-2004-17, issued on Feb. 3, 2004, warns that “[…]some promoters are inappropriately advising indebted taxpayers to file an Offer in Compromise (OIC) application with the IRS. This bad advice costs taxpayers money and time.”

20. Have government agencies shut down any of the national IRS Offer in Compromise mills?

Yes, state and federal agencies have stepped in to protect taxpayers from OIC mills.

For example, the Attorney General of California announced on Aug. 23, 2010 that he was suing the national firm of Roni Deutch for “victimizing thousands who sought her aid in dealing with the IRS.” He is seeking US$34 million in damages. For more information, click here to check the California Attorney General’s website.

In addition, California sought to enjoin Roni Deutch from doing business. Click here to read the legal brief.

In a second example, the Federal Trade Commission (FTC) took action against American Tax Relief, a national tax debt relief company, claiming ATC is a scam that swindled clients out of millions of dollars. At the FTC’s request, ATC was shut down and their assets frozen.

For more information, click here to go to the FTC’s website and here to read the news clippings.

In a third example, the Texas Attorney General has filed suit against TaxMasters, Inc. The Texas Attorney General’s office states that there are nearly 1,000 complaints about TaxMasters, Inc., and that are seeking restitution and fines on behalf of those harmed.

To quote the Attorney General’s press release, TaxMasters, Inc. “routinely misled customers about the nature of their tax resolution service agreements – and worse, attempted to enforce those improper agreements through unlawful debt-collection tactics.” To read more, click here to access the Texas Attorney General’s website. Also, for an article in the Houston Chronicle detailing the lawsuit against TaxMasters, Inc. click here.

According to an ABC News report, there are thousands of similar complaints. To see this report, click here.

21. What do the consumer protection and business review websites have to say about the national IRS Offer in Compromise mills?

There are many opinions and unverified statements on the Web, which should all be taken with a grain of salt. Here are links to a few websites that may be of interest:

 

Swiss Banking
Christian Reeves

Swiss Banking is Dead

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Let’s face reality. Swiss banking is dead. It’s a brisk day here in Geneva with highs in the mid 40’s and a strong breeze coming off the lake. I spent the day ringing in the New Year with a group of investment advisers and bankers on Rue de Rhone, all of whom are typically Swiss about what’s happening to their country.

With Swiss banking privacy in the rear view mirror, banks are struggling to find their place. In days gone by, they were able to charge high fees in exchange for their integrity and a history of defending their client’s rights. Now, after rolling over for the Americans, Swiss banking is in a tailspin.

But the Swiss are pressing on. To a man, their attitude is that, while this is a permanent contraction, business will go on in one form or another. Those who can adapt to a new world order will succeed, and those who can’t will be left behind. Life changes and goes on.

Switzerland’s biggest banks, UBS and Credit Suisse, have shed 7,000 jobs and the downsizing is expected to continue. In addition to losing its allure, an overpriced Swiss Franc, a weak Euro, and other economic woes have hit this small country of nearly 8 million hard.

And those who still have their jobs are looking at significant pay and bonus cuts, as bank profits have fallen sharply. Because of a significant decrease in international business, combined with higher regulatory and other costs, salaries and all types of compensation are lower. Lower margin as forced to compete on price and not on privacy and protection.

In addition to lost respect and business affecting all Swiss banks, UBS has been singled out and smashed time and time again by U.S. authorities. In 2009, UBS paid the U.S. tax man $790 million and the U.S. SEC $200 million to avoid criminal prosecution, and gave up info on 17,000 accounts, which precipitated the current mess. Then, in May of 2011, UBS came up with another $160 million for the SEC. With cash strapped agencies smelling blood in the water, regulators are currently suing UBS for $1 billion in damages related to the U.S. mortgage crisis.

Not wanting to kill the cash cow, the Justice Department has given UBS conditional immunity on the LIBOR rate fixing case they are planning. Conditional immunity indicates that UBS confessed and gave evidence against others in the pending investigation.

A corporation can avoid criminal conviction and fines for antitrust crimes “by being the first to confess participation in a criminal antitrust violation, fully cooperating with the division, and meeting other specified conditions,” according to the Justice Department.

While the Swiss may be stoic, I believe this new world order will continue for the foreseeable future and that Switzerland as a world financial center is done. When banking secrecy was torn asunder, Switzerland lost its competitive advantage. Why hold money in Switzerland over Luxembourg, Singapore, or smaller and more competitive nations such as Andorra? The Americans have succeeded in doing what even World War II could not…turn Switzerland in to just another pretty tourist destination.

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Expat Taxes

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Filing Tax Returns—The Basics

The following page applies to U.S. citizens and residents living and/or working outside of the United States.

U.S. persons (citizens and permanent residents/Green Card holders) are required to file a tax return each year, no matter where they live, if their income is above US$9,350 when filing as single, or US$18,700 if filing as married (2010 thresholds).

Failure to file your U.S. personal income tax return can result in the loss of your Foreign Earned Income Exclusion, creating a disastrous situation for any U.S. citizen living abroad. As this exclusion can legally eliminate the income tax on your income earned outside the U.S., you don’t want to lose it.

You can qualify for the Foreign Earned Income Exclusion through either the Bona Fide Residency Test or the Physical Presence Test. The maximum amount to qualify was US$91,400 in 2009, and it’s currently US$91,500 for 2010.

The Physical Presence Test mandates that you must be outside of the United States for 330 out of any 365-day period. You meet the Bona Fide Residency Test if you are out of the United States for one full calendar year and move to a country with the intention of making it your home for the foreseeable future.

In addition, those living abroad are generally required to file a Foreign Bank Account Report with the United States Treasury. Failure to file this form can result in extremely severe penalties of up to US$100,000 per violation.

It is common for people living and working abroad to have neglected to file income tax returns for five, 10, or even 20 years. Because our computer system and the workflow we set up are designed to handle the preparation of multiple years of delinquent returns in a quick and efficient manner, in order to minimize the tax due, we are proud to say that we have successfully represented many expats and achieved excellent results.

Preparing and filing past delinquent returns (i.e., becoming compliant) is the first step towards an Offer in Compromise or an Installment Agreement with the IRS.

Also, the collection process is more complex for those living abroad. Because there are no standardized expenses, you must prove the necessity of each item. Also, the IRS may levy certain international banks and lien property in some countries, which makes experienced planning and preparation the key ingredients for success.

The expertise required to prepare international returns and the risks facing expats are unique. Our international tax group is headed by the U.S.-licensed tax attorney Christian Reeves, the author of the 2010 International Tax Bible, published by International Living, an expert in the field of international taxation. Together with him we will guide you through the maze of IRS collections in a professional and efficient manner.

Click here

Note:Because everyone’s tax preparation needs are unique, sign-up and payment must be made by phone, e-mail, fax, or regular mail.It is not available through our website shopping cart.

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Taxpayer Bill of Rights

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Taxpayer’s Bill of Rights

In tough economic times, many business owners and self-employed people find it difficult or impossible to pay their Federal taxes. When the debt is too large to pay, you then get the joy of negotiating with the Internal Revenue service.

NOTE: Of course, everyone has a hard time paying their taxes. Business owners and the self-employed are more likely to have large debts because many do not have taxes withheld from their paychecks, do not make quarterly estimates, and hope that there is enough cash in the business at the end of the year to keep the IRS at bay.

The following is a list of protections that taxpayers have when facing the IRS, known in the industry as the “Taxpayer’s Bill of Rights.” The first step in dealing with the IRS is to know these basic rights.

  • Innocent Spouse Relief (Publication 971):
    • Is available for ALL understatements of tax (previously, only substantial understatements) attributable to erroneous items (previously, only grossly erroneous items) of the other spouse.
    • You must file this claim within 2 years of the IRS beginning collection action.
    • You must show that the innocent spouse did not know and had no reason to know about the underpayment of taxes.
    • Innocent Spouse can be claimed for any tax liability arising after July 22, 1998 and any tax liability unpaid as of that date.
    • If Innocent Spouse is claimed and rejected, you can file a petition and go to tax court.
    • The IRS can grant equitable relief to taxpayers who do not satisfy the above tests.
    • If you filed a joint return, you can use innocent spouse as long as: 1) you are divorced or legally separated, or b) have been living apart for more than one year.
  • The IRS must abide by the Fair Debt and Collections Practices Act, which includes not communicating with you at an inconvenient time or place. This right basically protects against harassment.
  • The 10-year statute of limitations period on collection may generally not be extended, if there has been no lien on any of the taxpayer’s property.
  • The IRS must give you an installment agreement if:
    • You owe less than $10,000.
    • In the previous 5 tax years you have NOT 1) failed to file a tax return, 2) failed to pay any tax required to be shown on a return, and/or 3) entered into an installment agreement. and
    • Require full payment within 3 years.
  • A supervisor must approve the issuance of a Notice of Lien or Levy or seizing of property.
  • The IRS must notify you within 5 business days after the filing of a Notice of Lien and must include certain information in the notice, such as the amount of the tax and your appeal rights.
  • Anyone who will be affected by the filing of a lien is entitled to a fair hearing with an Appeals officer who had no prior involvement with the unpaid tax that gave rise to the filing of the lien.
  • You can get a certificate of discharge of a lien by depositing the amount in question with the IRS or you furnish a bond. You then have the right to sue to dispute the tax due.
  • The IRS must release a wage levy once it is determined that your outstanding tax liability is uncollectible. This basically means that the IRS determines that you do not have the financial resources (cash flow after allowed business and personal expenses and assets) to pay the debt.
  • You and 3rd parties can sue for money damages for reckless or intentional disregard of the statutory collection provisions. This has been made easier because it includes negligence on the part of an IRS employee. You must first follow administrative remedies and you are limited to $100k for negligence and $1m for intentional or reckless disregard.
  • The IRS must notify you, 30 days before filing a levy, that you have a right to a hearing.
    • You can then request an appeals officer hear the case before the levy.
    • You cannot challenge the underlying tax unless you had no previous opportunity to do so.
    • If not resolved, you have 30 days to appeal to the U.S. Tax Court or Federal Court.
  • Increase the amounts exempted from levy to $6,250 for furniture and personal effects and $3,125 for tools of the trade.
  • Property can’t be sold below the property’s minimum bid price.
    • Where no one is willing to pay the minimum bid price, the IRS can return the property or it is deemed to have paid that price.
    • b. Generally, this is 80% or more of the forced sale value.
  • If the amount of the debt is less than $5,000, the IRS cannot take your primary residence.
  • The IRS cannot seize your principle residence without prior court approval.
  • The IRS cannot reject an Offer in Compromise from a low income taxpayer solely on the basis of the amount of the offer.
  • While you have an Offer in Compromise pending, and 30 days thereafter, the IRS cannot take your property or levy your bank account.

The key to success and minimizing the expense, in your dealings with the IRS is a well-planned and documented financial statement, used to setup an installment agreement or to submit an Offer in Compromise.

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Offer in Compromise Basics

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Getting Out of Trouble—the Offer in Compromise

By Christian Reeves

Tax Attorney

“Chris, I’m in a big trouble,” started one of my clients. “I owe around US$50,000 to the IRS for the last three years and I’m now unemployed. My only asset is a car worth about US$1,000. Do I have options?”

“Yes, you do,” I assured him.

My client owed back taxes, but couldn’t afford to pay the entire bill. I advised him to opt for an Offer in Compromise, which would allow him to clear his debt by paying just part of what he owed.

Let’s start with the basics.

The Offer in Compromise is a program established by the IRS aimed at helping people who can’t pay their back taxes because they are experiencing financial hardships. Through this program, taxpayers can negotiate a reduction of their debts.

“How come,” you’d ask. “Isn’t the government running huge deficits these days?”

Correct.

The government needs your money…but many hardworking Americans cannot afford to pay their bill in full. To the IRS it’s better to get back even a small percentage of that debt than nothing at all. Seen from this perspective, making a deal with you makes sense.

Note that the IRS does not grant Offers in Compromise to everyone. In fact, only one in every four Offers in Compromise filed is ever negotiated. However, when it made a deal, the IRS settled for an average of about 16% of the taxpayer’s ability (Source: United States Government Accountability Office, Report to the Committee on Finance, U.S. Senate, April 2006)

Filing an Offer is not for the faint of heart. You must prove you can’t afford to pay in full and it is in the best interest of the IRS to settle for less. This means that you have to open up all of your financial records to the IRS, including bank statements and mortgage documents. You need to provide receipts for each and every item on your expense list. To make matters even more complicated, you have to take into account the fact that the IRS has its own table of “allowed expenses” to determine what kind of lifestyle you should be permitted to keep until the tax debt is paid off. Properly analyzing your tax satiation (actual income vs. allowed standards) and fully documenting your case are the keys to getting an Offer in Compromise accepted.

 The Procedure

You will be required to submit forms 656, 433-A, and 433-B, if applicable, as well as all the supporting documentation to substantiate your assets, liabilities, income, and “allowed living expenses.”

The amount you can afford to pay the IRS each month is determined by subtracting from your average monthly income the “allowed living expenses.” In determining these living expenses, the IRS uses what it calls the “national standards” of what it will allow for food, clothing, and other items; the “local standards” are used to determine the maximum allowed expenses for housing, utilities, and transportation. These calculations are applied regardless of your actual expenses documented on form 433-A.

The amount you can afford to pay the IRS in the Offer in Compromise program is the value of this stream of income plus the value of your assets, such as retirement accounts, automobiles, real estate, etc. The value of your monthly payments (income stream) is calculated by multiplying the monthly figure by 48 or 60 months, depending on the type of Offer you submit. More on this in a minute…

Remember: The IRS will only consider an Offer in Compromise after all other payment options have been exhausted. In fact, the Service encourages you to explore all the available ways to pay the liability such as cash advances on credit cards, borrowing against 401(k) funds or life insurance policies, etc. You may even be given an extension of time to pay, ranging from 30 to 120 days.

Finally, before an Offer in Compromised is considered, the IRS evaluates the possibility of you qualifying for an Installment Agreement. For this purpose, if you owe less than US$25,000 in taxes, Form 9645 also needs to be filed. If you can’t afford to pay the tax debt in full in an Installment Agreement, only then will you be considered for an Offer in Compromise.

When applying for an Offer in Compromise you must generally include a US$150 application fee and a deposit of 20% of the amount you offer (for example, if you owe US$50,000 and offer to pay US$2,000, then you have to include one check for US$150 and another one for 20% of US$2,000, or US$400) in the case of a “lump sum” payment option. You can also choose other payment options, but this typically results in your Offer being delayed for up to 12 months.

There are additional requirements for applying for an Offer in Compromise. For a start, all your federal tax returns must be filed…the IRS absolutely will not consider an Offer in Compromise if your returns are unfiled. Also, you can’t be in bankruptcy. You must wait to exit bankruptcy to file an Offer in Compromise, if your tax debt will not be discharged.

If you are a senior citizen living on a fixed income or suffering from a serious illness, then you may expect special consideration from the IRS. Be prepared to show medical records, doctor’s statements, and other supportive documents, even write a letter detailing your special circumstances. As a colleague of mine used to say, ”paint it black” and you’ll stand a better chance of reducing your debt through an Offer in Compromise.

In the event your Offer in Compromise is accepted, you will be required to file and pay all your taxes on time for a period of five years. Also, you’ll agree that the IRS may keep any tax refunds that would have been payable to you during the calendar year when your Offer in Compromise was approved and for the years prior to the Offer.

 Pros and Cons of Making an Offer in Compromise

Having an Offer in Compromise approved is not taking a free ride. The government runs vigorous enforcement programs and, if not careful, your original debt may be reinstated in full, together with all penalties and interest accumulated.

But let’s first talk about the advantages (some of them are…well, obvious):

  • You save money…a lot of money, actually. If accepted, the amount you’ll pay under the agreement may be just pennies on the dollar of the original debt.
  • After you’ve paid the amount agreed to, any tax lien is released within 30 days and your credit rating will improve.
  • Your stress level is reduced while the Offer is pending because all collection actions are suspended during this time.

Are there disadvantages? Sure, I’ve just mentioned one at the beginning of this section…having to adhere religiously to the IRS rules. Here are others:

  • Filing an Offer gives the IRS extra time to collect from you. Normally, the IRS has 10 years to collect your debt; after the 10 years are up your debt is canceled. When you file an Offer in Compromise, the collection period is extended by the time the Offer is under consideration, plus 30 days.
  • You’ve now provided the IRS with everything about your financial situation, and thus with a roadmap for the Service to take better collection action in case your Offer is rejected.
  • And now a biggie…In most cases when the taxpayer has a large debt for which an Offer in Compromise is desired, he/she also owes state income taxes, credit card debt and/or other financial obligations. The Offer in Compromise will not do anything for solving these issues. Therefore, the Offer in Compromise is not a complete solution for all the debt you owe. The only solution to eliminate the federal tax debts as well as other financial problems you may have is bankruptcy. Read hereLINK about dumping your tax debt in bankruptcy.
    • Note than many states have Offer in Compromise programs very similar to the federal program. It is possible to eliminate state and federal tax debts by filing Offers in Compromise with both agencies simultaneously.

 What if My Offer Is Rejected?

This happens very often. It may be that the IRS thinks you can pay off all your debt or it deems the amount you offered to pay too low. I’ve even had Offers rejected on the nebulous grounds of “against public policy,” whatever that means.

Also, a very large number of Offers are returned each year because the forms are completed incorrectly, or the Offered amount, and thus the 20% deposit, is unreasonable. The reason may even be as simple as forgetting to sign the form (it happens more often than you’d think) or not listing your Social Security number. Analyzing, documenting, and submitting an Offer in Compromise is a very mechanical and detailed process, which takes years of experience to master.

In the case when the Offer amount is too low then you can submit another form, with a higher amount. If the rejection is due to a different reason, you will find it explained in your rejection letter. You have the right to appeal the IRS decision within 30 days from the date of the rejection.

 When You Need a Tax Professional…

Always choose a reputable tax professional who has experience preparing Offers in Compromise. Many unscrupulous promoters claiming they can slash your debt to just pennies on the dollar advertise on billboards, late-night TV, and the Internet. These so-called “offer mills,” often with slick advertisements, can take away your money and not live up to the promises they made in the first place. For reviews of some of these promoters, check out the FAQs section LINK of this website.

At Premier Tax & Corporate, Inc. you will find a group of well-trained professionals who will work together with you in order to achieve the best available result for your particular situation. Our enrolled agents and tax attorneys add the most value in planning, preparing, and documenting your Offer in Compromise. Also, just as important, our professionals can determine if you qualify for an Offer in Compromise prior to its being filed, saving you thousands of dollars and months of time. Contact us by phone at (800) 581-6716 or by e-mail at sales@taxreliefguaranteed.com. We are here to help.

 

 

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IRS Statute of Limitations

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IRS & The Statute of Limitations

By Christian Reeves

Tax Attorney

 The bottom line is that the IRS usually has 10 years to collect from you once a tax return is filed, and generally has 3 years to audit your return to assess additional tax.

Understanding the 10 year collection statute is important when negotiating an installment agreement or Offer in Compromise with the IRS. For example, if there is only one year remaining on the collection statute, offering to settle the debt for 75% is probably not a good deal for the taxpayer. It may be better to delay and enter in to an installment agreement for the remaining collection period.

Here are the basics:

Tax Return Audits

The statute of limitations limits the time during which an action can be brought by the IRS for an audit and the time for IRS tax collection activities. Generally, there is a 3-year statute of limitations when the IRS audits a tax return and a 10-year statute of limitations for the IRS to collect tax.

Under section 6501(a) of the Internal Revenue Code (Tax Code) and section 301.6501(a)-1(a) of the Income Tax Regulations (Tax Regulations), the IRS is required to assess tax within 3 years after the tax return was filed. This means that, unless special circumstances apply, the IRS must assess a new tax as the result of an audit within 3 years of the return being filed.

Under section 6501(e) of the Tax Code and section 301.6501(e)-1 of the Tax Regulations the statute of limitations is 6 years if the taxpayer omits additional gross income in excess of 25% of the amount of gross income stated in the tax return filed with the IRS. This is known as the substantial understatement assessment period because it comes in when the taxpayer understates their income by 25% or more on the return.

If the tax return was prepared by the IRS as a Substitute for Return (SFR), under the authority of section 6020(b) of the Tax Code, the statute of limitations does not apply. See section 6501(b)(3) of the Tax Code and section 301.6501(b)-1(c) of the Tax Regulations. This is because an SFR is generally based on the information the IRS has in its computers, and without the participation of the taxpayer.

Also, the statute of limitations does not apply in the case of a false tax return or fraudulent tax return filed with the IRS with intent to evade any tax. See section 6501(c)(1) of the Tax Code and section 301.6501(c)-1 of the Tax Regulations. In other words, if you commit tax fraud, or intentionally attempt to defraud the IRS with the filing of your return, you do not receive the benefit of the statute of limitations.

Statute of Limitations on the Collection of Tax

As of November 5, 1990, the collection statute of limitations is 10 years. Prior to this date, the collection period was six year. Basically, the IRS has 10 years to collect from you from the date you file your tax return or the date tax is assess. Tax is usually assessed after an audit is completed and all of your rights of appeal have been exhausted, or you agree that the results of the audit are correct. Tax is also assessed when the IRS files a SFR. Note that, if you do not file your tax return, and the IRS does not file an SFR, then the collection statute never begins to run.

The 10 year statute of limitations can be extended by agreement between you and the IRS provided the agreement is made prior to the expiration of the 10 year period. See section 6501(c)(4) of the Tax Code and section 301.6501(c)-1(d) of the Tax Regulations.

In rare instances, the IRS can go in to Federal court and extend the statute by 10 years without an agreement with the taxpayer. This is very uncommon, thus not discussed in detail here.

For additional information, see Section 6502(a)(1) of the Tax Code and section 301.6502-1 of the Tax Regulations. Court proceedings must also be started by the IRS within the 10 year statute of limitations. Section 301.6502-1(a)(1) of the Tax  Regulations.

Tolling of the Collection Statute

The collection statute is tolled, or placed on hold, any time the IRS is prohibited from collecting from you. There are two common instances where the statute is tolled:

  1. The collection period is tolled while you are in bankruptcy. This may be a few weeks, a few months, or even a few years, depending on your situation.
  2. The collection period is tolled while you have an Offer in Compromise pending with the IRS. Assuming your Offer is reasonable, it generally takes 6 to 12 months for it to be processed by the Service, during which time all collection actions are on hold.

It is important to note that, while the IRS is prohibited from collecting while the statute is tolled, interest and penalties continue to accrue. It is common for someone to exit bankruptcy with a much larger tax debt than they entered with.

Make sure you understand the starting date for the running of the statute of limitations, any exceptions to the tolling of the statute of limitations, the last day that the IRS can audit a tax return, and the last day that the IRS can collect overdue tax on a tax return.

Because the IRS is unable to collect from you once the 10 years is up, the collection statute can be a very valuable tool for the knowledgeable taxpayer the Offer in Compromise and Installment Agreement program. Once the statute expires, the debt is eliminated and any installment agreement terminates. An installment agreement that does not pay off the tax in full is called a partial pay agreement.

Statute of Limitations on Taxpayer to Claim a Tax Refund

A taxpayer may file a claim for a tax refund of an overpayment of any tax within 3 years from the time the tax return was filed with the IRS or 2 years from the time the tax was paid to the IRS, whichever period is the longer. If no tax return was filed with the IRS, the claim may be made within 2 years from the date that the tax was paid to the IRS. See section 6511(a) of the Tax Code.

In this instance, “tax paid” includes amounts taken by the IRS in a bank levy or wage garnishment. This means that, if your account is levied as the result of a tax assessment from a SFR, you should immediately prepare your delinquent return to ensure you will get any refund due.

This 3 year statute can be quite harsh on taxpayers who have taxes withheld from their paychecks but never file a tax return. I once filed a return for a client who lost a $55,000 refund because she came to me 1 week after the refund statute expired.

 

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Installment Agreements

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When the IRS Makes a Deal with You—the Installment Agreement

By Christian Reeves

Tax Attorney

 

“I owe the IRS $20,000 because I didn’t have enough withheld from my paycheck over the last few years. I’m working full-time, but I have no savings. Is there any way I can pay off my debt?”

Yes. In fact, almost every client I have worked with in the last 10 years, who has requested an installment, has been approved…eventually. The trick is always the same: getting to a number that both you and the IRS can live with.

If you owe taxes to the IRS, but can’t afford to pay it off all at once, and you don’t qualify for (or can’t afford) an Offer in Compromise, then you can usually set up a payment plan, called an “Installment Agreement” in IRS lingo. The amount you will need to pay each month is based on a number of factors, including:

  • Your income;
  • Your assets;
  • The amount you owe;
  • Your actual expenses;
  • Your allowed expenses;
  • The remaining collection statute of limitations; and
  • Whether or not you can afford to pay off the debt in full over the collection statute.

The key to setting up an Installment Agreement is the analysis of these and other factors, and thereby proving to the IRS how much you can afford to pay each month.

Here are the basics of an IRS Installment Agreement.

The IRS will enter a written agreement with you which requires installment payments based on the amount you owe and your ability to pay it within the period of time the Service has to collect from you (the “statute of limitations,” as it is called). The IRS has 10 years to collect from you once you filed a return. When the 10 years are up, the debt is canceled and you get a fresh start. Depending on the amount of tax due, there are different options within the program (see below).

To apply for an Installment Agreement, you usually need to file Form 9465 and Form 433-A or Form 433-F (versions of the IRS Financial Statement, the key form when dealing with IRS collections at any level). If you are self-employed, or own a business, you may also need to file Form 433-B. A few people also need Form 433-D. If your Agreement is accepted, you will be charged a fee of $105 for a new agreement, or $45 for a reinstated agreement.

“What is a ‘reinstated agreement,’” you’d ask.

An Installment Agreement is binding. You must pay the amount agreed-upon on time, every month of the year. If you skip a payment, you usually have 30 days to catch up. If you are not able to get current with your payments, the Agreement is canceled. You may apply for a new Agreement, but your new proposal may be met with skepticism and can even be rejected. Worse, you must provide updated financial information, which may have very dire consequences if your income has increased or the person reviewing your data is less accommodating than the prior agent. If you’re lucky and it’s accepted again, then you’ll have a “reinstated agreement.”

There are two types of Installment Agreements, mandatory and discretionary.

A “mandatory” agreement means that the IRS is required to accept the Agreement you propose if:

  • You owe less than $10,000 (exclusive of interest and penalties);
  • You’ve filed your tax returns and paid your due taxes on time during the past five years;
  • You haven’t entered another Installment Agreement during those past five years;
  • You demonstrate that you can’t pay the tax in full;
  • You agree to pay the full amount you owe within a period of three years;
  • You guarantee that you’ll comply with the tax laws during the term of the Installment Agreement.

If you meet all these criteria, the IRS doesn’t have the right to reject your Installment Agreement. An additional advantage of this type of agreement is that it doesn’t require the same in-depth financial verification that a normal application does.

If you owe more than $10,000, you need a “discretionary” Installment Agreement, which means that the IRS can deny you a payment plan if it deems it unsatisfactory. The IRS has to consider your Installment Agreement and will request you to prepare a Financial Statement (Form 433-A or Form 433-F). If the IRS concludes that more information is needed to evaluate the proposal, then it can request you to provide supporting documents or other proof of income and expense. If not supplied, the IRS can reject your application.

During the processing of your Installment Agreement (until you receive the notice about the result of your application) your stress level will lower considerably as the IRS is not allowed to collect from you. If your IRS installment agreement request is rejected, your case will be on hold for 30 days, giving you time to appeal. If you file a timely appeal, then the IRS can’t touch your property or money during the pendency of the appeal.

How much of my debt will I pay through an Installment Agreement?

The answer is that it depends on your ability to pay, the assets you have available, and the collection statute of limitations. If you have sufficient means then the IRS will require a Full-pay Agreement. This is when you pay your tax debt in full, including interest and penalties, over a period of time.

A Full-pay Installment Agreement may be for a fixed monthly amount, or it may increase at predetermined intervals. In each case, it will pay off the debt during the collection statute of limitations.

An IRS Installment Agreement where you pay a fixed amount each month until the debt is paid in full is easy to understand. An Installment Agreement where your monthly payments increase over time takes a bit of explaining.

As you know, your ability to pay the IRS is based in part on your income vs. your allowed expenses. When your actual expenses exceed your allowed expenses, you are generally given time to modify your lifestyle.

For example, you may be given six months to find a lower-cost apartment. If your current apartment exceeds your allowed rental expense by US$400, the IRS may set up an Installment Agreement that will increase by US$400 in six months’ time.

Another example is where your allowed expenses go down. The most common situation is where your automobile will be paid off, thereby reducing your allowed expenses. If your auto payment is $550 and your car will be paid off in eight months, you might set up an Installment Agreement that will increase by $550 in eight months’ time.

 

Warning: What if you have unexpected repair bills, or need to purchase another car when this one is paid? You might be forced to default on the IRS Installment Agreement and need to start the process over…something everyone dreads.Careful analysis of your current and future finances, along with a solid understanding of IRS practice and procedure, prior to applying for an Installment Agreement can prevent these and other problems.For example, as a result of planning ahead, you might decide to purchase a new car, with a longer payoff period, before submitting your request. 

What if I can’t afford to pay off the IRS in full?

In the case you (1) do not have sufficient income to support a Full-pay Agreement, and (2) have no significant equity in assets or cannot sell or borrow against assets due to the fact that selling them will cause an undue hardship, then the IRS will grant a Partial-pay Agreement and you’ll pay off only a portion of your debt within the statute of limitations, with the remaining debt being canceled.

However, if you are granted a Partial-pay Agreement, you must provide updated financial information every two years to prove your continuing financial hardship. If your income has increased, or your allowed expenses have decreased, you will be required to increase your monthly payment.

Still, there’s a third situation. You pay zero dollars. Is that possible? Sure. Basically, when you cannot afford an Offer in Compromise, you have no assets to use to pay the IRS, and your income equals your allowed expenses, you can’t afford to pay IRS anything.

A taxpayer in an Installment Agreement at zero dollars is referred to as being “temporarily uncollectable,” with temporarily being the operative word here. As with a Partial-pay Installment Agreement, the IRS will review your financial situation periodically to see if it can start collecting from you. If your financial situation doesn’t improve and the statute of limitations runs out, then your debt is eliminated. In other words, if you prove to the IRS that you are uncollectable over the entirety of the collection statute of limitations, you have paid nothing and your debt expires.

IMPORTANT NOTE: While you are making installment payments to the IRS, penalties and interest accrue on the unpaid balance. Essentially, you are locked into a late-payment penalty of one quarter of a percent a month plus interest on the unpaid amount. Taken together, the cost comes at around 10% a year. It’s still less than the interest you pay on your credit card, but you need to think before you commit.

What if my Installment Agreement is rejected?

This may happen in one of the following cases:

  • The information included in Forms 433-A or 433-B is incomplete or untruthful. If the IRS discovers that you have property or income not recorded on the forms then it will reject your application.
    • Your financial statement is signed under penalty of perjury, so it is very important to be truthful and very detailed in the information you provide to the government.
  • The IRS deems some of your living expenses unnecessary. If you owe money to the government but nevertheless send your kids to private schools or drive expensive cars, then be prepared to get no deal at all. The IRS expects you to have quite a frugal life while paying off your debt.
  • You defaulted on a prior Installment Agreement. It’s a matter of trust…if you’ve once defaulted on your payments then the IRS will think twice whether to grant you a second chance.

If your Installment Agreement is rejected, then you can appeal the decision. If the IRS sees your efforts to pay off your debt then your application may be reconsidered.

What if I need professional help with filing an Installment Agreement?

A reputable tax professional masters the art and science of analyzing your tax situation, as well as your income and expenses, preparing a plan of attack, and then filling out the forms necessary for an Installment Agreement. More importantly, he can determine your chances of obtaining the Agreement in the first place, and will help you plan, prepare, and document your application.

At Premier Tax & Corporate, Inc. we will work together with you in order to achieve the best available result for your particular situation. If you are ready, let’s get started

<LINK Get Started>.

For more information, contact us by phone at (800) 581-6716 or by e-mail at sales@taxreliefguaranteed.com. We are here to help.

 

 

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Collection Standards

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The IRS Collection Standards—Friend or Foe?

By Christian Reeves

Tax Attorney

 Chances are that you are reading this because you are considering paying your back taxes through an Offer in Compromise or an Installment Agreement. In the forms you have to fill out in both cases you’ll need to document all your expenses. There’s a lot of common sense here: You cannot owe the government $50,000 and continue living like a king, send your kids to private schools and eat at fine restaurants every day of the week. In the case you are making an Offer in Compromise or an Installment Agreement the IRS gets to set the standard of the lifestyle you are permitted to keep until the debt is paid off.

The collection standards. What are they?

The IRS has developed living expense standards that are used by agents when working out payment plans with taxpayers for overdue taxes. In the IRS lingo they are called “allowable living expenses.”

The “allowable living expenses” include those expenses that meet the necessary expense test.   The necessary expense test is defined as expenses that are necessary to provide for a taxpayer’s (and his or her family’s) health and welfare and/or production of income. These expenses are calculated in at least two different ways. In some cases, as with transportation and housing, the debtor puts his or her own expenses into the calculation, up to the amounts allowed by the IRS guidelines. With food, clothing, personal care, and entertainment, the debtor can put into their budget the full amount allowed for these items by the IRS, even if he or she does not normally spend that much.

But I’m getting ahead of myself…Let’s first examine the basics.

The IRS has established both national and local standards in order to establish the minimum a taxpayer and his family need to live. The “national standards” have been established for six necessary expenses: food, housekeeping supplies, apparel and services, personal care products and services, miscellaneous items, and out-of-the-pocket health care. In the case of the first five categories, the standards are derived from the Bureau of Labor Statistics’ Consumer Survey, which collects information on country’s buying habits. As I started mentioning above, for these categories taxpayers are allowed the total national standards’ amount per month for their family size, regardless of the total sum they actually spend. The out-of-the-pocket health care standards have been established for expenses allowed in addition to the amount taxpayers pay for health insurance. The table for health care allowances is based on the Medical Expenditure Panel Survey data for the whole nation and establishes reasonable amounts for health care costs including medical services, prescription drugs, and medical supplies (e.g., eyeglasses, contact lenses, etc.).

The “local standards” are established for two categories of expenses: (1) housing and utilities and (2) transportation. The housing and utilities standards are derived from the census data and are provided for each county within a state. They include mortgage or rent, property taxes, interest, insurance, maintenance, repairs, gas, electricity, water, heating oil, garbage collection, telephone, and cell phone for taxpayer’s primary place of residence. The transportation standards for vehicle owners include ownership costs (amounts for monthly loan or lease payments) and additional operating costs (maintenance, repairs, fuel, registrations, etc.) broken down by Census Region and Metropolitan Statistical Area. If a taxpayer has a car, but no car payment, only the operating costs portion of the transportation standard is used to figure the allowable transportation expense. In both of these cases, the taxpayer is allowed the amount actually spent or the standard, whichever is less. For the taxpayers who are using public transportation there is a single nationwide allowance for mass transit fares for train, bus, taxi, ferry, etc.  Taxpayers with no vehicle are allowed the standard per household, without questioning the amount actually spent.

You may also qualify for what is called “conditional expenses.” These do not meet the necessary expense test, but are allowable if the tax liability, including the penalties and interest accumulated can be fully paid within five years. If you cannot pay within five years, the IRS may allow you the excessive necessary and conditional expenses for up to one year in order to modify or eliminate the expense.

Remember: Properly analyzing your tax situation (actual income vs. allowed standards) and fully documenting your case are the keys to getting an Offer in Compromise or an Installment Agreement accepted.

At Premier Tax & Corporate, Inc. you’ll find a group of well-trained professionals who will work together with you in order to achieve the best possible result for your particular circumstances. Contact us by phone at (800) 581-6716 or by e-mail at sales@taxreliefguaranteed.com. We are here to help.