Estate Planning for the International Taxpayer by Karla Hopkins

It is essential for people with multiple citizenship and/or residency to understand that the timing and manner of wealth ownership, transfers and growth can affect their tax burdens.

Questions to ask:

Is a donor a U.S. citizen or domiciled in the U.S.?
If either are true, all gifts made and assets owned worldwide at death are subject to U.S. transfer tax in the absence of a relevant tax treaty. In addition, even if the individual has no connection to the U.S. but passes away with certain types of property located in the U.S. the estate tax applies to the U.S. assets regardless of citizenship or residency unless a treaty exemption applies.

What creates U.S domicile for estate and gift purposes?
According to the IRS, a person can establish domicile by living in a place for even a brief period with no definite, present intention of moving. However this test requires a facts and circumstances analysis which includes factors such as citizenship in another country, location of investment assets, driver’s registration, bank accounts, homes etc. Domicile is separate from Income Tax Residency therefore it is possible to acquire income tax residency without becoming domiciled in the U.S. for estate and gift tax purposes.

If beneficiaries of a gift or bequest are located in the U.S. and the donor is not a U.S. citizen or with a U.S. domicile, must U.S. transfer taxes be paid?
In almost all cases the answer depends on the location of the transferred assets, not the location of the beneficiary. Gifts of real property located in the U.S. would be a type of asset subject to the U.S. transfer tax even for a nonresident. Gifts of intangibles, including stock, to a beneficiaries located in the U.S. from a nonresident would not be subject to U.S. transfer tax. Nonresident aliens who make gifts subject to U.S. transfer tax are not eligible for the unified credit either. The $13,000 exclusion is allowed thus a nonresident alien is only allowed the equivalent of $60,000 lifetime exclusion compared to the $5.12 million in 2012 for U.S. citizens and domiciled residents.

What are the benefits of an estate treaty?
Unless an estate/inheritance or gift tax treaty applies, lifetime transfers and all assets owned at death by a person domiciled in the U.S. who is a citizen of another country are subject to U.S. taxes and his or her country’s tax. Currently 16 countries have estate tax treaties or a combined estate and gift tax treaty with the U.S. Some of these include, France, Germany Ireland, Italy, Japan and the United Kingdom. The general purpose of these treaties is to avoid double taxation. However each treaty is different and can apply their provisions differently regarding the situs of property and the domicile of the taxpayer. In addition, there is a limit to the use of a treaty for preferential treatment if a person has lived for a significant period of time in the U.S. Longer term residents will not be eligible for relief under a treaty.


What are the implications of transfers to a Non U.S. Citizen spouse?
Even if U.S. domicile has been established and the taxpayer is allowed the full unified credit the tax law does not allow the unlimited marital deduction for spouses who are not U.S. citizens, with a few exceptions. So in addition to potentially all assets of a U.S. domiciled foreign person being subjected to U.S. estate tax, if there is no applicable estate tax treaty, the taxpayer cannot benefit from a full marital deduction unless the spouse is a U.S. citizen. Considering the lower tax rates in many countries such as Brazil, China, and Venezuela or even where there are no estate taxes, establishing domicile in the U.S. can be costly.

Other considerations include:
Many European Union countries have a forced heirship system which must be considered. This may require specific beneficiaries as a matter of law and could cause U.S. estate plans for foreign citizens to be problematic.

Many continental European countries along with many Latin American countries follow a community law system. International treatment of community property can bring up a variety of conflicts of laws too.

As a result of the possibly significant transfer tax issues that a global taxpayer could face, it is important to seek professional help from attorneys and CPA’s who are knowledgeable in this area and who can consult with professionals from the initial country of citizenship.

A Social Security Safety Net by Karla Hopkins

FDR said Social Security was not intended to be the only means of support for the aged but rather a Social Security safety net.  Many today though regard Social Security as a major part of their retirement funding.

In 2009 the poverty rate for people over age 65 was just under 10%.  Without Social Security, the rate would be 45%.  Today, members of the Baby Boom generation are beginning to turn 65 and this group, which is known for spending and not saving, will put a strain on society and the Social Security system.  Today’s need for a Social Security net is as great as it was during the Great Depression.  The difference is that this time the Social Security system’s ability to pay full benefits beyond a 25-year horizon is doubtful. 

Some projections indicate that by 2036 the system will only be able to pay benefits at a 77% rate rather than a 100% rate. Therefore, when you prepare a long term budget, you should be conservative and assume your benefits will only be 75% of the amount calculated.

Taxation of Social Security benefits began in 1983. The dollar limits that determine the taxable portion of Social Security have remained constant such that many must pay income tax on their benefits.  So how do you minimize the taxation of your benefits?

First, you must understand the rules.  In general, an individual or married couple adds one-half of their Social Security benefit to their modified gross income.  If the total exceeds $25,000 for a single person or $32,000 for a married couple, 50% of the Social Security benefits are taxable.  If the total exceeds $34,000 for a single filer or $44,000 for a joint filer then 85% of your Social Security benefits are taxable.  Planning for receiving Social Security benefits could reduce or eliminate taxation of the benefits for some.

A few planning ideas to reduce your income each year when collecting Social Security follow:

You may be able to begin taking distributions from other pretax retirement accounts before turning 70 ½.  Doing so could reduce the required distributions once you turn 70.  You may also want to wait until you are 70 to begin taking Social Security benefits. This could increase your benefit by 8% per year.  The higher Social Security benefit will offset the lower required minimum distribution from another pretax retirement plan that you may be required to take.

Additionally, you could convert taxable IRA’s into Roth IRA’s. You will pay tax now, but at retirement age you  will not be required to take a minimum distribution from a Roth IRA, nor are any of the distributions taxable if you are over age 59 ½.  To calculate the amount of IRA that you convert, calculate the maximum amount that does not increase your marginal tax rate in the year of the conversion. 

Also, you may wish to reposition your after-tax investment portfolio by investing in more growth oriented stocks.  Using your pretax portfolios for income generating investing can help reduce your adjusted gross income.  Carefully planning your capital gain and loss recognition can also minimize your gross income. 

Other issues to consider when planning for Social Security include when to begin benefits, any government pension offset and divorce issues.  It is never too early to think ahead to your retirement years and the taxes that can be avoided or deferred with good tax planning.

Did You Say Accelerate My Income? Part II by Carolyn Flaherty

On May 10^th I published an article on accelerating income. The article discusses some of the provisions that are due to “sunset” as of January 1, 2013 and what their impact will be. As promised, if you anticipate being affected (and there are few people who would not be), here are some suggestions to discuss with your accountant.
Those whose tax rate will increase due to marginal tax rate changes should explore accelerating income to 2012 and/or deferring deductions to 2013. Some ways to do this would be to bill clients earlier, sell appreciated property, avoid installment sales that defer gain, and accelerate bonuses.

Considering charitable contributions? If you are planning to give to charity toward the end of 2012, you may want to defer and contribute in January 2013 when tax rates are higher.

Note also that if tax rates do indeed increase, pre-paying the annual property bills at year end will not be advantageous in 2012.

Furthermore, individuals should review their withholding rate or consider larger estimated tax payments starting in 2013. Married couples and taxpayers with qualifying dependent children should pay particular attention as the child tax credit is slated to revert to $500 per qualifying child and the Marriage Relief Penalty may not be renewed.

If your portfolio includes appreciated capital property, 2012 is a good year to sell. Maximum capital gains rates are slated to jump from 15% to 20% in 2013. As long as the sale is bona fide and the proceeds are received in 2012 you will obtain considerable tax advantage. However, you cannot sell and then immediately after re-acquire without invoking the wash sales rules.
Corporations may want to explore declaring a special dividend before January 1, 2013 to get cash out of the company while it is still taxable to shareholders at the reduced rates. As of January 2013, all dividends will be taxed at the applicable ordinary income tax rates unless legislation is passed.

As advisors, we find it very hard to direct clients during uncertain times such as these. There is always the possibility that some or all of the tax relief provisions will be extended. In which case, the planning and speculation is null and void. Therefore, don’t rush out and sell off your portfolio. However, you should consult your advisor and consider some “what if” scenarios. As year-end approaches, the tax landscape will become clear and if you have a plan in place, you will be able to execute it effectively. Without a plan, you just may end up in a difficult tax situation in 2013.

Did you say Accelerate my Income? PART I: By Carolyn Flaherty

Historically the theme of taxation is defer, defer, defer. After all one in the hand is worth two in the bush so the saying goes. So why might your financial advisors be encouraging you to accelerate income in 2012?

Remember all those Bush-era tax cuts put in place back in 2001 and 2003? The cuts impacted individual, capital gains, and dividend and estate tax rates and made an additional thirty plus tax savings changes to the Tax Code. All those provisions are set to expire at the end of 2012.

The loss of these savings will not only impact the wealthy. On the contrary they impact every single tax payer and quite possible the knockout punch lands more solid on the middle class. Some areas that may affect you:

·         Marginal tax rates are currently 10, 15, 25, 28, 33 and 35 percent. They will increase to 15, 28, 31, 36 and 39.6 percent.

·         While your marginal tax rate inflates your payroll tax is also scheduled to increase 2% as the payroll tax cut enacted under the Middle Class Tax Relief and Job Creation Act of 2012 expires.

·         “Marriage Penalty” relief disappears.

·         Fewer people will qualify for the Earned income Credit.

·         The Child Tax Credit will be reduced from $1000 to $500.

·         Maximum capital gains rates will revert from 15% to 20%.

·         Tax on dividends will go from 15% to the ordinary income rates; or a maximum tax rate of 39.6%.

·         More taxpayers will be subject to the dreaded Alternative Minimum Tax.

·         Coverdell Education Accounts maximum contribution will go from $2000 to $500.

·         The student loan interest deduction will be available to few individuals.

·         Elimination of 100% bonus depreciation, research credit, State and local sales tax deduction, teacher’s classroom expense deduction, mortgage insurance premium deduction, energy tax incentives AND cancellation of mortgage indebtedness exclusion for personal residence.

This is not intended to be and is not an all-inclusive list of the sunset provisions that will impact individuals. Yet, I’m sure each and every person reading this realizes the gravity of the situation. There are also many provisions that will impact businesses that will be discussed in a subsequent blog.

Extending these tax cuts is estimated to cost the government 2.84 million over the next 10 years. To complicate matters, Congress is currently confronted with mandatory reductions in federal spending under the Budget Control Act of 2011. Financially it seems unlikely that government can extend the provisions. However, the impact on individuals will be severe enough that to not extend at least some of the provisions may have dire political impact for the parties. Democrats and Republicans are at a standoff as to how to proceed and agreement before the November elections does not seem likely.

Next week we will explore some ways that you can plan for the sun setting of these provisions and perhaps accelerate some of your income during 2012 to take advantage of the still existing tax breaks before they expire. Tune in for more next Thursday and please comment with any questions you may have about the provisions set to sunset.

Ensuring Alimony Classification by Carolyn Flaherty

Just because a settlement refers to a payment as alimony does not make that payment deductible for income tax purposes. While a payment may indeed be alimony under domestic relations statutes or bankruptcy statutes, it may not be qualified alimony under the Internal Revenue Code. So how do you know the difference?

There are eight requirements, listed below, that ALL must be met in order for a payment to be considered alimony for tax purposes. Each payment is reviewed individually to determine if it meets the criteria to be characterized as alimony. Intent of the parties controls only the property rights of the payment and NOT the classification or deductibility for income tax purposes.

1. Payments must be made under a divorce decree or other written instrument pursuant to such a decree or under a written separation agreement.
2. After divorce or legal separation has been finalized, spouses cannot be members of the same household.
3. Payments must be made in cash or a cash equivalent.
4. The payments must be made to the former spouse or on behalf of the former spouse.
5. The written agreement cannot specifically state that the payments are not alimony.
6. Spouses must file separate income tax returns.
7. The payments cannot be referred to as or deemed to be child support.
8. Payments must terminate upon death of the receiving spouse.

Why does the characterization as alimony matter so much?
The designation effects whether or not the payment is deductible by the payer for federal income tax purposes and includable in income by the recipient. Alimony payments are deductible while child support and other payments are not. Though not commonly utilized, there is an option to elect out of this the alimony classification. In which case the payer agrees not to deduct the payment and the recipient does not include the amounts as income on their return even though the amount qualifies as alimony.

Some common mistakes or stumbling blocks are as follows:

• Any payments that are made before a written agreement is executed are NOT deductible EVEN IF the agreement is made retroactive to the date earlier payments were made.
• Payments made over the amount stipulated in the agreement are NOT deductible. Changes to the amount of alimony must be done via formal modifications of your agreement because an oral agreement is not enough for tax purposes.
• Payments in the form of bonds, annuity contracts, promissory notes, property or services are not deductible.
• Paying the mortgage on a house you own that your former spouse lives in is NOT deductible as alimony. However, if your former spouse owns the home and you pay the mortgage directly to the mortgage company, that payment likely qualifies as a deductible alimony payment.
• Any payments that are automatically reduced upon events related to a child such as a child maintaining a specified age, the death or marriage of a child, completion of child’s schooling, child leaving the household, or a child’s income are deemed child support even if stipulated as alimony by your agreement and are therefore non-deductible.
• When alimony payments stop or drastically reduce within the first three years of your agreement, you may invoke mandatory alimony recapture. Learn more and utilize a recapture calculator at http://www.smartmoney.com/personal-finance/marriage-divorce/deductible-alimony-calculator-9661/

Divorce is messy and confusing emotionally and financially. Properly navigating your settlement agreement and completing your income taxes, particularly in the initial year in which you file separately from your former spouse, will likely require the assistance of a professional. We also recommend that you consult not only an attorney or mediator, but also a tax professional during the preparation of your agreement so that you do not encounter unpleasant and unexpected tax or financial consequences.

Note: Rules as stipulated in this article govern divorce instruments written after January1, 1985. For law prior to that date refer to the prior tax code. Furthermore, the article discusses only federal tax code and does not address state law. Payments qualifying as alimony under federal law do not automatically qualify under state law.

Timing Social Security Benefits by Carolyn Flaherty

Many people wonder when they should begin taking their Social Security benefits. Most people believe that they should wait as long as possible before tapping into Social Security so that payments will be higher. However, choosing when to begin collecting is actually more complex than deferring as long as possible. In reality, timing must be analyzed based on the facts and circumstances of each individual including what other assets the individual has, the taxability of the other assets, what income streams can be generated in retirement and how much income the individual requires.

Although it is estimated that those who begin collecting at age 62 reduce their overall Social Security benefits by 20-30%, in some cases it is actually still more beneficial to begin collecting as early as possible.

For example: the lower income earner in a married couple may wish to begin collecting as early as possible. Why collect early? Because when the higher earner passes away, the lower earner’s benefit level becomes irrelevant anyway and they instead obtain survivor benefits that are essentially an inheritance of the higher income earner's benefits.

This can be particularly true for women who have taken time out of the workforce and therefore have lower total career earnings and hence lower social security benefit levels. Women also generally tend to outlive their male spouses. Therefore, they should consider starting their own benefits as soon as they are eligible.

Taking survivor benefits as early as possible is another scenario where taking early benefits may be financially savvy. Surviving spouses should consider taking survivor benefits while letting their own Social Security benefits continue to grow until age 70, at which point they can switch over to their own benefits.

You can begin collecting Social Security while continuing to work. However, your benefits will be reduced based on the amount your earned income exceeds certain levels established on an annual basis. For example, for the tax year 2012, a person under full retirement age may earn up to $14,640 and NOT lose any benefits. After that threshold your benefits are reduced $1 for every $2 you earn. A beneficiary who is of full retirement age can earn up to $38,880 in 2012 and NOT lose any benefits. After the threshold the benefits are reduced $1 for every $3 earned. Note that these thresholds relate to earned income and not to investment income. For more information visit the frequently asked questions section of the Social Security Administration site at http://ssa-custhelp.ssa.gov/app/home/session/L2F2LzEvdGltZS8xMzM1MzY0Nzc4L3NpZC9qaHhIZHhXaw%3D%3D .

There is no “right” answer that applies to everyone when deciding how to time your Social Security benefits. Therefore, you must do your research and consider consulting an advisor.

Another Season Passes by Carolyn Flaherty (as first posted 4/15/2011)

As the tax season comes to a close, we have decided to recycle this blog which first appeared in April of 2011. We wish you all a lovely spring full of sunshine, hope and happiness...

Most New Englanders can relate to the awaking that public accountants, (particularly those living in New England), experience upon the passing of each tax season. For months we have been entombed in a winter hibernation necessitated by the harsh New England winter and always stalling spring; and for those of us in public accounting, also by our work. Due to shortened days and a heavy workload, for months on end, many of us drive to work in the dark and leave the office in the dark. If we are fortunate enough to have a window in our proximity; we occasionally see the sun.

In New England at least, we can feel comfortable with our pasty pallor and lack of vitamin D. As the deadline approaches we celebrate the rain and cold that clings to our area because it is much easier to concentrate when the outdoors is not calling us to come and play.

Then, the fated day arrives and a feeling like the first day of summer vacation settles upon us all. We are free. We leave the office with a smile instead of a sigh. For the first time in months we are not thinking of the piles of work waiting for us. We are not prioritizing deadlines. We can sleep. We can make plans. We can spend time with our families and savor the moments rather than think of what we “should” be doing. We see the world like someone who has just gotten a pair of glasses and looks in wonderment at the outline of individual leaves on trees rather than the familiar blur of green. All things are brighter and crisper.

We are fortunate that the date often corresponds with April vacation for our youngsters and many of us embark on much needed vacations, in search of sunshine and repose. It is also rather symbolic that as we emerge, the days have begun to lengthen, crocus and tulips are rising from their winter sleep, the Red Sox are back on the field and the world is blossoming all around. Almost as if the world around us is celebrating as well.

I myself find that the energy I have poured into the tax season is now an available resource for the rest of my life and I rapidly throw myself into spring cleaning, landscaping, and a much needed return to physical fitness. As the energy ebbs so does the arrival of summer come upon me and I come in to a routine that matches the flow of the season once again.

Most people would consider a career choice as a public accountant to be a safe and secure career choice with a great deal of potential for advancement and financial gain. All this is true. The career path can also garner a great deal of flexibility. However, I would place a large wager that no college professor or recruiting company ever advises that being a CPA will cause you to appreciate life and routine and simple freedoms the way it does each April 15th.