When Hurricane Newton came up, I immediately thought of friends and acquaintances that live and own property right along the track of the storm. Luckily there may not have been loss of life, but there have been material losses. And of course, it is important to know that for federal income tax purposes, some losses may be claimed as a deduction on your federal return.
To be able to claim a deduction, you must have filed claims with any applicable insurance. The amount of the loss is then reduced by insurance reimbursements you receive or expect to receive. Annual loss deductions are also limited by one’s adjusted gross income and by any value left in the property (salvage value). The annual loss allowance has a “floor” of 10% of AGI. If your AGI was, say, $25,000, then the “AGI floor” is $2500. Only the loss portion exceeding that amount is deductible. Also, one must subtract $100 from the computation for each loss event. The Internal Revenue Code requires both the “per event” $100 and the “annual” 10% “haircuts” from loss computations).
In the cases of thefts, the rule is similar. You must be able to substantiate the loss (for example, with police reports) and its extent (a good starting point is documents supporting what the item cost you).
For U.S. persons, casualty and theft losses in Mexico are deductible in one’s federal return with the general outline above. IRS Form 4684 and its instructions have more details. For personal (nonbusiness) losses, the deduction is an itemized deduction on schedule A of the federal return.
For Mexico income tax, however, things are less exciting. Generally speaking, Mexico Income tax law does not allow loss or theft deductions if the type property affected was not income producing (originally deductible, usually by being used in a trade or business). In the past, Mexico has issued special decrees easing the rules somewhat with regards to due dates of tax payments and tax compliance, to benefit persons affected by large storms or disasters. As I read previous decrees, I feel they are just temporary measures that do not lead to any permanent tax benefit, unlike the U.S. rules. As of today, no ruling has yet come out on Newton, although one may be forthcoming.
Bottom line: A tax benefit may be available with regards to losses from casualties and thefts. Begin collecting documentation as soon as the loss occurs!
Orlando Gotay is a California licensed tax attorney (with a Master of Laws in Taxation) admitted to practice before the IRS, the U.S. Tax Court and other taxing agencies. His love of things Mexican has led him to devote part of his practice to the tax matters of U.S. expats in Mexico. He can be reached at firstname.lastname@example.org.
A question I get quite often is, “Are Social Security benefits taxable”? “Do I have to file a federal return?”
It all depends, and it is important to note these are two separate questions with separate dollar thresholds for each.
SS Benefits may or may not be taxable, depending on what other sources of taxable income you have during the year. To figure it out, the IRS has published a dollar threshold (different for single, married filing joint and others). If the number exceeds the threshold, the benefits must be included in a tax computation.
To figure if they are to be included or not, take ½ of the social security earnings for the year, and add to it any other taxable income earned during that year. If married, one must add the spouse’s other income too. If the number is greater than $32,000, some of your benefits may be taxable (and includable in the next step…do I have to file?)
To figure if you need to file a return, there is another dollar threshold to examine. It depends on your filing status and your age (and that of your spouse). In the case of spouses, both over 65 years of age, married filing jointly, a return was required if the gross income was at least $23,100 (for 2016). If in step 1 you determined that your SS benefits were not taxable, then they don’t count in figuring if you have a filing requirement.
This is more important that it may sound. For expats, a federal filing requirement may generate other additional forms, such as Form 8938, “Statement of Specified Foreign Assets” that would otherwise not be required to be filed.
As the year progresses, it is wise to keep track of your income and begin checking to see if you will be required to file a federal income tax return. Planning makes a difference! IRS Pub. 501 has all the details.
One of the least understood aspects of our tax system is that forgiven debt constitutes taxable income to the debtor. As odd as it may sound, from a tax perspective, it makes perfect sense.
When one borrows money, loan proceeds are not taxable. That’s because the loan has to be paid back. Seen that way, proceeds do not increase one’s wealth because of the payback obligation.
When one does not pay a loan, something different happens than originally contemplated. The borrower suddenly acquires “wealth”, since he no longer is going to pay back. And the Internal Revenue Code sees that as something very appropriate to tax. It is income. It is “phantom” income, to be sure, but income nonetheless. Therefore, a forgiven debt becomes fair game for the taxman.
In the real world, this has very real consequences. Suppose you owe more on your house than it is worth (your loan is “upside down”) and you sell “short”. The amount forgiven (the note balance less what the sale provided to pay off the note) is income. Most who sell short do so because their finances no longer support a mortgage payment, and the sudden federal and state tax bill adds insult to injury.
Cancelled credit card debt, repossessed cars, business debt…any of those things can also lead to cancellation of debt income.
The creditor sends you a form 1099-C reflecting the forgiven amount, and from there, it is supposed to go right on your return.
The Mortgage Debt Relief Act of 2007 generally allowed taxpayers to exclude income from the discharge of debt on their principal residence, but only applied to debt forgiven in calendar years 2007 through 2014. That is no longer available.
The insolvency exception….
There is an important exception to this unsavory rule. If one is “insolvent” then the cancelled debt is not included in income. That is huge.
How do you know if you are “insolvent”? Simple. You are insolvent when your total debts exceed the total fair market value of all of your assets. Assets include everything you own, e.g., your car, house, condominium, furniture, life insurance policies, stocks, other investments, or your pension and other retirement accounts.
The liability section is calculated immediately before the forgiveness, so it includes the forgiven debt itself, and any other debts you owe.
Remember the old formula: Assets-Liabilities=Net Worth.
If that number results in a negative number, voila! You are insolvent. This information is provided to the IRS on Form 982, which is attached to your federal income tax return. Publication 4681 has a worksheet to help you figure if you are insolvent.
What if you got a 1099-C for 2014, did not know about the insolvency exception, and you already filed? You can file an amended return. If you timely filed your tax return, you can still make the election to exclude the “cancellation of debt income” by filing an amended return within 6 months of the due date of the return (excluding extensions). Write “Filed pursuant to section 301.9100-2” on the amended return and file it at the same place you filed the original return. Of course, this will likely also require you to file an amended state tax return…in this case, a very good deal.
By Orlando Gotay
Our beloved snowbirds arrive in droves. Palm Springs welcomes them with open arms. In exchange for lovely weather, our Canadian friends eat, drink, play, making Palm Springs their home, until spring arrives, and it is no longer glacial in the provinces. I love watching how they seem to arrive in “waves”… folks from the furthermost ones already with us.
We all like that. But there are other eyes ominously looking, too. The Internal Revenue Service and the California Franchise Tax Board keep close tabs on the presence of snowbirds. Unsuspecting visitors can fall into very significant and expensive tax traps.
Count the days you stay in the United States. If you stay here long enough and you do not take specific affirmative steps, the IRS could consider you a resident, and tax you accordingly. U.S. residents are taxed on their worldwide income. Have you got “foreign” bank accounts? You would have to report them to the US Treasury. Do you have Canadian Registered Retirement Savings Plans (RRSP) or Registered Retirement Income Funds (RRIF)? You have to report those, too. Because of the weird overlay of federal and state taxation, California will tax you on the income made by those accounts, even if no distributions were taken out. Harsh, eh?
The headache can be avoided if one keeps careful track of the days spent in the United States. Generally, every day or fraction counts. The IRS formula has a three-year “look back” period. This year’s days count in full; last year’s by half, and the preceding year’s, by one sixth.
Suppose you come in on Nov. 1 and leave April 1 every year. That’s 90+60=150 days (Did you forget to count January through April for this year? You were here, weren’t you?) For year 2, it would be 75 days (half of 150), while for year 3 it would be 25. That adds to 250, and you would meet the test. Bingo!
Exceeding the magic number, 180, satisfies the “substantial presence test” and you will be deemed a resident. The IRS folks no doubt will turn on the K-Mart “flashing blue light” special, throw confetti in their offices and open bags of Doritos whenever this happens.
My recommendation? Keep track of your days. The clock starts running the second you cross the border.
Keep a record of every day you spend in the United States. If you meet the substantial presence test, not all is lost. If you have a closer connection with a foreign country (Oh, Canada!), you can file a form claiming the “closer connection exception” to the substantial presence test. (Don’t you love this?). You can even claim a closer connection to two foreign countries. This form is due by April 15, even if you have no US tax obligation. A little bit of planning can go a long way to help you understand how to recognize and act regarding U.S. and California income tax laws.
Orlando Gotay is a Tax Attorney in private practice, based out of Palm Springs.
Do you have a California mailing address “for convenience”? Do you use that address in federal tax returns, even though you do not reside in the state?
If you do, well, be prepared for the FTB computer in Sacramento to send you a love note.
How does the FTB know? Easy. The IRS has information sharing agreements with state and local taxing agencies. The first thing the FTB does its run the IRS return database with California addresses, expecting to find a matching California return.
If it does not, you will get a letter, telling you the FTB thinks you may have to file a return. Note: You may or may not have a filing obligation in California, but the FTB is simply asking. If you were a non resident of the state for that year, it is imperative that this be communicated to the FTB. Supporting evidence is always helpful. Some taxing jurisdictions will expect you to send a copy of another state’s tax return, but that is not required and in my view, provides “too much information”.
If you were required to file, well, they will welcome you with open arms.