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.
This is a question I hear often. So, here's a reminder for my friends who are outside of the United States: There are several types of extensions. Some allow you an extension to file AND pay taxes, most do not.
Automatic 2-month extension. You are allowed an automatic 2-month extension to file your return and pay federal income tax if you are a U.S. citizen or resident alien, and on the regular due date of your return:
If you use a calendar year, the regular due date of your return is April 15. Even if you are allowed an extension, you will have to pay interest on any tax not paid by the regular due date of your return.
- You are living outside the United States and Puerto Rico and your main place of business or post of duty is outside the United States and Puerto Rico, or
- You are in military or naval service on duty outside the United States and Puerto Rico.
Married taxpayers. If you file a joint return, either you or your spouse can qualify for the automatic extension. If you and your spouse file separate returns, this automatic extension applies only to the spouse who qualifies for it.
How to get the extension. To use this automatic 2-month extension, you must attach a statement to your return explaining which of the two situations listed earlier qualified you for the extension. [ I recommend, for instance, writing "TAXPAYER RESIDING ABROAD" in red letters at the top of the return].
Automatic 6-month extension. If you are not able to file your return by the due date, you generally can get an automatic 6-month extension of time to file (but not of time to pay). To get this automatic extension, you must file a paper Form 4868 or use IRS e-file (electronic filing).
The form must show your properly estimated tax liability based on the information available to you.
Previous 2-month extension. If you cannot file your return within the automatic 2-month extension period, you generally can get an additional 4 months to file your return, for a total of 6 months. The 2-month period and the 6-month period start at the same time. You have to request the additional 4 months by the new due date allowed by the 2-month extension.
The additional 4 months of time to file (unlike the original 2-month extension) is not an extension of time to pay. You must make an accurate estimate of your tax based on the information available to you. If you find you cannot pay the full amount due with Form 4868, you can still get the extension. You will owe interest on the unpaid amount from the original due date of the return.
You also may be charged a penalty for paying the tax late unless you have reasonable cause for not paying your tax when due. Penalties for paying the tax late are assessed from the original due date of your return, unless you qualify for the automatic 2-month extension. In that situation, penalties for paying late are assessed from the extended due date of the payment (June 15 for calendar year taxpayers).
Additional extension of time for taxpayers out of the country. In addition to the 6-month extension, taxpayers who are out of the country can request a discretionary 2-month additional extension of time to file their returns (to December 15 for calendar year taxpayers) (this means that the IRS grants it if it feels like it. But one can always help by establishing sufficient facts to get it granted).
To request this extension, you must send the Internal Revenue Service a letter explaining the reasons why you need the additional 2 months. Send the letter by the extended due date (October 15 for calendar year taxpayers) to the following address:
Department of the Treasury
Internal Revenue Service Center
Austin, TX 73301-0045
You will not receive any notification from the Internal Revenue Service unless your request is denied.
The discretionary 2-month additional extension is not available to taxpayers who have an approved extension of time to file on Form 2350, discussed next.
This is really cool! Extension of time to meet tests. You generally cannot get an extension of more than 6 months. However, if you are outside the United States and meet certain requirements, you may be able to get a longer extension.
You can get an extension of more than 6 months to file your tax return if you need the time to meet either the bona fide residence test or the physical presence test to qualify for either the foreign earned income exclusion or the foreign housing exclusion or deduction. The tests, the exclusions, and the deduction are explained in chapter 4.
You should request an extension if all three of the following apply.
If you are granted an extension, it generally will be to 30 days beyond the date on which you can reasonably expect to qualify for an exclusion or deduction under either the bona fide residence test or the physical presence test. However, if you have moving expenses that are for services performed in 2 years, you may be granted an extension until after the end of the second year.
- You are a U.S. citizen or resident alien.
- You expect to meet either the bona fide residence test or the physical presence test, but not until after your tax return is due.
- Your tax home is in a foreign country (or countries) throughout your period of bona fide residence or physical presence, whichever applies.
How to get an extension. To obtain an extension, file Form 2350 either by giving it to a local IRS representative or other IRS employee or by mailing it to the:
Department of the Treasury
Internal Revenue Service Center
Austin, TX 73301-0045
You must file Form 2350 by the due date for filing your return. Generally, if both your tax home and your abode are outside the United States and Puerto Rico on the regular due date of your return and you file on a calendar year basis, the due date for filing your return is June 15.
Also, don't forget Foreign Bank Account Reports are due on or before June 30, 2015!
Where to file returns:
Internal Revenue Service
P.O. Box 1303
Charlotte, NC 28201-1303
Department of the Treasury
Internal Revenue Service
Austin, TX 73301-0215
For folks who are required to file with California:
--If you are residing or traveling outside the USA on April 15, 2015, the deadline to file your tax return and pay the tax is June 15, 2015. Interest will accrue from the original due date until the date of payment. If you need additional time to file, you will be allowed a six-month extension without filing a request. To qualify for the extension, file your tax return by December 15, 2015. To avoid any late-payment penalties, pay your tax liability by June 15, 2015. When filing your tax return, write “Outside the USA on April 15, 2015” at the top of your tax return in RED INK.
The IRS is increasing its enforcement of reporting requirements for foreign financial accounts. (Note to my friends who have accounts in U.S. possessions: Puerto Rico, U.S. Virgin Islands, Guam, American Samoa and the Commonwealth of the Northern Mariana Islands): If you have a federal income tax return filing requirement, you may be required to report financial accounts in U.S. possessions. Click below for an overview about FBARs and Forms 8938....consult me if you have questions.http://money.cnn.com/2015/04/01/pf/taxes/irs-penalties/index.html?source=zacks
The following email was sent out earlier:(My comments are in [brackets]. All underlining is mine.)
Dear U.S. citizens,
The Internal Revenue Service (IRS) has provided the following guidance for U.S. citizens abroad preparing for the 2015 tax filing season. This IRS guidance is posted under Federal Benefits and Obligations on travel.state.gov. U.S. embassies and consulates cannot mail tax returns on behalf of U.S. taxpayers living abroad.
1. Who Must File?
All U.S. citizens and resident aliens must file a U.S. individual income tax return, even if they permanently live outside the United States and may not owe any tax because of income exclusion or tax credit.
2. When is the 2014 Federal Tax Return Due?
Due date for Form 1040: April 15, 2015
· An automatic extension to June 15, 2015, is granted for taxpayers living outside the United States and Puerto Rico. No form is required; write "Taxpayer Resident Abroad" at the top of your tax return. [Write it in RED CAPITAL LETTERS]
o Caution: This extension applies only for filing your tax return, not for payment. If you owe any taxes, you're required to pay by April 15, 2015. Interest and penalties will generally be applied if payment is made after this date.
· To request an additional extension to October 15, 2015, use Form 4868.
· Caution: This extension applies only for filing your tax return, not for payment. If you owe any taxes, you're required to pay by April 15, 2015. Interest and penalties will generally be applied if payment make after this date.
· Other extensions may be available on IRS.gov.
3. Can I Mail My Return and Payment?
You can mail your tax return and payment using the postal service or approved private delivery services. A list of approved delivery services is available on IRS.gov. If you mail a return from outside the United States, the date of filing is the postmark date. However, if you mail a payment, separately or with your return, your payment is not considered received until the date of actual receipt.
4. Can I Electronically File My Return?
You can prepare and e-file your income tax return, in many cases for free. Participating software companies make their products available through the IRS. E-File options are listed on IRS.gov. [Whether to file paper or electronically depends on many factors. One actually makes it easier on the IRS by filing electronically.]
5. What Forms May I Need?
· 1040, U.S Individual Income Tax Return
o Instructions to Form 1040
o 1116, Foreign Tax Credit
o 2013 Instructions to Form 1116 [...]
2350, Application for Extension of Time to File U.S. Income Tax Return (for U.S. citizens and residents abroad)
o 2350 in Spanish
· 2555, Foreign Earned Income Exclusion
o Instructions to Form 2555
· 2555-EZ, Foreign Earned Income Exclusion
o Instructions to Form 2555-EZ
· 4868, Application for Automatic Extension of Time To File U.S. Individual Income Tax Return
o 4868 in Spanish
· 8802, Application for United States Residency Certificate
o Instructions to Form 8802
· 8938, Statement of Specified Foreign Financial Assets,
o Instructions to Form 8938
· 14653, Certification by U.S. Person Residing Outside of the United States for Streamlined Foreign Offshore Procedures
6. How Do I Pay My Taxes?
You must pay your taxes in U.S. dollars.
· Direct pay. You can pay online with a direct transfer from your U.S. bank account using Direct Pay, the Electronic Federal Tax Payment System, or by a U.S. debit or credit card. You can also pay by phone using the Electronic Federal Tax Payment System or by a U.S. debit or credit card.
· Foreign wire transfers. If you have a U.S. bank account, you can use the Electronic Federal Tax Payment System. If you do not have a U.S. bank account, ask whether your financial institution has a U.S. affiliate that can help you make same-day wire transfers.
· Foreign electronic payments. International taxpayers who do not have a U.S. bank account may transfer funds from their foreign bank account directly to the IRS for payment of their tax liabilities.
7. Other Reporting?
You also may have to file FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR), by June 30, 2015.
8. Does the IRS Provide Help in Other Languages?
The IRS provides tax information in Chinese, Korean, Russian, Spanish, and Vietnamese. Go towww.irs.gov and use the drop down box under "Languages" on the upper right corner to select your language.
9. Where Can I Get Help?
Contact the International Taxpayer Service Call Center by phone or fax. The International Call Center is open Monday through Friday, from 6:00 a.m. to 11:00 p.m. (Eastern Time).
Tel: 267-941-1000 (not toll-free)
You may also contact the IRS office in London, Paris, or Frankfurt. For addresses and telephone numbers, contact my local office internationally.
10. I Received a Notice from the IRS – What Do I Do?
If you receive a notice from the IRS and need to contact the IRS, call the number listed on the notice or the International Taxpayer Service Call Center (see above).
11. Where Can I Get More Information?
For information on the IRS website about international taxpayers,see this page.
For general information about international taxpayers, see Publication 54, "Taxation of U.S. Citizens and Residents Abroad."
For information on the Affordable Care Act and taxpayers outside the United States, seePublication 5187, "Health Care Law."
12. I Haven't Filed All My Tax Returns – What Can I Do?
If you have not filed all the returns required of you and want to catch up on your filing obligations, see this announcement: IRS makes changes to offshore-programs. [Consult tax counsel
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.
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.