It would appear as though for the next two years we will see a US President who is a Democrat attempting to change tax laws he does not like while ignoring the fact that the Republicans have a majority in the Senate and House of Representatives. Recently President Obama decided that 529 College Savings Plans, with tax free withdrawals, were being used primarily by the wealthy and that the law should be changed to now tax withdrawals.

It has also come to our attention that many US-based children of Bermuda parents are likely in violation of the US requirement to e-file the annual Report of Foreign Bank and Financial Accounts.

529 College Savings Plans

529 refers to Internal Revenue Code Section 529 which is also known as the Qualified Tuition Programmes. The law was initially enacted as a method for taxpayers to accumulate funds to pay college tuition for their children. Under this law which has been in effect in its current form since 2001 contributions to a 529 college savings plan are not deductible but any earnings within the plan are not currently subject to income tax. If withdrawals from the plan are used for college expenses such as tuition, books, supplies and required fees the withdrawals are tax free. Hence, income is allowed to accumulate over many years, tax free.

Contributions to the 529 College Savings Plan are considered gifts to the children subject to the annual gift tax exclusion that is now $14,000. As both a husband and wife have separate gift tax exclusions up to $28,000 can be deposited to a 529 account each year for each child. Deposits are not limited to the parents and grandparents and uncles, aunts etc can all contribute to the account. All of the 529 plans are administered by the individual states with many having different rules. In some states you can make ten years worth of contributions today, effectively negating any contributions for the next years.

According to the New York Times in 2008 Barack and Michelle Obama made $2,680,000 and deposited $240,000 each into a 529 college savings plan for Sasha’s and Malia’s education. Some seven years later, President Obama, in his State of the Union address, decided that a 529 plan was a tax break for the wealthy and proposed to end the tax-free withdrawals, but only on new deposits. Consequently, when the Obama’s withdraw funds to pay for Sasha’s and Malia’s education, they will not pay tax on this money but for those just starting, well that is a different story. The negative reaction not only came from the Republicans but also from high-ranking members of his own party, so the proposal has now been scrapped.

In a 529 plan the beneficiary can be changed at any time and the beneficiary could even become the parent. This does make sense in that what happens if your child wants to become a rock star and forgo college? The ability to change beneficiaries to that of another child or to a niece or nephew or to yourself adds flexibility to the decision to name a beneficiary today for something that will not happen for 17 or 18 years. We have also seen instances where couples whose children have long graduated have set up 529 accounts for themselves with the idea of retiring and then spending two years at a branch of a US college based in Paris and studying French art history.

Bermuda citizens and US-based children

Are you a mature Bermudian with bank and brokerage accounts in Bermuda? Have you reached the age where you have put your children’s names on all your accounts solely as a precautionary step? And do your children live or work in the United States? If so, have your children e-filed FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR)? Or have they checked the box on Schedule B of their US Federal individual income tax return reporting the existence of a foreign bank account? The answer is likely no, when it should be a resounding YES.

If your US-based child’s name is on your Bermuda accounts your child has a requirement to e-file FinCEN Form 114. A financial interest in a foreign financial account is defined as one for which the US person is the owner of record or holder of legal title, regardless of whether the account is maintained for the benefit of the US person or for the benefit of another person. If they have not done so they may be eligible for the Streamlined Offshore Procedure by filing FBAR’s for the years 2008 to 2013. When they do so they will also be subject to a 5 per cent penalty based on the highest amount in the foreign account during this six-year period. Failure to comply could lead to as much as a 50 per cent annual penalty being imposed based on the highest amount in the foreign account during 2006 to 2013.

Fatca and FBAR

As noted in earlier columns over 80,000 banks and financial institutions have agreed to provide the US Treasury with the name, address, account number and the sum in the account for all US citizens who had an account at that institution as of June 30, 2014. In many cases this information has not yet been transmitted to the US Treasury. As previously noted Bermuda based banks are making a diligent effort to either clearly identify account holders who are US citizens and are asking other account holders for proof that they are not US citizens. This delay in furnishing information to the US Treasury allows US citizens or resident aliens who have not complied with the law a short window of opportunity to do so under either the Streamlined Foreign Offshore Procedure or the Overseas Voluntary Disclosure Programme. Failure to do so will result in draconian penalties being imposed by the US Treasury.

The new math

When passing tax legislation Congress is required to measure the economic effect of a tax cut or a spending bill. Under the concept of “it’s not how you count, it’s how you figure” the House of Representatives have passed a new rule allowing the use of “dynamic” scoring (does more than one person knows what this means?) factoring in the projected economic effects of legislation when computing the amount of revenue raised or lost. This “new” method raised the economic impact from $650 billion to $700 billion on just one proposed bill.

Pursuant to the requirements relating to practice before the Internal Revenue Service, any tax advice in this communication is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties imposed under the United States Internal Revenue Code, or (ii) promoting, marketing or recommending to another person any tax related manner.

The tax advice given by this column is, by necessity, general in nature. You should, of course, check with your own US tax consultant as to how specific transactions affect you since tax advice varies with individual circumstances.

James Paul Sabo, CPA, is the President of ETS Ltd, PO Box HM 1574, Hamilton HM GX, Bermuda. Questions should be sent to: jsabo@expatriatetaxservices.com