Happy 100th birthday to the United States Federal income tax which was signed into law on October 3, 1913.

The initial income tax rate in 1913 was one percent with a one percent surcharge on income over $20,000 rising to a six percent surtax for income over $500,000. The standard deduction was $3,000 for single and $4,000 for married filing joint with allowable itemised deductions for state and local taxes and interest expense. Form 1040 was three pages long and only one percent of the populace actually paid the income tax. A few years later with the First World War ending the top tax rate increased to 77 percent on income over $1 million. Even in the good old days Congress taxed the rich.

October 15 filing deadline

Even though the Internal Revenue Service had been closed in the days leading up to the October 15 filing deadline for individual taxpayers no announcement has been made after the Internal Revenue Service reopened that would give relief to taxpayer’s who had questions, no one to speak to prior to the filing deadline and who have not filed. While tax payments are now being processed all refunds are being held in abeyance and no paper tax returns will be processed until funding is resumed. The Internal Revenue Service computers will continue to send out notices of tax due but correspondence in response to these notices is also not being processed.

Year-end gift tax planning

During 2013 an individual can make a gift of up to $14,000 without incurring a gift tax or using their lifetime $5,250,000 gift/estate tax exemption. If you are married your spouse can also gift $14,000 so each donee can receive $28,000 without your paying any gift tax. Once the gift is made, the assets are no longer in your taxable estate.

If your estate is projected to be under $10,500,000 ($5,250,000 for each spouse with the unused exemption passing to the surviving spouse) why should you consider making gifts?

One need only to look at the history of the exemption over the last 12 years when it went from $600,000 to $3,500,000 to no estate tax in 2010 to its current $5,250,000 to realise that change is the norm and that one should take advantage of what is available today as it could be gone tomorrow.

The annual gift tax exclusion can be used to assist a child who is between jobs, assist with redecoration, give fractional shares of a vacation home to your children or simply to start reducing your taxable estate.

Qualified Personal Residence Trust

A qualified personal residence trust (QPRT) is usually used in connection with the last residence you intend to own.

As an example, suppose you retire at age 60 sell your residence in Maine and buy a smaller retirement home for $1 million in Florida where all your children live.

With a life expectancy of 20+ years it is likely that the value of your Florida residence will appreciate over this 20-year period by 150 percent or $1,500,000.

Is there a way to keep this future appreciation, as well as the current $1 million out of your estate? The answer is “yes” and you can do so by setting up a QPRT.

Under a QPRT you make an unequivocal transfer of the residence to the trust and you pick a period of time when you will continue to live in the residence, usually half your life expectancy.

You then look to IRS tables to determine the value of the gift to the trust taking into account your continued presence. This usually works out to about 40 percent of the current value or $400,000. If you did not set up the QPRT you would have a residence worth $2,500,000 in your taxable estate. By setting up a QPRT you would only use about $400,000 of your lifetime exemption. Are there any negatives? Yes. At the ten-year mark ownership of the residence then passes from the trust to your beneficiaries. Once the property passes to your beneficiaries you need to start paying them rent if you want to continue to live in the residence and if you die before the ten-year mark the residence reverts to your estate.

3.8 percent Medicare surtax

Even though the 3.8 percent Medicare surtax on net investment income for singles with adjusted gross income in excess of $200,000 and married filing joint $250,000 (prior to deducting the foreign earned income and housing exclusion) has been widely reported many individual taxpayers have not adjusted their estimated tax payment to account for this addition tax plus the 0.9 percent surtax on wages and self employed income. The Internal Revenue Service recently released new Form 8959 and Form 8960 that will be used to make the computation of these additional taxes.

2013 year-end income tax planning

November is a good time to take stock of your 2013 income, deductions and taxes. You should be able to closely project what your salary, bonus and allowances are, dividends and interest for 2013 will likely have been fully paid and your itemised deductions should be known. With this information in hand your tax advisor will be able to provide you with a projection of your 2013 income tax and you can then adjust your 2013 January 15, 2014 estimated tax payment or your withholdings. With a combination 4.6 percent tax increase for individuals earning over $450,000, the 3.8 percent and 0.9 percent surtax coupled with a three percent reduction in itemised deductions and a phase-out of personal exemptions individuals in the upper brackets can generally expect a ten percent increase in their 2013 taxes.

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