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.
Along my professional career, I have been asked many times to provide “a general idea” of the tax consequences of a particular problem. I always decline.
Usually, the request also comes with a statement that is usually couched in these, or similar terms: “it will only take you a few minutes”.
Let’s talk about the issues this raises, and why, in the almost twenty years I have been licensed to practice law, I have yet to opine verbally on a tax matter.
When it comes to transactions, most people come to tax attorneys because they are facing a choice in courses of action. In their gut, they know that whatever choice they make may have a tax consequence. What will that be? The outcome is usually very important, for large amounts of money, tax penalties, and interest may be at stake. Sometimes, it’s a person’s liberty that may hang in the balance.
Persons who are unfamiliar with the complexities and intricacies of the law of taxation lamentably assume that a “general answer” will suffice. As many of my colleagues will attest, there are rules, but then there can be exceptions to the exceptions to the exceptions. Oftentimes, the “general answer” will be wrong for the facts, and relying on the “general answer” will likely lead to a bad outcome.
From the outset, there are challenges unique to tax law. Defining the facts on which a tax opinion will be based on, is a skill in itself. In taxation, all relevant facts must be explored and developed. Sometimes, a particular fact is simply not known or cannot be ascertained. If it is relevant, it must still be accounted for. Clients may not fully be aware that a particular fact is very relevant to their matter!
Tax opinions begin with a complete recitation of all the relevant facts on which the opinion is based. Good opinions also warn that any deviation in the facts may render the opinion invalid. The task of collecting all the pertinent facts therefore resides in the hands of the attorney drafting the opinion.
Then there’s the issue of finding the applicable law and applying it to the facts. There’s the Internal Revenue Code, all its regulations, Revenue Rulings, Private letter Rulings, Chief Counsel Memoranda, Revenue Procedures, instructions on tax forms, cases from the U.S. Tax Court, every single federal district court in the United States (94 of them), the Court of Claims, the 12 Courts of Appeal for the Circuits, and the U.S. Supreme Court. There’s also tax treaties that may come into play. And it is seldom I see a tax problem that also does not have a state and local angle. Repeat for each of the states, and some local jurisdictions too. To make it even more exciting, tax law changes constantly. Tax attorneys and others in the industry must spend inordinate amounts of time just to stay on top of the latest ruling, court case, or development. That takes time, effort and energy. Some clients may not know about or wish to begin to understand.
Some problems are income tax cases. Some involve estate, gift, generation skipping transfer, franchise, net worth, excise, employment taxes, real and personal property taxation….some involve multiple states, several countries…it can get hairy quickly.
And it should of course, only take “a few minutes”. It really does not. While some really wish for free advice and do not want to pay a fee, others just may not fully appreciate the enormity of the training, education and experience needed to get these things right.
If the opinion is not right, the client will come knocking, lawsuit in hand, because the client relied to his or her detriment in what he or she were told. That’s why written opinions provide the clearest assurance to both client and attorney.
You wish for solid tax advice? Retain one of us. You want general advice? Buy a book.