Offshore Tax for Americans Living and Working Abroad

Payroll Tax Increase

Payroll Tax Increase Hits Millions of Americans at Home and Abroad

Millions of Americans found their wallets a bit lighter today. While politicians promised tax increases for the wealthy, almost all Americans will face higher rates because of the payroll tax increase. If you are a U.S. citizen living and working abroad, and paying self-employment or payroll taxes, you have options.

In 2012, Congress passed the Middle Class Tax Relief and Job Creation Act to reduce the payroll taxes of working Americans from 6.2% to 4.9%. This reduction targeted the Old Age, Survivors and Disability Insurance taxes, which are capped at $110,100 per employee. Self-employed individuals received a comparable benefit.

Because this Act was allowed to expire, the average worker will pay around $1,000 more in taxes for 2013, with a maximum increase of $2,202 (2% on up to $110,100 in salary). This means a household with two highly paid wage earners will be about $4,400 lighter. It also means that the new definition of “wealthy” is any American with a job.

In addition to this payroll tax increase, Obamacare will raise your Medicare tax by 0.9% if your salary exceeds $200,000 for a single person, and $250,000 for married filing joint. This tax increase, which came in to effect on January 1, 2013, is to be withheld by your employer on form W-2.

The payroll and Medicare tax increases affects all Americans working for U.S. employers through U.S. corporations, and any self-employed American. It does not matter where you are living, or if you qualify for the Foreign Earned Income Exclusion. If your employer is a U.S. company, or you are self-employed and not using an offshore corporation, your payroll and Medicare taxes (or self-employment taxes) have increased.

Remember that the Foreign Earned Income Exclusion reduces your Federal Income tax. It does not affect other taxes, such as FICA, Medicare, Social Security or self-employment tax. Also, the FEIE does not reduce investment or passive income, only ordinary / active wage or salary income.

If an American business has employees outside of the country, the company and its workers may both benefit from a simple international tax plan. All it takes to save big on employment taxes is to form one entity in a tax free offshore jurisdiction (such as Belize, Panama or Nevis). No employees or work need be done in your country of incorporation, and no complex accounting tricks are required.

Those workers who are U.S. citizens and qualify for the Foreign Earned Income Exclusion are employed by the offshore corporation, rather than the parent company. They receive a W-2 from the subsidiary, and can keep all of the same benefits of the parent, such as medical, retirement accounts, etc.

By running payroll for international employees through an offshore corporation, both the employer and the employees eliminate all employment related taxes. This results in a combined savings of about 15% on $110,100 of wages.

The same solution is available to any self-employed American who qualifies for the Foreign Earned Income Exclusion. If you operate your business through an offshore corporation, rather than a U.S. LLC, or no structure at all, you will eliminate self-employment tax of about 15%. Remember that a self-employed person pays both halves of payroll tax, so your net savings is approximately 15%.

To qualify, you need to do the following:

  1. Incorporate your business in any tax free country,
  2. pay yourself a salary every two weeks or once a month,
    1. If your income varies month to month, you can fluctuate your payroll amounts accordingly.
  3. obtain a U.S. tax ID for your international corporation, and
  4. issue a W-2 to yourself at the end of the year.

It doesn’t matter where you incorporate, nor does it matter where you live. So long as you qualify for the Foreign Earned Income Exclusion, and structure your business in a country that will not tax your profits (again, such as Belize, Panama or Nevis), you will maximize the tax benefits of your offshore structure.

Finally, if your corporate profits exceed the Foreign Earned Income Exclusion, you may be able to retain earnings in the company, thereby deferring or eliminating U.S. business tax. For additional information and corporate tax options, please see my website at or call me at (619) 483-1708 for a consultation.

Long Term Capital Gains Rates

U.S. Long Term Capital Gains Rate up to 23.8%

Most of you know that the U.S. long term capital gains rate went up from 15% to 20% for high income individuals. I’ll bet quite a few will be surprised by an additional increase of 3.8% on just about all types of investment income for “wealthy” Americans.

Effective January 1, 2013, the Obamanation tax increase imposed a new levy on net investment income of 3.8%, which is to be used to shore up our failing Medicare system. This surtax generally applies to investment profits of individuals, estates and trusts with incomes above the statutory threshold. This threshold amount for a single taxpayer is $200,000, and $250,000 in the case of married couples filing joint. The threshold amount for estates and trusts is a mere $11,950 for 2013.

The thresholds for the Medicare surtax are imposed independent of the $450,000 and $400,000 thresholds under the American Taxpayer Relief Act of 2012 that set these as the starting points for a 20% long term capital gains tax rate. These taxes are paid with your personal tax return, Form 1040.

The Medicare surtax defines net investment income very broadly. It encompasses many types of income, such as interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities, and businesses that are passive activities to the taxpayer (partnerships and LLCs are passive investments unless you are involved in the day to day operations).

Here is how the long term capital gains rate and Medicare surtax work at their most basic level:

  • If you are in the 10% or 15% (low income) tax brackets, you will pay no capital gains tax.
  • If you exceed the 15% bracket, but earn less than $250,000 married filing joint, your long term capital gains tax rate is 15%. In other words, the 15% rate would continue to apply to taxpayers in the 25%, 28%, 33% and 35% income tax brackets.
  • If you earn more than $250,000, but less than $450,000 MFJ, your long term capital gains tax rate is 15% and your investment tax is 3.8%, for a blended rate of approximately 18.8%.
  • If you earn more than $450,000 MFJ, your long term capital gains tax rate is 20% and your investment tax is 3.8%, for a blended rate of approximately 23.8%.

For a more detailed analysis, see the Forbes blog or the Wall Street Journal.

For the American abroad, it is important to remember that you are required to pay U.S. tax on your worldwide income, which includes all passive and investment income. The only deduction available for passive income is the foreign tax credit, which should eliminate double taxation on investment income, but does not reduce your net tax below the U.S. rate.

Also, the Foreign Earned Income Exclusion does not affect your U.S. tax bracket, nor does it reduce your adjusted gross income amount, which is used in calculating your capital gains rate.

For example, if a husband and wife are living abroad, each qualifies for the FEIE, and each earns a salary of $96,000 for 2013, they will pay zero U.S. Federal Income tax on their salary. However, their adjusted gross income for determining capital gains rates will be $192,000, and their long term capital gains will be taxed at the blended 18.8% rate.

This also means that every dollar earned in excess of the FEIE is taxed at the 28% or 33% tax rate. Your tax rate does not start from zero after taking the FEIE consideration.

Please contact us at if you would like us to prepare your U.S. personal or business tax returns. We are experts in the tax laws applicable to American’s living and working abroad.

retained earnings in an offshore corporation

How to Manage Retained Earnings in an Offshore Corporation

The key to maximizing the tax benefits of being offshore is to generate retained earnings in an offshore corporation. Retained earnings in an offshore corporation will allow you to accumulate (basically) unlimited amounts of tax differed dollars in your company.

If you have been reading my postings for a while, you know that anyone operating a business outside of the United States should be using an offshore corporation. You are also aware of the risks associated with these entities if not structured and reported correctly.

Operating a small business through an offshore corporation allows you to draw a salary of up to the Foreign Earned Income Exclusion (FEIE) amount, which is $97,600 for 2013. The offshore corporation also eliminates payroll or self-employment taxes, saving about 15% in most cases.

But, what if your business net profits exceed the FEIE amount? What if you earn $1 million? Must you pay tax on $902,400? The answer is yes; unless you structure your business from day one to provide for retained earnings in your offshore corporation, you will pay U.S. taxes on the income over and above the FEIE amount.

So, how do companies like Google defer tax on $10 billion with a Bermuda offshore structure? Why does Bloomberg claim there is $1.2 Trillion (yes, Trillion, with a capital T) in untaxed profits offshore? These companies spend big money on political lobbying to protect the Active Financing Exception, which can be found in Section 954(h) of the U.S. Tax Code and was recently renewed in the Fiscal Cliff deal.

The Active Financing Exception allows multinationals to create “friendly” offshore banks which actively lend and invest in the controlled group’s international divisions. The profits of this bank can be retained offshore indefinitely, or until the parent decides to repatriate these profits to the United States.

The Active Financing Exception works great for the world’s largest companies, but what about the rest of us? How can we use an offshore corporation to defer U.S. tax on our business profits? We must generate retained earnings in our offshore corporation from an active business.

How to get Retained Earnings in an Offshore Corporation

In order to get tax deferred retained earnings in an offshore corporation, you must first:

1. Be living and working abroad and qualify for the FEIE,

2. Operate through a properly structured and maintained offshore corporation,

3. Generate ordinary / active business income in excess of the FEIE,

4. Pay yourself a salary of up to the FEIE amount,

5. Retain profits in excess of the FEIE in the corporate bank account,

6. Pay tax in the U.S. on those retained earnings in your offshore corporation when you take them out in the form of dividends or other payments.

This first step, to be living and working abroad while qualifying for the FEIE, is covered in great deal on this website. Click here for additional information on the FEIE for 2013.

If you are an American who may generate retained earnings in an offshore corporation, you should begin your business with the proper structure…and that structure should be created by a U.S. international tax expert. Please contact us at (619) 483-1708 or for a confidential consultation to design your offshore structure.

The basics of a properly structured offshore corporation are these: you must utilize a corporation (not an LLC, Foundation, Partnership, or other pass-through entity), which is incorporated in a country that will not tax your profits. It does not matter where you live, or where you operate your business (unless you provide professional services, see below), you should incorporate in a tax free jurisdiction such as Belize, Panama, or Nevis.

You must report your activities and retained earnings of the offshore corporation on IRS Form 5471, report your foreign bank account, and keep up on all other U.S. reporting requirements. As your profits grow, so do the penalties for failing to properly report your activities. See the list of filing requirements below.

You may generate retained earnings in an offshore corporation from ordinary / active business profits. Ordinary business income is income received from the sale of a product and must be attributable to the normal and recurring operations of the company.

Next, you should pay yourself a monthly salary up to the FEIE amount. If a husband and wife are both operating the business, they can each draw $97,600 for 2013, and leave the rest of the money in the corporation.

The remainder of your net profits is to be held in the corporate bank account and become your tax deferred retained earnings. By creating retained earnings in an offshore corporation, you are deferring U.S. tax on those profits. In most cases, you must pay tax when funds are withdrawn from the corporation.

  • One possible exception would be paying out retained earnings as salary in future years where those salaries benefit from the FEIE. The availability of this option would depend on a number of factors and your bona-fide business must be ongoing (see below).

Four rules that allow you to hold retained earnings in an offshore corporation

Rule 1: Understand the U.S. tax regulations regarding retained earnings in your offshore corporation.

The theory behind an offshore corporation is simple: these are not U.S. entities, so the IRS has no right to tax them. Not to be deterred by such a technicality, the IRS goes after the shareholders, not the entity.

The U.S. claims authority over anyone with a U.S. passport, no matter where they live. Our government has enacted a number of laws controlling how and when U.S. citizens must pay tax on earnings from or retained in offshore corporations.

If you are going to generate retained earnings in your offshore corporation, there are two international tax code sections you should be familiar with:

Controlled Foreign Corporation (CFC): If a U.S. person holds 10% or more of the stock (or voting control) of an offshore corporation, and U.S. persons hold more than 50% of the shares or control of that company, then U.S. persons can defer tax on active income, but not passive income.

In other words, if American(s) control an international business, then that business may defer U.S. tax on retained earnings in an offshore corporation from active / ordinary activities, not from investments. If less than 50% of the business is owned by U.S. citizen(s), then the CFC rules do not apply. For Deloitte’s worldwide CFC guide, click here.

The CFC rules also limit deductions and control how retained earnings are taxed upon distribution:

  • Passive income from interest, dividends, investments, etc. is not active income, thus no U.S. tax deferrals are available. Passive income flows through to the shareholders of a CFC and is taxable on your personal return.
  • When you distribute retained earnings from a CFC, they are taxed at your marginal rate. Long term capital gains rates (currently 20% for 2013) are not available.
  • Losses in a CFC do not flow through to the shareholders. Losses are not deductible until the company is liquidated.
  • If you die holding shares in a CFC, your U.S. heirs do not get a stepped up basis. When they sell the shares, they will pay tax on their value when you acquired them, not when they inherited them.

Passive Foreign Investment Company (PFIC): If you or your offshore corporation generates high levels of passive income, or invest in non-U.S. mutual funds, a complex tax regime may be imposed on those earnings.

Basically, you can elect to pay U.S. tax on the appreciation in your investment account each year, or you can pay U.S. tax on the gain when you sell funds or shares from your account. If you elect to pay tax when you sell, a punitive interest rate is added to the tax due to eliminate any benefit from deferral.

PFIC rules are complex and I consider them in their most basic form here. My intention is to let you know of their existence and warn you that passive income in an offshore corporation is not tax exempt or deferred. If you hold a U.S. passport, America gets a piece of your investment profits. The only major tax benefit available to the offshore entrepreneur is for active business income.

Rule 2: Have a bona-fide offshore business

You must be operating a bona-fide business if you wish to hold tax deferred retained earnings in your offshore corporation. In its most basic form, this means you should be selling something on a regular and continuous basis, you should make a profit in at least 3 of the last 5 years, you should be working at the enterprise full time, and it must be a business and not a hobby.

You should be selling a product, not providing a professional service. A professional service which is performed outside of your country of incorporation and generates income from technical, managerial, engineering, architectural, scientific, skilled, industrial, or commercial activities is not bona-fide ordinary income for U.S. tax purposes.

If you are operating a consulting or professional service business, you may utilize the Foreign Earned Income Exclusion, but you are not allowed to hold retained earnings in your offshore corporation. For additional information, see Section 4.61.24 and 25 of the IRS CFC Audit Guide.

A hobby is an activity you do for entertainment and does not have a significant profit motive. Here are a few factors use to determine if you have a business or a hobby:

  • Does the time and effort put into the activity indicate an intention to make a profit?
  • Do you depend on income from the activity?
  • If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?
  • Have you changed methods of operation to improve profitability?
  • Do you and your advisors have the knowledge needed to carry on the activity as a successful business?
  • Have you made a profit in similar activities in the past?
  • Do you expect to make a profit in the future from the appreciation of assets used in the activity?

As you can see, the most important component in the hobby vs. business analysis is your profit motive. Your bona-fide business must generate significant profits over a number of years or risk being classified a hobby. This can be an issue for a business with one big year, followed by losses in all subsequent years.

Of course, this bona-fide business must be operated outside of the United States. The U.S. owner and operator must be living and working abroad and qualify for the Foreign Earned Income Exclusion in order to generate retained earnings in their offshore corporation.

An offshore corporation may have shareholders who live in the United States. These shareholders must be passive investors, having no control over the company’s day to day operations. The offshore corporation should not have a U.S. office or employees. Nor should it have any U.S. agents working exclusively to market or distribute its goods in the United States.

NOTE: A bona-fide business rarely includes individuals who trade their own investment accounts. This is the number one question I get at conferences and in emails – though I have had only one client in 12 years who was a professional trader. Unless you are working full time at your trading business, you are not considered a trader in securities. And, unless you are a professional trader, you may not utilize the Foreign Earned Income Exclusion, or generate retained earnings in an offshore corporation from your investment activities.

Rule 3: Keep records as if you were in the United States

Remember that you must file U.S. tax returns and therefore may be audited by the IRS. Your offshore business must maintain records of income and expense in accordance with U.S. accounting principles. If you can’t prove your expenses, they may be denied by the Service.

For additional information on accounting for business expenses, see IRS Pub 535. For a list of small business tax deductions, click here.

Rule 4: Know your reporting requirements

Offshore corporations must file a number of U.S. tax forms. Failure to file can result in some very draconian penalties.

  • A foreign corporation or limited liability company should review the default classifications in Form 8832, Entity Classification Election and decide whether to make an election to be treated as a corporation, partnership, or disregarded entity (


The risks and rewards are great when doing business offshore and generating retained earnings in an offshore corporation. If the business is properly structured, you may be able to eliminate or defer U.S. tax on 100% of your active income. However, most of these tax rules are “all or nothing.” If you miss qualifying for the FEIE by one day, you lose 100% of the benefit. If you use the wrong type of structure, the ability to retain earnings offshore is gone. If fail to accurately and completely report your activates, you may face enormous penalties from the IRS – possibly hundreds of thousands of dollars.

The U.S. licensed tax experts and international attorneys at Premier Offshore, Inc. give you the best of both worlds – unparalleled offshore know-how combined years of experience in dealing with the IRS. Please contact us at or (619) 483-1708 for a confidential consultation on any aspect of offshore corporate formation and tax law.

Recent Articles (External Links)

Because of the tough economic times most American’s have experienced in recent years, much ado has been made of multinationals use of offshore tax tools to hold out on Uncle Sam. Here are a few articles on this topic, most of which are quite biased against the entrepreneur.

Older Articles (External Links)

Foreign Earned Income Exclusion

Weak Dollar Crushing the Foreign Earned Income Exclusion

If you are using the Foreign Earned Income Exclusion and are paid in a foreign currency, your U.S. taxes may have tripled in the last few years! This is because the value of the FEIE is falling fast, along with the value of the US dollar. Let me explain.

Editors Note: This post was written in January of 2013. Since then, the dollar has soared and other currencies have faltered. This article is still helpful in understanding how to calculate the FEIE and, like all things, currency valuations are cyclical.

The Foreign Earned Income Exclusion allows you to exclude $97,600 in 2013 from your Federal Income Taxes. This exclusion amount goes up most years and is indexed to inflation. For example, the Foreign Earned Income Exclusion was $91,400 for 2009, $91,500 for 2010, $92,900 for 2011, $95,100 for 2012. For additional information on the FEIE, please see my article on taxation, or click here for

When you report your foreign salary, you must translate from your local currency into U.S. dollars. If your currency is strong compared to the dollar, as most are, your U.S. tax bill will increase as the dollar weakens.

Here is an example from a group of tax returns I prepared this month:

This client is living and working in Japan and needed to catch up on his delinquent Federal 2009, 2010 and 2011 returns, and file his 2012 return. His salary has remained constant for these years at 12,000,000 Yen.

Using the yearly average charts on the IRS site for 2009, 2010 and 2011, and Oanda for 2012, here are the approximate conversion amounts:

  • ¥12M is $123,250 in 2009, compared to a FEIE of $91,400.
  • ¥12M is $131,370 in 2010, compared to a FEIE of $91,500.
  • ¥12M is $144,400 in 2011, compared to a FEIE of $92,400.
  • ¥12M is $150,500 in 2012, compared to a FEIE of $95,100.

If this client had earned the same salary of 12M Yen in 2006, the conversion to U.S. dollars would have been $97,938 against a Foreign Earned Income Exclusion rate of $82,400.

So, even as the buying power of this client’s salary has done down over the years (no increase for inflation, etc.), his U.S. taxes have skyrocketed. In 2009, his net taxable income (salary in US$ minus FEIE) was $31,850. In 2012, his net taxable income is $55,400. Had this client earned ¥12M in 2006, his net taxable income would have been only $15,500. This means his taxable income has increased by a multiple of 3.5 since 2006!

There are a few planning tools you might use to mitigate these affects. For example, when reporting your salary, there is no exchange rate mandated by the IRS. The only requirement is that you be consistent year to year and use a published rate. If your salary is about the same each month, then a yearly average exchange rate is the most accurate. If you receive a large bonus at the end of the year, or other incentives, you may benefit from a more complex calculation. In that case, I generally recommend, or

The Foreign Earned Income Exclusion remains the most important tool in the Expat’s tax toolbox, but its value is falling fast, just as your tax rates continue to climb. This means that other tools, such as foreign corporations for the self-employed and the ability to retain earnings offshore are becoming even more important.

Offshore Corporation

Tax Traps and Landmines in Your Offshore Corporation

An Offshore Corporation can provide extraordinary tax planning opportunities to those living and working offshore. For the misinformed, this same structure is fraught with risk and may blow up in your face if planned or reported incorrectly.

I take calls every day from those who want me and my team of U.S. licensed tax experts to form an offshore corporation and to discuss their tax filing obligations. Most of you have done your research and are well versed on the topic. You have searched the web, called around, got a few quotes, and talked to a variety of sources.

I take great pride in the fact that my readers are well informed and I’m glad you, like me, are significantly invested in being offshore. Unfortunately, so much of the information on the internet, or provided by unscrupulous unlicensed promoters, is incorrect and intended to deceive.

For example, I was speaking with a potential client…we will call her Ms. Q…yesterday. By way of background, she is living and working in California, is self-employed, and most of her clients (and revenue) are from Asia. She had been talking with a promoter in Nevis and was convinced she could operate her business through a Nevis corporation and not pay any tax.

Here is the gist of her conversation with the promoter:

Q: If my Nevis offshore company earns money from Asia, will I pay any taxes on that money if I don’t bring it in to the U.S.?

A: No, you will not pay any taxes in Nevis. Your offshore company is not required to file a tax return or pay any taxes of any kind.

Q: Do I need to follow certain accounting standards, file accounting reports, or keep records?

A: No, Nevis does not require you to keep business records, provide audited statements, or file any documents. Basically, all you need to do is pay your monthly fee to keep the company in good standing.

Q: Can my offshore corporation retain earnings?

A: Sure, you can retain as much capital in your Nevis Corporation as you like. Nevis imposes no requirements on dividends or corporate capital.

Q: When will I need to pay taxes on the money earned by my offshore corporation?

A: In most cases, clients must pay tax on the money they pay themselves in salary. So, you may need to pay taxes on your earnings when you take them out of the company.

Q: Is my offshore bank account private?

A: Absolutely. We value your privacy in Nevis and have very strict laws preventing disclosure of your offshore corporation or bank account to anyone.

The client came away from this conversation with the belief that her bank account would be secret and that no taxes would be due unless and until she repatriated money from Nevis to the U.S. The promoter stuck to the facts, misdirects but did not lie, and gave only one side of the story…that of Nevis…ignoring the client’s obligations in her home country.

In fact, the tax rules for offshore corporations are rather simple:

1. If you are living and/or working in the United States, an offshore corporation or LLC provides no tax benefit. Where your clients are located is irrelevant. Your domicile while performing the work controls.

a. The offshore corporation will provide unparalleled asset protection, access to international markets, the ability to diversify out of the United States and its currency, and other benefits, but it is tax neutral for the U.S. resident.

2. If you are living and operating a business outside of the United Sates, and qualify for the Foreign Earned Income Exclusion, then doing business through an offshore corporation may reduce or eliminate all U.S. taxes.

(Note: An IRA or other retirement account may achieve significant tax savings by going offshore but this is outside the scope of this article. For more information on this topic, click here.)

In other words, if you are living in the U.S., an offshore corporation should not increase or decrease your U.S. tax bill. It may require you to file a number of forms with the IRS, but it should be tax neutral. If you are living outside of the States, then an offshore corporation may be a great tax tool and you should consult with a U.S. licensed expert.

Ms. Q was asking all the right questions, but to the wrong person. If you ask a Nevis attorney a tax or legal question, you will get an answer according to the law of Nevis. As a U.S. citizen, it is important that you operate from a tax free jurisdiction like Nevis, Belize or Panama, but the majority of your tax planning and structuring concerns involve the U.S. tax code. So, your offshore corporation must be created and maintained by a U.S. licensed tax expert.

Here is another example: I recently received a call from an investment advisor who had read my article on International Taxation. He came away from that page thinking that an offshore corporation can be used to eliminate self-employment taxes for those living in the U.S.

To eliminate self-employment and/or Social Security, Medicare, and FICA taxes through an offshore corporation, you must 1) live and work outside of the United States, 2) operate your business through a non-US corporation, and 3) qualify for the Foreign Earned Income Exclusion.

A U.S. resident may operate his business through an offshore corporation for asset protection or other reasons, but your salary will be fully taxed. Your corporation should issue a W-2 and have proper withholding. If a W-2 is not filed, or a payroll system is not in place, you should report all income from the offshore corporation on your personal return as being subject to self-employment tax.

The moral of the story: If you carry a U.S. passport, your offshore corporation or international asset protection structure must be created and maintained by a U.S. licensed tax expert. Failure to comply with the various tax laws can result in extremely draconian penalties. For example, click here for FBAR rules or click here for the IRS Disclosure Initiative.

If you are considering incorporating offshore, please contact me for a confidential consultation. We can be reached at (619) 483-1708 or For more information on offshore corporations, please click here.

Convert to a Roth 401k

Fiscal Cliff Tax Break for Your 401(k)

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.

2013 Tax Increase

The Spoils of War – Big Time Tax Increases for 2013

The mêlée at the edge of the fiscal cliff is over and the Democrats have scored a decisive victory.

The battle lines were simple: Democrats wanted to raise taxes while Republicans wanted to cut spending. When the fighting was over, tax revenues were up by $620 billion against only $15 billion in spending cuts…a massacre if there ever was one.

And you can be sure there are hidden landmines and random scud missiles on the way – in the form of concessions on unemployment insurance, Social Security, FICA, et al and the inheritance tax. When taken in total, revenues may be increased by as much as $800 billion.

As it stands today, the fiscal cliff deal resulted in $1 dollar of spending cuts for every $41 in tax increases…possibly the most one sided victory since the Battle of Little Bighorn in 1876. By comparison, when President Ronald Regan increased taxes, he secured $3 in spending cuts for every $1 in tax hikes. When George H. Bush was at the helm, he negotiated $2 in spending cuts for every $1 in tax hikes.

Most of the casualties in this battle royale are individuals with incomes over $400,000 and couples making over $450,000, but there will be significant pain and suffering for those with incomes as low as $250,000.

I also note that any hope of a tax system which treats married couples and single persons with some level of equality was blown to hell. Two single persons could earn $800,000 combined before being smashed by the tax hikes, compared to only $450,000 for a married couple.

Here are the casualties by the numbers:

  • Tax rates will shoot up to 39.6 percent from 35 percent for individual incomes over $400,000 and couples over $450,000.
  • Tax rates on dividends and capital gains would also rise, to 20 percent from 15 percent, on income over $400,000 for single people and $450,000 for couples.
  • Personal exemptions and deductions will be phased out, beginning at single people earning $250,000 and $300,000 for couples.
  • The estate tax will increase, but less than Democrats had wanted. The value of estates over $5 million will be taxed at 40 percent, up from 35 percent. Democrats had wanted a 45 percent rate on inheritances over $3.5 million.

Under the deal, these new rates on income, investment and inheritances are permanent.

Among all of the explosions and cries of anguish, there was good news for the American abroad: The Foreign Earned Income Exclusion survived, and even got a little bump up for the cost of living. If you are living and working abroad, you can earn $97,600 in 2013, up from $95,100 in 2012.

Also, the self-employed Expat can avoid the Unemployment, Social Security and FICA tax increases (also called self-employment taxes) by incorporating offshore and qualifying for the FEIE. By operating your business through an offshore corporation, you might eliminate these taxes completely, a savings of about 15%.

But be careful: the 2013 tax increases and phase-outs will apply to any ordinary income over $97,600 and all passive / investment income.

Because the tax brackets ignore the FEIE, and Expats are taxed on their worldwide capital gains (now at 20% rather than 15%), many higher earning Americans abroad will be shocked by their 2013 tax bill. For additional information on these issues, please see:

For the self-employed, there are a number of planning opportunities. For example, you can retain earnings over the FEIE amount in your offshore corporation or utilize a Solo 401-K to shelter income in a retirement plan.

For the investor, you can make tax advantaged investments offshore through your IRA and thumb your nose at the 20% short term capital gains tax. In fact, there are a number of tax advantages for the sophisticated offshore IRA investor – just ask Mitt Romney.

As tax rates go up, so does the need for competent tax and business advice. I strongly recommend you contact your international advisor as early as possible this year to develop a plan of action.

And remember, so long as you hold a U.S. passport, you must file Federal returns and abide by these laws. Regardless of which country you call home, make sure your global tax plan is approved by a U.S. tax expert.

For additional information on this article, or for a free international tax consultation, please contact us at or call (619) 483-1708.

Foreign Earned Income Exclusion 2013

Foreign Earned Income Exclusion 2013 Amount

The Foreign Earned Income Exclusion 2013 amount got a little bump up for inflation and managed to avoid the financial cliff. The Foreign Earned Income Exclusion 2013 amount is $97,600, up from $95,100 in 2012.

As an American citizen living overseas, you are subject to the same U.S. tax laws as a United States resident. One of the only personal tax benefits you get for living abroad is the Foreign Earned Income Exclusion. If you are out of the U.S. for 330 days, or are a resident of another country, you can exclude up to $97,600 of earned income from your U.S. personal return using the Foreign Earned Income Exclusion 2013 amount via Form 2555.

Note: My website has a number of resources explaining the Foreign Earned Income Exclusion 2013 amount and use. Please click here for an in-depth article on international taxation for Americans.

Earned income is active income and is defined as wages, salaries, commissions and professional fees. It does not include investment, rental, or other types of passive income.

If you earn more than the Foreign Earned Income Exclusion 2013 amount, you will pay Federal tax on the excess. However, if you are operating a business, or are self-employed, you may be able to eliminate this tax by using an offshore corporation and retaining earnings in the entity over and above the Foreign Earned Income Exclusion 2013 amount.

Note: Yes, the ability to retain earnings offshore also survived the fiscal cliff and will be the topic of a future article. For additional information, check out this article from Bloomberg.

Foreign Earned Income Exclusion 2013 and Prior

Historically, the Foreign Earned Income Exclusion has increased with inflation, with the exception of 2002 through 2005, when it was stuck at $80,000.

  • Tax year 2013: $97,600
  • Tax year 2012: $95,100
  • Tax year 2011: $92,900
  • Tax year 2010: $91,500
  • Tax year 2009: $91,400
  • Tax year 2008: $87,600
  • Tax year 2007: $85,700
  • Tax year 2006: $82,400
  • Tax years 2002-2005: $80,000
  • Tax year 2001: $78,000
  • Tax year 2000: $76,000
  • Tax year 1999: $74,000
  • Tax year 1998: $72,000

Sources: IR-2012-78, Oct. 18, 2012 for the 2013 amount, Revenue Procedure 2011-52 (PDF) for the 2012 amount, Revenue Procedure 2010-40 (PDF) for the 2011 amount, Revenue Procedure 2009-50 (PDF) for the 2010 amount, Revenue Procedure 2008-66 (PDF) for the 2009 amount, Revenue Procedure 2007-66 (PDF) for 2008 amount, Revenue Procedure 2006-53 (PDF) for 2007 amount, Revenue Procedure 2006-51 (PDF) for 2006 amount, Internal Revenue Code Section 911 for the tax law concerning the foreign earned income exclusion.

Remember that the Foreign Earned Income Exclusion is a “use it or lose it” tax break. If you are living abroad, do not file your returns, and are audited, you may lose the Foreign Earned Income exclusion. This means that 100% of your worldwide income will be taxable in the US.

If you are delinquent on your U.S. tax filing obligations, catch up before the IRS gets a hold of you. For information on our Expat tax filing services, please call us at (619) 483-1708 or email for a confidential consultation.

For the current FEIE amount, see Foreign Earned Income Exclusion 2020

IRS Voluntary Disclosure Program Gives Big Breaks to ExPats

IRS Voluntary Disclosure Program is great news for some Expats and dual-nationals

As an ExPat American, you know that you are required to file a U.S. tax return each year and report your foreign bank accounts if you have more than $10,000 offshore. If you have failed to file these forms, and want to get back in to the good graces of the IRS, the IRS Voluntary Disclosure Program may be for you.

Unless you have been living under a rock in Bangladesh, you also know that the IRS has been pushing hard to force disclosure, compliance and payment. The drive for increased revenues started in 2003 when the IRS began investigating offshore credit cards. At that time, it was about compliance. The government had not yet figured out that putting people in jail for tax crimes would generate a lot of news, thus cause many more thousands to come forward, and bring in a truckload of money…and promotions.

In 2008 the U.S. government began its attack on UBS in Switzerland, eventually forcing the Swiss to disclose 4,450 names of U.S. citizens with unreported accounts. The U.S. followed this up by prosecuting a few people in each State or region of the country to ensure maximum news coverage and created the voluntary disclosure program to capitalize on their campaign.

So far, there have been three IRS Voluntary Disclosure Programs allowing people to come forward and voluntarily report their offshore bank accounts. As of June 26, 2012, the IRS brought in over $5 billion in new taxes, interest and penalties.

The third, and current IRS Voluntary Disclosure Program came into effect on September 1, 2012 and has several benefits for what it considers “low-risk” persons. These are U.S. citizens, including dual-citizens, who currently reside overseas, who owe little or no U.S. taxes. The objective is to convince these people to report the value and locations of their money and assets in exchange for not being hit with excessive civil penalties.

These low-risk persons will be able to file three years of delinquent U.S. tax returns (including required information reporting forms) and six years of FBARs without the imposition of program penalties. Whether a taxpayer is “low-risk” will depend on a number of factors, but will primarily require that the tax due is less than US$1,500 for each of the covered years, that the person was living and working outside of the U.S. during these years, and that the person did not take steps to conceal their income from the U.S.

It should be noted that this procedure will provide no protection from the risk of criminal prosecution. The IRS website indicates the following regarding criminal prosecution: “The IRS Voluntary Disclosure Program has a longstanding practice of IRS Criminal Investigation whereby CI takes timely, accurate, and complete voluntary disclosures into account in deciding whether to recommend to the Department of Justice that a taxpayer be criminally prosecuted. It enables noncompliant taxpayers to resolve their tax liabilities and minimize their chance of criminal prosecution. When a taxpayer truthfully, timely, and completely complies with all provisions of the voluntary disclosure practice, the IRS will not recommend criminal prosecution to the Department of Justice.”

Because the tax due amount within the IRS Voluntary Disclosure Program takes the Foreign Earned Income Exclusion and Foreign Tax Credit in to consideration, most Expats and foreign residents will qualify as low risk. For example, anyone who is employed in a high tax country (a country with a tax rate equal to or greater than the U.S.), should be in the clear, as will most people earning less than $80,000 to $95,000 per year who are living in a low tax country. Those at risk are entrepreneurs living in low tax countries, high net worth individuals with significant untaxed capital gains or passive income, and just about any self-employed person who was not operating through a foreign corporation and is thus subject to self-employment tax.

There are two groups of ExPats that are excluded from this IRS Voluntary Disclosure Program: 1) if your account is at a bank that is currently under investigation by the U.S., you may not be eligible, and 2) if you attempt to fight the release of your banking information from your foreign bank, you will not be eligible for this program. For example, if the U.S. issues a summons to Bank ABC in Lichtenstein requesting all U.S. accounts, and you fight the request, you are disqualified from this program.

In addition, the IRS may announce that certain groups of taxpayers that have or had accounts at specific offshore banks will be ineligible to participate in the IRS Voluntary Disclosure Program due to pending US government actions in connection with those specific institutions. Details regarding eligibility or ineligibility of specific taxpayer groups connected to such institutions will be posted to the IRS website.

The IRS says: “US persons with undeclared bank accounts are reminded that the 2012 IRS Voluntary Disclosure Program gives taxpayers with unreported foreign bank accounts a chance to come clean while mitigating the risk of criminal prosecution, and that they should consider remedying any past non-compliance with their US tax and information reporting obligations while there is still an opportunity to do so.”

If you are a U.S. citizen who has been living and working abroad, and are willing to disclose your accounts and assets, now is the best time to evaluate your rights.
I recommend the following three step plan of action:

  1. discuss your situation with a qualified tax attorney to evaluate your risks of criminal prosecution,
  2. have your attorney prepare U.S. tax returns to determine the amount of taxes due, and
  3. if you qualify as a low-risk citizen, join the voluntary disclosure program program as soon as possible and before your bank comes under attack or you are disqualified for another reason.

If you do not qualify as a low-risk taxpayer, you may still participate in the current IRS Voluntary Disclosure Program. However, you will be subject to substantial taxes and program penalties, which are more severe than those levied by previous initiatives.

In addition to the standard tax, interest and penalties associated with your delinquent returns, the following penalties will be assessed, and must be paid or you will be disqualified from the program:

  • 20% accuracy-related penalties on the full amount of your offshore-related underpayments of tax for all years;
  • Pay failure to file penalties, which are up to 25% of the unpaid tax, if applicable;
  • Pay failure to pay penalties, which are up to 25% of the unpaid tax, if applicable;
  • Pay, in lieu of all other penalties that may apply to your undisclosed foreign assets and entities, including FBAR and offshore-related information return penalties and tax liabilities for years prior to the voluntary disclosure period, a penalty equal to 27.5% (or in limited cases 12.5% or 5%) of the highest aggregate balance in foreign bank accounts/entities or value of foreign assets during the period covered by the voluntary disclosure;

Note that this penalty includes the value of all foreign assets, including real estate.
As you can see, the penalties are very severe if you do not qualify as a low-risk taxpayer. However, getting back in to the system and removing the risk of criminal prosecution will motivate many to come forward, pay up, and sleep better at night knowing that Uncle Sam will not come knocking…not yet, anyway.

If you have unreported accounts or questions about your U.S. Expat taxes, please contact me for for a free and confidential consultation regarding the IRS Voluntary Disclosure Program. I can be reached at (619) 483-1708, or

The IRS has no Problem Using Weapons of Mass Destruction

IRS Attacks Forcing High Net Worth Americans out of the Country

The number of American expatriations is at a record high as tens of thousands of Americans a year are moving abroad in search of better lives. A root cause is how the U.S. government is treating its citizens these days.

At least 1,788 Americans officially threw away their U.S. citizenship in 2011, exceeding the totals from 2007, 2008, and 2009 combined. The Internal Revenue Service has been keeping a tally of U.S. citizens driven to renouncing that title since only 1998, but last year’s number has officially raised the bar when it comes to calling America quits.

Out of the 34 countries that belong to the Organization for Economic Cooperation and Development, the United States is the only nation that taxes its citizens no matter where they reside on Earth. As long as a person maintains citizen status, they are expected to send the United States government pennies on every dollar earned no matter where they live. The good old U.S. of A is also one of the only countries in the world that locks up its citizens in boxes for failing to pay up.

As the U.S. government works ever-more-aggressively to find ways to fund the deficit and as their worldwide bullying continues to create a backlash for us Americans trying to diversify offshore, more and more of us Americans who understand the importance of diversifying offshore are considering the idea of saying thanks, but, no, thanks, Uncle Sam. Here’s your passport back.

Just about every call I get now related to expatriation is from someone either battling the IRS or afraid of winding up in a clash with the Government.

Why are so many citizens concerned? I believe it is because the tone of the Internal Revenue Service has changed dramatically in the last five years.

Historically, if an average American failed to report his income accurately and completely it was a civil or a financial issue…he or she had to pay the taxes and penalties. Increasingly, the IRS is turning those sections of the tax code enacted to go after drug dealers and mafia kingpins (think Al Capone) on ordinary citizens, all in the name of increasing revenues.

These weapons of mass destruction (which, in this case, the U.S. government has no trouble finding) put regular people in jail for years for failing to file a form or to report income. They are being used not only to go after multi-millionaires and billionaires with huge accounts offshore, but everyday hard-working Americans, as well.

Here are three examples from my clients. There are hundreds of similar cases being argued throughout the United States right now.

Example #1 – Offshore Account

I know a single father of three who makes about US$80,000 a year as a self-employed consultant. Eight years ago, he moved some money offshore, to diversify and for asset protection. He never filed the necessary IRS forms, and he failed to report the account on his tax return.

Unfortunately for him, the account was at UBS Switzerland. He was reported to the IRS, which has decided to prosecute him.

Here is the rub: He did not have any unreported or untaxed income…which is to say, the account did not earn any interest, and the guy would not have had to pay any additional U.S. tax had he reported it.

That’s irrelevant now. In settlement negotiations, the man is facing up to one year in jail and a fine of US$540,000.
He has little money left and will never be able to pay the fine.
What is the point of the prosecution? The IRS gets to issue a press release showing a conviction in this city. This press release will forget to mention that there is no tax loss in the case, but it may induce many others to come forward…thereby increasing revenues on the back of an everyday citizen who made a mistake.

Example #2 – Cash Transactions

A retired U.S. citizen I know, living in California, age 60, is concerned about a major devaluation of the U.S. dollar. He decided a while ago that he wanted to purchase gold. He owns a condo with some equity and has a few hundred thousand dollars in retirement money.

As a regular guy, he can´t afford to buy large amounts of gold bullion, so he purchased gold coins from a local dealer. He paid cash for these coins so the dealer would not have to wait for a check to clear before handing over the merchandise. He has never sold any of his coins, thus there is no tax issue.

What did he do wrong? He took cash out of his account once or twice a week, always less than US $10,000 at a time, to make the gold purchases. To the IRS, this can qualify as “Structuring,” which is a crime.

The man’s bank sent two suspicious transaction reports to the IRS and closed his account. He had been a client of this bank for more than 30 years, yet the bank made no effort to warn him in advance of the reports they made to the IRS or to offer any assistance. They just turned him in.

As a result, the man is looking at a fine of up to US$100,000 and possible criminal charges that could incarcerate him for up to five years. Add to this a minimum of US$100,000 in potential legal fees, and the reality for this guy is that he and his family could be wiped out. Again, this is all the result of an innocent mistake.
Example #3 – Dual Citizen

Another client is a 55-year-old engineer who has been working at the same job for 20 years. He is a dual citizen of the United States and the United Kingdom. When he moved to the States, he rented out his U.K. home. Ever since, he has deposited this rental income in a U.K. account.

The man has filed tax returns in the U.K. reporting the rental property, but he did not report it, or the U.K. account, to the IRS. Had he reported the property and the related rental income all along, it would not have made any tax difference in the United States.
In fact, reporting the rental could have reduced his U.S. tax, thanks to the depreciation he could have claimed.

In 2009, this man learned of the requirement to file an FBAR form and entered the IRS Voluntary Disclosure Program. As a result, this story has a happier ending than the others. This guy will not face criminal charges.
He will, though, pay a fine of approximately US$22,000.

Cases like these and the hundreds of others currently being argued have changed the way that tax attorneys deal with clients. While we once would say, ‘Come clean, be honest, and let’s get through this,’ now we advise, ‘Be afraid…be very afraid.’

It is this culture of fear that is pushing many Americans to look around the world for places where they might live better, freer, and less fearfully.

I’ll note that these changes are not the result of one political party or another. They represent a permanent change in perspective by the U.S. government in general, in how both parties view their citizens. Changes to the tax laws, and in the ways the laws are interpreted, began under George Bush II with the Patriot Act and continue under Barack Obama with the Bank Secrecy Act and the HIRE Act.

In the face of a troubled U.S. economy and out-of-control spending, the U.S. government desperately needs to expand its tax revenues, and the IRS has decided that it can raise more money with fear and violence than with honey.

It’s a situation that qualifies as dire, and sensible Americans are looking to escape it as quickly as they can.

Convert to ROTH

Expats – Convert to a Roth ASAP!

If you qualify for the Foreign Earned Income Exclusion and have a traditional IRA, now is the time to convert that relic to a Roth. Doing so may save you a fortune in taxes, especially if completed in 2012.

The Foreign Earned Income Exclusion (FEIE) allows you, the intrepid Expat, to eliminate up to $95,100 of wage or ordinary income from your 2012 tax return. If you and your spouse are both operating a business, or are wage earners, you might exclude up to $190,200 combined.

To qualify, you must be living and working outside of the U.S. This means you are 1) employed by a corporation (it does not matter if you own that company) and 2) are a resident of a foreign country or are outside of the U.S. for 330 out of any 365 day period.

So, the FEIE takes care of your ordinary income. However, we Expat Americans are still required to pay U.S. tax on our investment and passive income, no matter the source. That means all of the benefits of a retirement account apply and the tax rate and rules for investment income are the same for Expats and residents.

For an Expat, a Roth IRA has numerous tax planning advantages over a traditional IRA. This is because you pay taxes on the front end while you are maximizing the FEIE and you don’t pay taxes when you withdraw funds in retirement. Also, there are no required minimum distributions when you hit retirement age.

A traditional IRA allows you to deduct contributions on your tax return and any earnings grow tax-deferred until you retire. But these deductions may be of little or no value to the Expat whose income is less than $95,000 or $190,000 joint. Also, because of significant capital gains and other passive income, an Expat’s tax rate may be higher in retirement than while working under the FEIE. In that case, converting to a Roth after retirement can be costly.

Converting to a Roth or contributing to a Roth while abroad will allow you to make the most of your itemized deductions. For example, all Americans may deduct mortgage interest (on up to two homes), property tax, medical, etc., or take the standard deduction of $5,800 single and $11,600 joint (tax year 2011). It does not matter if you maintain a home in the U.S. for your family and/or you have a home abroad, all citizens get the same deductions.

If all of your taxable income is being eliminated by the FEIE, you aren’t utilizing your standard deduction or your itemized deductions…you are already paying zero tax, so these deductions provide no added benefit. Converting to a Roth or investing in a Roth under these circumstances may save you tens of thousands of dollars each year.

Let’s run some numbers on the tax cost of converting to a Roth IRA.

One of my tax preparation clients has been living in Cayman Islands for a number of years. He earned a salary from his offshore company, which is incorporated in Panama, of $81,000 in 2012. All of his ordinary wage income is covered by the FEIE, so he pays zero U.S. taxes, and he has about $60,000 in a traditional IRA. His itemized deductions are about $34,000 for 2012, mostly the result of mortgage interest on his home in Cayman.

If this client were to convert his IRA to a Roth in 2012, his total tax bill on $60,000 would be only $2,300. This is because the Foreign Earned Income Exclusion eliminates his salary and he now gets to make use of his $34,000 in itemized deductions.

If this same client, who is married filing joint, had no itemized deductions or Schedule A and took the standard deduction, his IRS bill would be about $8,000.

Note: If this same client wanted to pay zero tax, he could convert some of his IRA to a Roth in 2012, and the balance in 2013 and/or 2014, thereby maximizing his itemized or standard deductions for each year.

If this Caymanian did not qualify for the FEIE, his U.S. tax bill on $81,000 would be about $4,200 (remember, he has significant itemized deductions). If he also converted his IRA to a Roth while paying tax on his salary, his bill would be $18,400. If he had no itemize deductions, his total tax bill, including the conversion, would be $20,500.

So, converting his IRA while qualifying for the FEIE, results in a savings of $16,100 ($18,400 – $2,300) for this client. Each person’s tax situation is different. You should contact a tax professional to determine your possible savings before deciding to convert your IRA to a Roth.

Considering the approaching “financial cliff,” it is safe to assume that U.S. tax rates will increase and deductions will decrease in 2013. Any change to the IRA rules, tax brackets or capital gains rates, may have a significant impact on your net tax due and IRA conversion options. If you qualify for the FEIE, converting from a traditional IRA to a Roth in 2012 rather than 2013 is likely to save some serious cash.

Converting to a Roth is as simple as contacting your provider and telling them you wish to convert. If you would like to move your IRA offshore, or need assistance with your 2012 Expat tax returns, please contact us at or (619) 483-1708.

IRA Gold

$7 Million in Gold but no Estate Plan

If you have ever attended an offshore conference, you have heard the story of two kings from Mr. Joel Nagel: Elvis Presley, whose estate was decimated by lawyers and the IRS, and Sam Walton, who left nothing but an old pickup for the vultures.

Today I will tell you about Walter Samaszko Jr. of Carson City, Nevada. At the age of 69, Mr. Samaszko passed away in late June of this year. He left over $7 million in gold bars and coins, $165,000 in stocks and bonds, and $12,000 in cash hidden throughout his home, but only $200 in a checking account.

Mr. Samaszko lived in the same small home since the 1960s, where he had taken care of his mother until her death in 1992. He had no close relatives, and, apparently, no close friends (it was about 30 days before his body was discovered). He left no will and no trust. Reports indicate that his estate will go to his first cousin, Arlene Magdanz, who lives in San Rafael, California.

The gold coins and bars had been minted as early as the 1840s and were from a number of countries, including Mexico, England, Austria and South Africa. The estimated value of $7 million is based on the gold weigh alone. It is likely that the collectors’ value will be much higher.

Mr. Samaszko was obviously a hardworking and intelligent man to have amassed such wealth. He also took great precautions against government interference and economic collapse. So, why no estate plan? Why work so hard simply to leave a large portion of the money to a government he clearly feared?

If we assume that the total value of Mr. Samaszko’s estate, including the collectors’ value of coins, is $8 million, here is the government’s cut:

1. Mr. Samaszko is “lucky” to have died in 2012, when the Federal estate tax only applies on amounts over $5 million. A quick calculation estimates Federal estate tax due of $1,008,000. Had he passed away in 2009, Federal estate tax would have been over $2 million.

2. Nevada does not have an estate tax and California, where his heir lives, has no inheritance tax. Had Mr. Samaszko lived in Washington State, his State estate tax would have been about $1 million.

3. There are a number of fees associated with probate (a legal process required when one dies without a living trust), which includes appraisal costs, executor’s fees, filing fees for the court, surety bond fees, legal fees and accountancy fees. Nevada has adopted a statutory fee schedule, but a judge may approve any amount he deems to be reasonable. Based on the particulars of this case, including the fact that there appears to be only one heir and no contest to probate, one might guestimate the estate fees at 4% to 10%, or $320,000 to $800,000.

If additional heirs are located, legal fees are likely to skyrocket.

With planning, Mr. Samaszko could have reduced or eliminated the bulk of these costs. The most basic tool would be a U.S. living trust. This would have controlled the distribution of the estate, may have included charitable contributions, and would have eliminated probate fees of $320,000 to $800,000. A do-it-yourself book costs about $30, and a lawyer may charge a few thousand dollars for a custom plan.

In addition, he could have diversified out of the United States and in to physical or certificate gold and stock investments around the world. The use of an offshore trust, Panama foundation, or offshore company would have maximized his protection and access to international markets. While it is advisable to have some assets at home and within reach, safety and prudence dictate an international plan to protect you and your assets.

There are a number of other U.S. estate planning tools available at little or no cost, but may be of great benefit if they are needed.

Many are available for free on the internet. These are:

1. Durable Power of Attorney: Allows you to designate to access and control your financial assets. It can take effect immediately, or it can “spring” into effect if an event you define triggers its operation, such as incapacitation or unavailability.

2. Prenuptial Agreement: This keeps your property separate from your spouses, and is especially important in second marriages where you may want to leave assets to your children.

3. Health Care Proxy: Also called a durable power of attorney for health care, this document identifies the person you’d like to make medical decisions on your behalf if you become unable to make them yourself.

4. Living Will: An advance health care directive, also known as living will, personal directive, advance directive, or advance decision, is a set of written instructions that a person gives that specify what actions should be taken for their health if they are no longer able to make decisions due to illness or incapacity. The most common directive is when a person wishes no extreme measures or life support equipment be used in their care.

5. HIPAA Release: A Health Insurance Portability and Accountability Act, or HIPAA, release allows medical professionals to discuss your medical condition with your personal representative. Without this form, the hospital may not be able to discuss your care with your representative.

6. Life Insurance: Life insurance allows you to take care of those who depend on you. If you do not have financial responsibilities, you do not need life insurance.

7. Business Succession Plan: If you are self-employed or own a business, and you want the business to continue after retirement or death, a succession plan must be in place. If your children will take over operations, a relatively simple agreement can be drafted. If you will sell some or all of the business, or there are multiple partners, a more robust strategy will be required.

There are two certainties in life: death and taxes. A detailed estate plan is the only guaranteed way to minimize death taxes and can include a number of tools that diversify your investments, maximize privacy, and plant your financial flag in a favorable jurisdiction.

An attorney with Premier Offshore Investor will be happy to discuss your options. Contact us for a confidential consultation at (619) 483-1708 or email with any questions.

Update: December 19, 2012

The gold coins were eventually valued at $7.5M and the entire estate went to a distant relative via judicial decree. For additional information, checkout CBS News.

Offshore business tax reporting

IRS Snitch Gets Rich

IRS Snitch Gets Rich – UBS Whistleblower Receives $104 Million.

How much are 40 months of your life, and your dignity, worth? $104 million (or about $4,600 for each hour spent in prison) seems a good answer.

As you may have heard, The Internal Revenue Service awarded tax whistleblower and former UBS banker Bradley Birkenfeld $104 million for turning in his clients and giving insider information on the banks operations. This ultimately allowed the IRS to shatter the veil on Swiss bank secrecy, get paid a bribe or blackmail (how else can you describe paying money to avoid criminal prosecution) of $780 million from UBS, imprison hundreds of Americans, obtain records on 4,000 accounts, and raise $5 billion and counting in taxes and penalties.

Prosecutors have said they would have had no case against UBS without Mr. Birkenfeld, but they still sought one charge of conspiracy and prison time for this Good Samaritan. Mr. Birkenfeld was sentenced to 40 months and will probably do 85% of that sentence in one form or another. After serving 30 months, he was recently transferred to a halfway house in New Hampshire.

Clearly, Mr. Birkenfeld has seen the error of his ways and is on board with the IRS. He recently released the following statement through his attorneys: “The IRS today sent 104 million messages to whistleblowers around the world — that there is now a safe and secure way to report tax fraud and that the IRS is now paying awards,” and “The IRS also sent 104 million messages to banks around the world — stop enabling tax cheats or you will get caught.”

Well, before you decide to turn in your ex-spouse, business partner, or employer, you might like to know that the IRS has a history of screwing the whistleblower and denying claims for compensation.

In 2006, the IRS started a whistle-blower campaign which offers informants rewards of 15% for recoveries of less than $2m and 30% for recoveries in excess of $2m. However, the vast majority of claims submitted to the IRS go unanswered.

Of the cases that the IRS investigates, the usual time to completion is 5 years, you get a percentage of the amount recovered and not the amount assessed, and IRS records indicate they pay out an average of 4% of the money recovered, rather than 15 and 30%.

How can the IRS payout 4% on average when the regulation says 15 to 30%? Easy…they deny the majority of claims even after moneys are recovered. The IRS issues a letter saying they would have collected the money without the tip…that the tax cheat would have been found out through their normal audit procedures, and thus no money is due the whistleblower.

There are no appeals or legal remedies for the whistleblower. He or she is at the mercy of the Service.

While, I’m sure that there will be a flood of new cases coming in to the IRS Informant Program in the coming weeks, I’m just as certain that very few of these snitches will ever see a dollar for their efforts.

For additional information on the IRS program, and to tattletale on your friends and family in pursuit of a pay day, click here for the IRS website.

Attack on the Dollar

IRS Going After Cash Transactions

U.S. Goes After Cash Transactions

The New York Times recently reported that Federal and state authorities are investigating a handful of major American banks for failing to monitor cash transactions in and out of their branches. The government claims that this may have enabled drug dealers and terrorists to launder tainted money, according to officials who spoke on the condition of anonymity.

It is alleged that the primary target of the investigation is the embattled J.P. Morgan Chase. Who, fresh off a scandalous trading loss of $5.8bn, is in no position to stand up to another political firestorm. It is also suggested that the government is looking in to several other big name banks, including Bank of America.

Before I get in to this story, let’s define our terms:

A cash transaction is one where someone withdraws or deposits paper money. This does not include checks or wire transfers. A bank is required to report any cash transaction in excess of $10,000, and any transaction the teller deems to be “suspicious.”

A suspicious transaction is usually a group of transactions that are structured to avoid the reporting requirements. For example, you go in to the bank each day and deposit $9,500, or in to two branches with $6,000 each time. If the teller (or computer) notices, then a Suspicious Transaction Report will be sent to the IRS.

Tellers are also trained to spot signs of generally suspicious behavior. For example, if a customer asks about the reporting requirements or anything related to taxation or the IRS that is suspicious. If the customer seems nervous or otherwise sets of warning bells, a report will be generated.

With that said, let’s get back to the story:

The Comptroller of the Currency, as well as prosecutors from the Justice Department and the Manhattan district attorney’s office are all gearing up to go after these banks in order to protect us from drug dealers and terrorists…YEH! We should all stand up and applaud our government’s diligence!

Well, wait a minute. Who is the actual target here? Is al-Qaeda really transacting giant piles of cash and fooling tellers and computers in to not reporting? Are the internal bank compliance systems, on which these companies have spent millions of dollars, fooled so easily?

As someone who has represented both clients and family members caught up in these currency transaction reports and suspicious transaction reports, I can tell you that banks take them very seriously. I can also tell you that the teller’s credo is report first and ask questions later…CYA all the way.

So, why the sudden focus on cash transactions? In my opinion, it is a new battlefield being tested against average U.S. citizens, with nary a terrorist in sight. Are self-employed persons cashing their checks rather than depositing them to avoid paying taxes? Are they structuring their transactions to avoid a currency report?

With international tax evasion, the IRS has the Foreign Bank Account Form and related penalties. With domestic tax evasion, the government as the Currency Transaction Report to target anyone who lands in their crosshairs. Much like the FBAR, attempting to avoid the filing of a CTR is punishable by up to five years in prison.

As you may recall, it was just six years ago that the Patriot Act came in law under George Bush. The reasoning behind this act, as well as those to follow (HIRE, FATCA, et al.), was to put a stop to terrorist money laundering. Well, the Patriot Act led to the IRS attack on the Swiss bank UBS, $5 billion dollars and counting in new tax and penalty revenues, and the prosecution and imprisonment of hundreds of U.S. citizens…without a terrorist to be found
Now, as the government increases pressure on banks to report anyone transacting in cash, or acting suspiciously, and turns bank tellers in to unpaid IRS Criminal Investigation Agents, a new battle is brewing between the IRS and the average American self-employed person who may be fudging on his or her taxes.

When this is over, two things will come of it: 1) the IRS will persecute a few to collect from many and 2) the number of anonymous cash transactions will be reduced significantly, with business being done by credit card, check or wire, thereby traceable and controllable.