With Thanksgiving in the year
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 U.S. citizen should consider follow.
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 United States. 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 advisor 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 re-purchased 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 itemized 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 realize a tax benefit by paying early. This should be
discussed with your tax advisor.
Stock Options
Most stock options vest over a 3 or 4 year
period and are exercisable up to 10 years from the date of grant. Whether the
appreciation realized 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 U.S. companies because when the
employee exercises the option the employer is entitled to a corporate tax deduction
and the employee recognizes compensation that is taxed as ordinary income with
tax rates as high as 39.6%. An Incentive Stock Option is much more tax
favorable 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 recognizes 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 utilize when
requesting a “cashless exercise.” Failing to specify the Non-Qualified Stock
Option could increase the tax rate by almost 20%.
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 do 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 making a charitable contribution to them
deductible. How would you know who they are? Just ask them.
Internal Revenue Service Tax Liens and
Judgments
The Internal Revenue Service 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 Internal Revenue
Service and who just refuse to pay. Some individuals concern themselves about being
arrested when they enter the U.S. if they owe back taxes to the Internal
Revenue Service but the U.S. did away with debtor’s prison years ago. If an
individual owns assets in the United States such as a residence, bank account
or brokerage accounts these assets can and will be seized by the Internal
Revenue Service. Assets outside the U.S. are another story. I recently asked a
Bermuda attorney what would happen if a U.S. Court granted a judgment or lien
against a U.S. citizen who resides in Bermuda. The response was that a Bermuda
Court would not generally recognize such a judgment or lien.
In 1986 to combat this problem Congress
passed a law requiring that U.S. Immigration
not renew a U.S. passport without checking with the Internal Revenue
Service to ascertain that the individual had filed annual income tax returns
and that no tax liabilities were due. The strategy was that within 10 years (a
U.S. 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 U.S. 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 U.S. citizen has on their U.S. passport it would be
prudent for those who owe income tax to the Internal Revenue Service to monitor
the progress of this bill.
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