The 2012 tax-filing season has begun and the Internal Revenue Service is conducting audits of current and prior years' tax returns. In addition, there is a host of new and renewed legislation including the HIRE Act. As such, it is imperative that those filing American tax returns familiarize themselves with concepts regarding both U.S. and Israeli income tax law and how they may affect their personal situations.
Proper tax planning and minimization of your taxes requires an analysis of many important issues, including the interplay between the U.S. and Israeli foreign income tax credit rules, the foreign-earned income exclusion rules, and also how the applicable provisions of the U.S – Israel income tax treaty affects you. Below are some areas of current U.S. tax law which may have an impact on your U.S. tax return filings due in 2012. Please note that under the U.S. child credit rules, you are still eligible to receive free from the U.S. Treasury, up to $1000 per child per year, but the Making Work Pay Credit available in 2009 and 2010, is no longer available for the tax year 2011.
Foreign Bank Account Report (FBAR or Form TDF 90.22.1) must be filed yearly if you own or have authority over a foreign financial account, including a bank account (e.g. regular savings or checking), brokerage account, mutual fund, unit trust, or any other type of financial account. Under the Bank Secrecy Act, each United States citizen must file a Report of Foreign Bank and Financial Accounts (FBAR), with the U.S. Treasury if:
- The person has a financial interest in, or signature authority (or other authority that is comparable to signature authority) over one or more accounts in a foreign country, and
- The aggregate value of all foreign financial accounts exceeds $10,000 at any time during the calendar year.
Beginning in the 2012 Tax Year the Internal Revenue Service requires any individual with an interest in a foreign financial asset to attach a disclosure statement to their tax return if the total value of the foreign asset(s) exceeds $50,000. This would include financial accounts, foreign stocks and securities, interest in foreign entities and other financial instruments and contracts. You may be subject to a penalty of $10,000 for nondisclosure. This new form must be filed in addition to the Foreign Bank Account Report Form (FBAR).
The U.S. Child Tax Credit of up to $1,000 per eligible child potentially results in free money to you or a credit to subsequent years courtesy of the U.S. federal government via a U.S. check or direct deposit to your U.S. bank account, even if no U.S. income tax is due. If applicable, this credit may also be available to offset any potential U.S. income tax liability in a current or subsequent year. Taxpayers must have reportable earned income from wages or self-employment generated in Israel or in the U.S. in excess of $3,000 depending on the year you are filing. The earned income of both husband and wife can be combined even if one spouse is not a U.S. citizen. The non-citizen spouse requires a U.S. tax identification number (TIN), which can be acquired by filing U.S. Tax Form W-7. Children must be U.S. citizens aged 16 and below and must possess a U.S. Social Security number.
Maximizing the child credit can be quite complicated, since there are many factors to consider. In addition, the IRS has been conducting audits which may require verification of income. Amended returns may be filed back to the tax year 2008. (2008 amended returns must generally be filed by April 17, 2012).
The American Opportunity Credit expands and renames the existing Hope Credit. It can be claimed for qualified tuition and related expenses for any of the first four years of post-secondary education. The credit is up to $2,500 for those paying $4,000 or more in qualifying expenses for an eligible student. The credit is phased out for single taxpayers whose Modified Adjusted Gross Income (MAGI) exceeds $90,000 and for married taxpayers earning whose MAGI is over $180,000. Forty percent of the credit is refundable, which allows a taxpayer to receive up to $1,000 cash back for each eligible student even if no tax is due. You cannot claim the credit and the tuition and fees deduction in the same year. The credit is generally available for U.S. universities and for certain foreign universities.
U.S. Income Tax Rates are currently 10%, 15%, 25%, 28%, 33% and 35% respectively. The lower rates of 10% and 15% are available for the following taxable income levels: Single: up to $34,500; Married Filing Joint: up to $69,000. Under current U.S. tax rules, (often referred to as the "stacking rule") investment income may be taxed at a higher bracket, especially, if the foreign earned income exclusion has been used.
Foreign Tax Credits may generally be utilized a) when Israeli or other non-U.S. earned income exceeds the U.S. foreign earned income exclusion, b) for Israeli investment or other income that is also taxed in the U.S. (and vice versa), or c) if you are filing for the U.S. Child Tax Credit. Conversely, since Israel also taxes worldwide income, the Israeli income tax authorities will generally provide you with a foreign tax credit on income that was sourced and first taxed in the U.S. or in another country.
The Foreign Earned Income Exclusion has again been inflation adjusted and rises to $92,900 per taxpayer. As such, married taxpayers filing jointly, who meet certain requirements, may potentially exclude up to $185,800 of foreign earned income per tax return. However, one spouse may not utilize the unused portion of the exclusion of the other spouse and by electing the exclusion you may preclude eligibility for the U.S. Child Credit. This exclusion applies only to work or self-employed income and does not apply to other non-earned income such as pension, investment income, rental or any other non-work income. In addition, you generally must file a timely income tax return or claim benefits of Treasury Regulations in order to qualify for the exclusion.
Self-Employed Individuals are required to earn 40 credits (quarters) in order to qualify for future U.S. Social Security retirement benefits. These credits can be earned even while residing in Israel. If a taxpayer earns in excess of $5,000 during the tax year he/she can earn a maximum of 4 credits. This is primarily accomplished by:
- Being self-employed in Israel and reporting Israeli self-employment income on your U.S. income tax return,
- Working in Israel for a U.S. entity and receiving a Form W-2 (employee) or Form 1099 (independent contractor),
- Going to the U.S. to work as an employee (W-2) or as a self-employed individual (1099).
Automatic Extensions are available until June 15, 2012 for taxpayers who reside overseas. Interest will be charged, however, from April 17, 2012 if there is a balance due on your U.S. income tax return while penalties are calculated from June 15, 2012. Filing an extension will extend the time to file (but not time to pay) until October 15, 2012. It is strongly recommended that taxpayers, who owe income tax but do not file by June 15th, pay their estimated tax balance due by said date, along with the filing of the extension. For the upcoming year, it is imperative that taxpayers pay estimated taxes on a timely basis in order to avoid estimated tax penalties.
The U.S. - Israel Income Tax Treaty states that U.S. citizens living as residents in Israel are generally eligible to exclude from their adjusted gross income U.S. Social Security benefits received. This provision may result in substantial tax savings and even large refunds on your prior three years' income tax returns if you originally included Social Security benefits as taxable.
State and Local Tax Refunds may be available for taxpayers who may be unnecessarily filing resident State income tax returns after they moved to Israel. Maintaining a bank account, brokerage account or driver’s license in a particular State does not automatically necessitate a tax filing in that State. However, if you have real estate, maintain a business, commute to and work in a particular State, or have any other activity considered a nexus (strong connection) to a State, you would generally only file a non-resident income tax return in that State. Big refunds for current or prior years may be available.
Long Term Capital Gains rates (whether derived in the U.S., in Israel or in another country) generally apply to assets held for more than one year. With the extension of former President Bush's tax cuts, in 2010 the same capital gains rates that were used in 2011 (15%) will be kept in place. Capital losses are still fully deductible against capital gains, and any capital losses in excess of capital gains may fully offset up to $3,000 of ordinary income. Net capital losses in excess of $3,000 may be carried over indefinitely to future years. Israeli capital gains tax rules are significantly different than U.S. rules and a tax advisor should be consulted in this regard.
Qualified Dividends are taxed from 0% to 15%, the same as long-term capital gains. Generally, U.S. taxes paid on U.S. investment income may be used to offset Israeli taxes (and vice versa) thus potentially avoiding double taxation. In order to realize your savings from qualified dividends, you should compare the U.S. tax on your dividend income, which is taxed at 5% to 15%, versus the U.S. tax on your interest income which may be taxed at up to the highest U.S. marginal tax rate. With the recent extension of former President Bush's tax cuts, these rates will remain in effect for 2012.
Standard Deduction amounts are: Single or Married Filing separately - $5,800; Married Filing Jointly - $11,600; Head of Household - $8,500. Taxpayers over the age of 65 may claim an additional deduction of $1,150 each, if married, or $1,450 if single. Taxpayers with qualifying deductions in excess of these amounts may itemize their deductions. Mortgage interest, real estate tax (arnona), Israeli income taxes, and certain charitable contributions paid to Israel sources may qualify as itemized deductions.
The Personal Exemption amount increases to $3,700 for 2011. In some cases, grandparents may claim their grandchildren as exemptions on their income tax returns if they provided at least half the support of the grandchild and the grandchild lived with the grandparent. In 2011, there is no limit for personal exemptions and itemized deduction, regardless of the amount of your AGI.
Gifting of up to $13,000 annually to your children or grandchildren is an excellent way to potentially reduce the value of your U.S. taxable estate as well as future U.S. estate income taxes. The gifting limit is $26,000 if your spouse joins you in making the gift. Recent changes in the U.S. tax law in 2010 reinstated the Federal estate tax. The estate exemption amount will be $5 million per person in 2011 with a top tax rate of 35%. Please consult your tax advisor for more details or if you need assistance with estate planning and writing a personal will.
Tax Retirement Plans are available in the form of traditional IRA’s (Individual Retirement Account) and Roth IRAs, as well as other types of savings plans. Traditional and Roth IRA's allow for contributions of up to $5,000 per year ($6,000 if you are age 50 or over). Contributions to Roth IRAs can be made even after age 70 1/2. Roth IRA withdrawals are generally tax free if certain conditions are met and include a 5-year holding period and an age requirement of 59 1/2. Please note that potentially deductible IRA contributions can be made for taxpayers reporting compensation on their U.S. income tax return, including those taxpayers who are filing for the U.S. Child Credit.
Starting in the 2010 Tax Year there is no AGI (Adjusted Gross Income) limit for converting a traditional IRA to a Roth IRA. If you converted an amount from a traditional IRA in 2010 and elected not to report the taxable portion in 2010, you generally must report one half of the taxable gain in 2011 and the remaining one half in 2012.
"First Time" Homebuyers may still make an IRA withdrawal of up to $10,000 if single, and $20,000 on a jointly filed tax return ($10,000 for each spouse’s account) and still not be subject to the 10% early withdrawal penalty. The penalty will generally not apply if the funds are used within 120 days to buy, construct, or reconstruct a personal residence. In addition, there are other situations, such as for medical or educational reasons when penalties may also be avoided.
Corporations are excellent tax planning vehicles, especially for taxpayers working outside Israel and in light of Israeli tax reform. "C" Corporation tax rates are 15% on taxable income up to $50,000, 25% from $50,001 - $75,000 and 34% from $75,001 - $100,000, with higher rates for higher taxable incomes. "S" Corporations, Limited Liability Companies ("LLC's") and certain Trusts are called pass-thru entities. Your pro-rata share of the entity's income must be reported on your personal income tax return and is taxed at your individual income tax bracket.
Alan (Avraham) Deutsch is a CPA, with over 30 years of experience. Avraham and his associates specialize in income tax planning and compliance as well as in investment consulting. www.ardcpa.com
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