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Some year-end US tax planning tips

With Thanksgiving in the rear-view mirror and the Christmas shopping frenzy in full swing, year-end tax-planning takes a back seat to these joyful occasions. Some common year-end tax-saving strategies that a US citizen should consider following.

Annual bonus

Do you know or can you forecast what your year-end bonus is going to be? Do you have the flexibility to decide in what year you will receive your bonus, 2015 or 2016? If so, you should prepare a projection of your 2015 and 2016 income and tax and take the bonus in the year in which you expect to be in a lower tax bracket. Flexibility in determining when you receive your bonus is especially important for expatriates returning to the US. If you receive your 2015 bonus after your return the state that you moved back to will likely tax the bonus even though it was earned in Bermuda when you were a non-resident of that state.

Tax Loss Harvesting

Do you carefully review the monthly statement from your investment adviser and know whether you have a net capital gain or loss as of today? If not, you should ascertain what you have and then review the remaining portfolio to ascertain what other stock holdings could be sold to offset the gain or loss to arrive at or near a net zero position at year-end. Stocks sold at a gain that you want to hold can be purchased immediately and stocks sold at a loss cannot be repurchased for 31 days before or after the date of sale without your running afoul of the “wash sale” rules.

State and local estimated income tax payments

State and local estimated income tax payments are generally due on January 15, 2016. But if you wait until 2016 to make the payment you cannot obtain an itemised tax deduction for this payment until 2016. Should you make the payment in 2015? That will depend on you facts and circumstances. If you are already subject to the Alternative Minimum Tax it is likely that you will not realise a tax benefit by paying early. This should be discussed with your tax adviser.

Stock options

Most stock options vest over a three- or four-year period and are exercisable up to ten years from the date of grant. Whether the appreciation realised on the exercise or sale of the stock is taxable or not and what bracket it is taxed at is surprisingly unknown to most taxpayers.

Non-qualified stock options are the norm for US companies because when the employee exercises the option the employer is entitled to a corporate tax deduction and the employee recognises compensation that is taxed as ordinary income with tax rates as high as 39.6 per cent. An incentive stock option is much more tax favourable to the employee in that if the employee exercises the option and holds the stock for at least one year before selling it there is no taxable event at exercise and tax at capital gain rates on sale. However, if the employee does a “cashless” exercise or sells the stock within a year of exercise than the employee recognises compensation that is taxed as ordinary income the employer is entitled to a corporate tax deduction.

A common error that we see happens when an employee has both non-qualified stock options and incentive stock options and does not take due care to advise the employer as to which to utilise when requesting a “cashless exercise.” Failing to specify the non-qualified stock option could increase the tax rate by almost 20 per cent.

Conversion of a traditional IRA to a Roth IRA

A least understood and infrequently used tax planning method is to convert a traditional IRA to a Roth IRA. Distributions from a traditional IRA are subject to income tax at ordinary tax rates and a distribution from a Roth IRA is tax free. Amounts converted from a traditional IRA to a Roth IRA must be included in gross income for the tax year in which the amount is transferred to the extent that it does not represent a return of basis.

So why don't more individuals do so? Most clients expect to be in a lower tax bracket when they retire and do not see the value in reducing the amount in their retirement account today to pay income tax on funds that they don't plan on withdrawing for another 15 years. Others expect to receive a large inheritance in the future, expect to be in a higher tax bracket and do consider a conversion.

Charitable contributions

A cash contribution must be documented in order to be deductible. If you claim a charitable contribution of more than $500 in donated property, you must attach Form 8283 to your tax return. Contributions to foreign charities cannot be deducted. However, there are a number of Bermuda charities that have received a Code Section 501(c)(3) status from the Internal Revenue Service (IRS) making a charitable contribution to them deductible. How would you know who they are? Just ask them.

IRS tax liens and judgments

The IRS has a long history of not being able to collect liens and judgments against US citizens and foreign nationals living abroad who owe back taxes to the IRS and who just refuse to pay. Some individuals concern themselves about being arrested when they enter the US if they owe back taxes to the IRS but the US did away with debtor's prison years ago. If an individual owns assets in the US such as a residence, bank account or brokerage accounts these assets can and will be seized by the IRS. Assets outside the US are another story. I recently asked a Bermuda attorney what would happen if a US Court granted a judgment or lien against a US citizen who resides in Bermuda. The response was that a Bermuda Court would not generally recognise such a judgment or lien.

In 1986 to combat this problem Congress passed a law requiring that US Immigration not renew a US passport without checking with the IRS to ascertain that the individual had filed annual income tax returns and that no tax liabilities were due. The strategy was that within ten years (a US passport must be renewed every 10 years) the problem would be solved. I once asked a senior attorney with the Office of Chief Counsel why this did not work and the terse reply was “we do not talk to the people across the hall; what makes you think that we would talk to immigration?”

Some 30 years later Congress is trying again. A proposed US highway bill includes a provision to revoke an individual's passport if there is over $50,000 of unpaid income tax due and the Internal Revenue Service is seeking to collect through enforcement action. The provision has an effective date of January 1, 2016. Given the reliance that a US citizen has on their US passport it would be prudent for those who owe income tax to the Internal Revenue Service to monitor the progress of this 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

Planning for year-end: be aware of IRS rules

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Published December 02, 2015 at 8:00 am (Updated December 02, 2015 at 1:09 am)

Some year-end US tax planning tips

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