Expat Tax Help Online

Status: After well-nigh two years of contesting an erroneous IRS audit, an American expatriate couple continues in spite of challenging circumstances and mounting assessments to convince the Service to cancel their examination.

I.  A Tax Compliant Expatriate Couple.A married couple – let’s call them James and Isabel Platt - have resided in Spain since 1997. Together they run a business building single family homes in the Costa del Sol. As U.S. citizens, they file an annual tax return on which they report their earnings from their self-employment business on Schedule C of Form 1040. Since they pay Social Security taxes to Spain, they have never filed a corresponding Schedule SE the purpose of which is to calculate a Schedule C filer’s liability for U.S. Self-Employment (Social Security/Medicare) taxes.

II. IRS Audits the Couple’s 2006 Tax Return for Social Security Taxes.On April 13, 2009, the Internal Revenue Service (IRS) in Philadelphia audited their 2006 tax return. In the audit, the Service alleged that the couple owed $5,379 in Self-Employment Taxes on $38,068 of net profit from their home building business ($38,068 x .9235 x .153 = $5,379). In addition to these taxes, IRS fined them $538 in late filing penalty, $952 in interest charges and a 20% accuracy penalty of $1,076 ($5,379 x 20%), bringing their total assessed liability to $7,945 ($5,379 + 538 + 952 + 1,076). As they had never been audited for U.S. Self-Employment taxes in the past, Isabel was bewildered. She exclaimed: ‘Why are they doing this?!’

According to the postmark date, the Platt’s had not actually filed their 2006 tax return late. But the Service’s refusal to acknowledge foreign postal dates must have triggered the rather stiff late filing penalty. Besides the apparent injustice of the $2,566 in penalties and interest being assessed, an unbiased observer might ask why Social Security, which is after all a retirement pension fund, is subjected to such heavy-handed fines? Moreover, why does the Service inflict a 20% accuracy-related penalty for what can only be described in a worse-case scenario as an unintentional misdemeanor?

III. IRS Clarifies Its Case Against the Couple?In response to filing an appeal at the end of April, the IRS wrote on 21 September 2009: ‘According to our records you were penalized for not reporting all of your income. As a result, the Under-Reporting Department assessed you based on the income reported.’ This response was unclear and unsatisfactory. By charging the couple with under-reporting, IRS had created the impression that the Platt’s were charged with tax evasion. Sometime later, we would learn that IRS’s definition of under-reporting was the couple’s failure to report their Schedule C earnings on Schedule SE.

IV. Certificate of Coverage.As the 21 September from IRS had yet to arrive, we took the advice of an IRS agent in a phone call. He advised that we write a letter stating that the Platt’s, being long-time residents of Spain, pay Social Security taxes to the Spanish tax authority. The agent felt sure that such a letter of explanation which is supported by the Bilateral Agreement between Spain and the United States would close the audit. Accordingly a letter dated 10 August 2009 was prepared and sent to IRS in Philadelphia.

Responding to this letter, IRS wrote on 25 September: ‘Please send in documentation … showing you paid Social Security Taxes on your earnings of $38,068. Once we receive this information we will make the necessary adjustments to your tax account.’ This letter appeared fortuitous.

Yet no one was sure what sort of documentation the IRS required. After some research on the U.S. Social Security Administration website, it appeared that a Certificate of Coverage might satisfy the Service. Accordingly the client was advised. Subsequently the Platt;s, after undergoing some difficulties with the Spanish tax authority as to what a Certificate of Coverage in Spain might represent, they were able to acquire Certificados de Situacion de cotizacion from the ‘Tesoreria General de la Seguridad Social’ affirming that they do indeed pay Social Security taxes to Spain.

The couple, anxious lest they erred in acquiring the appropriate Certificate of Coverage and might therefore find themselves subjected to further IRS penalties, copied these certificates to me on 20 November 2009.

On 4 December 2009, these certificates were attached to a letter of explanation sent to Philadelphia IRS. The letter delineated conversations with IRS agents, pointed out that the couple pay Social Security taxes to the Spanish authority, reminded the Service of the existence of a bilateral treaty that grants Spain the right to tax residents on Social Security, suggested that the IRS could be failing to bridge cultural interpretations, and asked that the 2006 audit be set aside.

On 28 December, the couple received a more ominous notice from IRS: ‘Urgent!! We intend to levy on certain assets. Please respond NOW.’ Naturally when the couple received this notice, they would write me on 12 January 2010 at the end of the Christmas holidays: ‘It seems that (their notice) doesn’t relate at all to the letter you sent them. We just don’t know what to do.’ I replied: ‘(Their notice) relates to the same 2006 self-employment tax issue. It is as if IRS is mindlessly ignoring our correspondence. Someone pushed in a code number and now the collection process is on autopilot.’

In a phone call, Agent Ramer, Badge #0739802 of IRS, explained that IRS had not yet processed our 4 December letter. She did assure me that our appeal had been assigned to an agent and therefore we would receive a response within 30-45 days. IRS never did respond.

V. Appealing to Taxpayer Advocate.On 10 April 2010, I was writing the client: ‘Seems like IRS is really dragging its feet.’ Meanwhile the worsening tenor of assessment notices continued. On 3 May 2010, the client was again threatened with an IRS levy. ‘To prevent collection action, please pay the current balance now.’ The balance was $8,768.

The Service’s recommendation to the taxpayer is to always pay an assessment. Even if the taxpayer eventually wins the argument, paying off the taxes and other IRS fines will stop interest and notices from accruing. However, owing to the difficulty of resolving this audit, taxpayers are bound to feel mistrustful of paying an unjust assessment to an unreliable tax authority.

Frustrated by the Service’s unresponsiveness to our appeals in letters and phone calls, we contacted the Taxpayer Advocate Service. Nancy Chichilitti, Case Advocate, replied by ‘snail’ mail in a letter dated 20 May. She asked that the taxpayers fax to her their 2006 Form 1040 and related schedules. On 11 June by fax, I sent their tax return and a letter which states in part: ‘In 17 years of preparing tax returns for American expatriates, I never had an expatriated American client residing and earning in a European country being required to pay Social Security taxes to both their foreign country of residence and IRS.’

On 17 June, Advocate Chichilitti asked for a signed copy of page 2 of 2006 Form 1040. We could now take comfort that the IRS collection process was on a temporary holding pattern. However, as the summer season faded into autumn without our receiving any further word from Advocate Chichilitti and she had proved unreachable by phone, I spoke with another Advocate: Agent Neal, Badge #1000341613.

Agent Neal told me that the case had been closed on 23 September. Advocate Chichilitti had sent a letter on 23 August in which she asked to see an English translation of the taxpayers’ Spanish tax return in order to verify payment of Social Security taxes to Spain. The Platt’s never received this letter. Ms Chichilitti, not hearing back from the Platt’s, simply shelved the case. Nevertheless, a Spanish tax return is no proof of Social Security tax payments; rather it is for the filing and assessment of income taxes only.

Explaining to Agent Neal 19 October 2010 that the taxpayer had not received any letter from her Advocate colleague and possibly mentioning that a Spanish tax return is no proof that Social Security taxes have been paid to Spain, I asked that the case be reopened. Agent Neal promised to do so. In the meantime at her suggestion, I left my name and phone number so that an IRS representative in the international tax department could contact me. Later, however, the case was not reopened. Nor did the representative contact me.

VI. The Bilateral Agreement.About this time, I wrote the couple: ‘These Advocates are turning out to be useless. I am going to phone regular IRS tonight. In that phone call, an agent told me that resolving the dispute is simply a matter of pulling up the Totalization (Bilateral) Agreement between Spain and the United States. The agent took down my appeal on the clients’ behalf, gave me a reference number, and promised that someone who was expert in the field of Social Security in the IRS legal department should be calling or emailing me. No such person ever did contact me.

On 15 November 2010, IRS announced their intention to levy the taxpayers’ assets for $9,245. The Platt’s – utterly frustrated by now but feeling compelled to do something - contacted the Federal Benefits Unit (FBU) in Madrid. The result merely reconfirmed the requirement of a Certificate of Coverage. Based on FBU advice, the couple, in a replay from 2009, obtained another set of Certificates dissimilar to those obtained the year before. On 10 December 2010, this set of Certificates was sent to IRS with a cover letter.

As one should allow six to eight weeks for correspondence with IRS to enter their system, I phoned on 28 January. After apprising Agent Latasso, Badge #100130669, of the tedious circumstances of the audit, she informed me that my 10 December letter had been placed in the hands of the International Section on 12 January. She advised me to wait to phone again as their processing was very slow.

VII. The Audit Cancelled – Almost.On 12 February 2011, I spoke with Agent Gayle Clough, Badge #1000147298, of the International Division. Like many agents, she was courteous, business-like and capable. During quite a lengthy chat, she located the Certificates of Coverage and presented them to a tax lawyer there. He approved them as legitimate. So Agent Clough proceeded to cancel the assessment. But at the last moment, she reversed her decision. As the assessment had originated from the Under-reporting Department, her hands were tied. She said.

Agent Clough explained that by under-reporting, the taxpayers had failed to report their Self-Employment earnings on Schedule SE. So anyone who is self-employed in a foreign country that imposes Social Security taxes must also report his liability for self-employment taxes on the SE schedule. This requirement can only mean that the Totalization (or Bilateral) Agreement between Spain and the United States is mute!

VIII. Summary.

In his 2010 book – The Tax Reform Alternative (www.offshorepress.com) – the author has written: ‘The Internal Revenue Code contains more than 3.4 million words; printed 60 lines to the page, it would fill more than 7,500 letter size pages. To conserve space, the tax code uses extensive cross-referencing to other parts of the tax code as a substitute for explaining the cross reference in any semblance of English. This forces readers to look up numerous other parts of the tax code in order to understand the scope of any section with cross references. In spite of this mountain of verbiage, every citizen is presumed to be familiar with the entire US Tax Code. … (I)gnorance of the law is not an excuse for the imposition of numerous burdensome civil penalties.’

Given that IRS endorses such a draconian theory of jurisprudence in imposing harsh penalties on anyone they deem as having failed to comply with an incomprehensible system of rules and regulations, the Service can apparently victimize anyone at any time with impunity. Further, if James and Isabel Platt can be arbitrarily taxed by a taxing authority whose tortuous conduct effectively denies them a defensive platform, they might be tempted to pay the IRS for the sake of their own sanity. If they cannot win the argument, they can at least stop the dunning notices.

Barron Harper
19 February 2011

The United States tax authority – Internal Revenue Service – is the only institution that requires U.S. citizens and deemed U.S. residents to file an annual tax return on which is reported income from all sources worldwide. Other countries apply this requirement to residents rather than citizenry.

Occasionally Americans living abroad are surprised by this requirement in those circumstances where they are already filing a tax return and paying taxes to a foreign country of residence. So refusing to file a U.S. tax return, they may also believe that filing tax returns on the same income to both countries means double taxation.

As the Internal Revenue Service has in place the power and wherewithal to assess rather stiff penalties against anyone who neglects his/her duty, noncompliance can ultimately be expensive. Where one has not filed a return stateside for many years, IRS requires filings for three prior years in addition to the current year. In 2011 this means filing tax returns for 2007, 2008, 2009 and 2010. While owing taxes to the United States Treasury is unusual due to filers being able to apply foreign tax credits and/or foreign earned income exclusions against any IRS assessments, the Service will require that six years be filed in the event that taxes are owed.

Filing requirements are actually based on a predetermined income level per filing status. It works something like this:

Filing Status Age End of 2010 Gross Income Determines

Single Under 65 $9,350
65 or older 10,750
Married Filing Joint Under 65 (both spouses) 18,700
65 or older (one spouse) 19,800
65 or older (both spouses) 20,900
Married Filing Separate Any age 3,650
Head of Household Under 65 12,050
65 or older 13,450
Qualifying widow(er) Under 65 15,050
65 or older 16,150

So if your filing status is, say, Head of Household and you are under 65, you would have to file a U.S. tax return if your gross income in 2010 was at least $12,050.

Anyone whose estate is valued at more than $1m might wishfully contemplate dying this year. That is if they intend to leave property to their heirs. Because on 1 January 2011, the federal estate tax is scheduled to re-emerge with a vengeance and impose a 55% levy.

From 2001 - 2009, an increasingly valuable exclusion amount rose from $675,000 and a maximum tax rate of 55% to $3.5m and 45%. In 2010 the estate tax was repealed. Next year it may be adjusted to a $1m exemption amount and 55% top rate if Congress does nothing.

So beginning next year, families whose property values and retirement plans (and other assets too) have risen to over $1m will be vulnerable to the estate tax.

Meanwhile wealthy persons who died this year and so escaped the estate tax include George Steinbrenner, New York Yankees owner, whose estate has been estimated at $1.1 billion. The federal estate tax in 2009 was 45 percent, with the $3.5 million per-person exemption. If Steinbrenner had died last year, his estate could have been taxed almost $500 million. But not in 2010. Undoubtedly the beneficiaries of the estates of Lynn Redgrave, Art Linkletter, Dennis Hopper, J D Salinger, Lena Horne, Jean Simmons and other members of the rich and famous club are also comforted that Uncle Sam was not among the heirs of these decedents in 2010.

The Obama Administration would like to see the estate tax return to 2009 level. But Republicans blocked this proposal. More recently Senators Jon Kyl and Blanche Lincoln re-introduced legislation that exempts $5m from estate taxes with a 35% maximum tax rate. The problem with Congress passing a lenient bill is that the US Government needs the money. And though politicians may say little about raising taxes, privately they must surely be whispering in the quiet corridors of power: ’show us the money!’

The eligibility of American expatriates and their families to receive US Social Security benefits depends on understanding the qualifications. Citizens of most European countries may receive benefits but not US citizens residing in Cambodia, Vietnam, Cuba, North Korea or certain areas of the former Soviet Union. Survivors or dependents who are citizens of Central and South American countries as well as Bosnia-Herzegovina, Croatia, Cyprus, Hungary, Iceland, Jordan, Latvia, Liechtenstein, Lithuania, Monaco, Montenegro, Serbia, Slovakia and Turkey must meet certain additional requirements. Anyone who is not a US citizen or a citizen of these countries will not receive Social Security benefits after being outside the United States for six calendar months unless he or she is a resident of a treaty country. Treaty countries – countries with which the US has a Social Security Totalization agreement – include most European countries.

The right of non-US citizen dependents and survivors to receive benefits depends on US residency. They must have lived in the United States for at least five years, during which the family relationship on which benefits are based must have existed. This residency requirement is not required of citizens of most European countries or countries with which the United States has a Social Security agreement.

Non-US citizens, as opposed to dependents and survivors, can qualify to receive Social Security benefits as long as they were assigned a Social Security number based on authorization to work in the United States at any time on or after 1 January 2004 or were admitted to the United States as a nonimmigrant visitor for business.
When a Social Security recipient dies, the Social Security Administration should be notified as soon as possible. A one-time payment of $255 will be paid to the surviving spouse. In addition, the following surviving members may be eligible for monthly benefits:

  The widow or widower aged 60 or older (50 if disabled)
  Surviving spouse at any age who is caring for the deceased’s child age 16 or under (or    disabled)
  An unmarried child of the deceased who is younger than age 18
  Age 18 or older with a disability that began before 22 years of age
  Parents aged 62 or older who were dependents of the deceased for at least half their support
  Surviving divorced spouse under certain circumstances

Social Security can be contacted via their website: www.ssa.gov

Earlier this year, the Internal Revenue Service had in place a tax amnesty. In former times, a tax amnesty might have signified forgiveness of taxes. Tax debtors found their obligations to the governing authority wiped clean. The populace then felt good about their governors and, if anything, more readily paid up on imposed taxes.

The IRS wants to find Americans who have squirreled away their wealth in hidden accounts so as to tax the earnings they are convinced have long been undeclared. Indeed, the US government estimates that the treasury is losing $10b a year in tax revenues due to this sort of failure to report. And given that the government, despite an incomprehensible budget deficit, has obliged itself to continue financing wars in Afghanistan and Iraq, to pay Social Security retirement pensions to the aging baby-boomer generation, and to legislate a national health care system, the business of tax collection was never higher on the agendas of tax collectors.

Accordingly on 27 March 2009, the IRS announced a six month amnesty for Americans to voluntarily report their worldwide income, gains, bank accounts, trusts and other secreted entities. Given that only about one-third of American expatriates file annual tax returns and some 20% file the required foreign financial holdings report known as FBAR, the IRS has legislated this six month window of opportunity for anyone heretofore under the radar screen to emerge from obscurity.

Responding to this window, a representative of American Citizens Abroad had this to say: ‘The IRS this time apparently thinks it is offering us (Americans abroad) a tempting amnesty. But if you look more closely, it is rather more akin to urging us to commit financial suicide.’ Arguing that IRS can impose significant penalties for both unpaid income taxes up to six years and for failure to file FBAR, he warned that complying Americans can be economically destroyed.

The six month amnesty expired on 23 September. But IRS has just extended the deadline to 15 October. The amnesty protects Americans who come clean from possible criminal prosecution as well as substantial civil and fraud penalties.

The question noncompliant Americans abroad have to ask in an age of electronic technology and tax treaties, and in spite of portentous advice, is whether they are willing to continue rolling the dice.

Recently the friend of a client posed the question whether a US non-resident alien has to file a US tax return based on interest earned on an account in the US? To understand this tax filing requirement, it is first necessary to distinguish between resident and non-resident alien status.

A resident alien is someone who meets the green card or substantial presence tests. A green card holder is anyone who took no steps to revoke the card even though he or she is treated as a resident of a foreign country under a tax treaty. So according to this example, a non-resident alien can be treated as a resident alien for US tax purposes. The substantial presence test applies to any foreign person who a) was physically present in the United States for at least 31 days during the calendar year, and b) 183 days during the previous three calendar years (2008, 2007 and 2006). This latter criterion may be waived if the foreign person establishes that during 2008 he or she had a tax home in a foreign country and therefore had a closer connection to the foreign country of residence. It is possible while qualifying for substantial presence test in a tax year to be considered both a resident and non-resident alien.

Having established residency status, a non-resident alien may be obliged to file a US tax return on US source income. If the income is effectively connected with a US trade or business, then it is taxed at ordinary income tax rates and reported on line 9a of Form 1040NR (see www.irs.gov, forms and publications). Otherwise it is reported on line 76b and taxed at 30% unless superseded by tax treaty rate. Generally such income is reported by payers on Form 1042-S. When the withholding rate is correctly applied and no other US source income has been received, a non-resident alien is not obliged to file Form 1040NR.

1040NR filing is required of non-resident aliens where they have a trade or business in the United States, income is exempt from US taxation under a tax treaty, a deceased person or estate/trust is represented, or withholding amounts are incorrect. Resident aliens may file Form 1040, and is taxed the same as a US citizen.

US source interest income includes interest on bonds, notes or other interest-bearing obligations, interest paid by an entity engaged in a US trade or business, original issue discount, or government-source interest. Excludable interest income includes income not effectively connected with a US trade or business if from deposits with persons in the banking business; accounts with mutual savings banks, cooperative banks, credit unions, domestic building and loan associations, and other savings institutions chartered as savings and loan; and amounts held by an insurance company.

Generally speaking, if the income was derived from the conduct of a US business activity, then it is effectively connected.

RJ has been employed as a consular agent since 2003. As a foreign resident, he should qualify for the Foreign Earned Income Exclusion (FEIE) even though he does not report or pay taxes to the foreign country wherein he resides. To be sure, he consulted with IRS agents in Paris who told him that he qualified for FEIE because his employment was non-permanent and intermittent. As a result, RJ has taken the Foreign Earned Income Exclusion each year in filing his annual income tax return.

In 2008 he was audited by Internal Revenue Service for tax years 2006 and 2007. The auditor in a letter notified RJ that he was being denied FEIE and assessed Accuracy Penalties. On Form 886-A – EXPLANATION OF ITEMS – the auditor stated: ‘Per IRC 911(b)(1)(B)(ii), amounts paid by the United States or any of its agencies to its employees are not considered foreign earned income for the purposes of the foreign earned income exclusion.’

RJ, however, was bewildered. He had relied on the advice of IRS agents only to find their advice contradicted by another agent. In denying RJ his FEIE, the auditor was assessed additional taxes of $11,000 in 2006 and $9,000 in 2007, as well as Accuracy Penalties $2,200 ($11,000 x 20%) and $1,800 ($9,000 x 20%).

Accuracy penalties include 1) negligence or disregard of rules or regulations, 2) substantial understatement of income tax, 3) substantial valuation misstatement, 4) substantial overstatement of pension liabilities, and 5) substantial valuation misstatement in connection with gift or estate tax. In the auditor’s notice, the Accuracy Penalty was for substantial tax understatement per IRC Section 6662(d). The notice further stated: ‘If we increase your tax and the increase exceeds 10% of the corrected tax and is also equal to or greater than $5,000, the law requires an accuracy-related penalty due to substantial understatement of tax. The penalty is 20% of your tax increase.’

Human performance can be affected by a variety of factors such as age, attitude, physical health, state of mind, emotional state, and stressful events. To err is simply to be human. In addition to these contributing factors, accuracy errors in preparing a tax return occur due to missing tax documents, inexact records, mathematical mistakes, misinterpreting tax code or instructions, rush to meet filing deadlines, erroneous use of tax tables, etc.

IRS states that an Accuracy Penalty may only be decreased or waived if the taxpayer can 1) provide substantial authority (Internal Revenue Code, Regulations, Revenue Rulings, Revenue Procedures, etc.) used to treat disputed income or deduction; 2) show the facts supporting the treatment of disputed income or deduction; 3) submit a signed statement that outlines the facts supporting the treatment of understated income.

While it would appear heavy-handed that Congress should have armed the Internal Revenue Service with the power to assess Accuracy-related penalties and then allow limited defenses, taxpayers must exercise diligence in preparing their tax returns if they are to avoid the nightmare of IRS tax and penalty assessments.

Twenty years ago when the writer had a public tax practice in Santa Fe, New Mexico, he received a call from a shopkeeper on Canyon Road.  ‘I’ve received a notice from IRS. Can you help me with my taxes?’ Santa Fe is the capital of New Mexico and famous for its art community and its Mexican food.

Once at Tomasita’s near the old train depot, my brother and I had finished one of their great meals. As we were exiting through a very crowded lobby of people waiting to be seated, I hollered at my brother: ‘Sure was worth the 2 hour wait!’

Canyon Road climbs toward the Sangre de Cristo Mountains back of the old town plaza. The houses that were built there are adobe. Many have been converted into art galleries that attract tourists bent on acquiring art or adding to their art collections.

As a public accountant in that city of 60,000 inhabitants, I could count many clients from the small business and art community. Referrals were not unusual. So when this shopkeeper called, I soon learned that he had not filed any tax returns for a number of years. And so IRS was on the prowl, insisting he file the last three years. After a few moments of conversation in which he disclosed using one checking account for all his business activity, I advised:  ‘Put together for me three years of bank statements. We will first have to create year-end financial statements from those statements for each of the three years, and then from those statements prepare the tax returns.’

We met the following week. He had dutifully put together the statements. I discovered that he made and sold attractive decorator pillows. He rented a small space in a larger gallery to display his works.

In the coming week, the financial statements and tax returns were prepared. For each year, the shopkeeper had had a net profit of approximately $10,000.  His tax liability for each year, though, was over $2,500.  In 1988, the Social Security Administration published that the poverty level of a single person in America was someone who earned no more than $6,000 in a year.  Santa Fe being one of the most expensive small cities in America would have put this person at the poverty level.

The idea behind a graduated tax system is that everyone should contribute his or her fair share to the tax treasury regardless of living circumstances.  But should contributions be enforced when the income is at or near the poverty level?  It would perhaps be fairer if a tax structure were something like the following.  Suppose a person’s average income is $5,000 and his necessary expenses amount to the same sum, then no taxes should be collected from him.  If another person’s income is $10,000 and his necessary expenses are $5,000, then he could be assessed 10% since there will be no decline in his standard of living. If a third person has an income of $20,000 and his costs of living are determined to be $10,000, he should be assessed twice the amount or 20% of the person earning $10,000.  And if still another person earns $50,000 and his expenses are $20,000, then he should pay 30% of his income in taxes.  But if an indigent person has an income of $4,000 where the poverty level is determined to be $5,000 and he sacrifices to make his living but the fruit of his labor is inadequate, he should be helped from the treasury so as not to live in want.

So a fair graduated tax system would not impose taxes on the lower income earners. It would help those whose incomes are below the poverty level. And it would not impose excessive tax rates on middle income levels so as to encourage their productivity and contributing to economic growth.

As to high income earners, America between 1944 and 1963 imposed in most of these years 85% + on taxable income levels over $400,000 ($4,000,000 today).  So the idea that the wealthy should also pay their fair share was once acceptable.  But given the anemic condition of the economy and the treasury today, it could again become acceptable.  In America, the top bracket is 39.6%.

The history of capital gains treatment stateside is interesting. As well, it is reflective of how the American tax authority periodically tampers with the tax law. From 1913 to 1921, capital gains were taxed at 7%. In 1921, a rate of 12.5% was applied to assets held for two years or more. From 1942, investors could exclude 50% of gains on assets held for at least six months. In 1978, the exclusion was increased to 60% against which 28% tax was applied. Three years later, this tax rate was lowered to 20%. The Tax Reform Act of 1986 repealed the capital gains exclusion and raised the maximum tax rate to 28%. In 2003 the rate was reduced to 15% for the higher tax brackets and 5% for the two lower ones (rates that apply to 2007 tax returns). In 2008, 2009 and 2010, the tax rate on long term capital gains has been lowered to 0% for anyone in the 10% and 15% income tax brackets. After 2010, this situation will change. A Single taxpayer whose taxable income is less than $32,550 will pay 5% on long term capital gains in 2007; 0% from 2008 - 2010. A married joint filer’s taxable income can be $65,100 for the 5% rate in 2007.

To take maximum advantage of capital gains tax rates, investors need to understand what happens when there is an interplay between short-term and long-term gains, the distinction being for assets held for more than one year before sold versus assets held for less than a year. Long term gains are taxed at the favorable capital gain tax rates. Short term gains are taxed at ordinary income tax rates.So a sale can be long term. Or it can be short term. When both sales occur in a tax year, four possible outcomes can occur:

1. Long term gain with short term gain. The former is taxed at 5% or 15% depending on tax bracket. The latter is taxed with your other income up to 35%. 
2. Long term loss with short term gain. If the gain is bigger than the loss, you will be taxed up to 35%. If the loss is bigger, the resulting netlong term loss up to $3,000 for married joint filers can be taken to offset other income.
3. Long term gain with short term loss. If the gain is bigger, you would have a net long term gain taxed at favorable capital gains tax rates. If the loss is larger, the resulting net short term loss up to $3,000 applies as in 2) above.
4. Long term loss with short term loss. Long term losses offset long term gains while short term losses offset short term gains. But whenshort term losses exceed $3,000, you must use these up first to offset that ordinary income with the balance being carry-forwarded with the long term losses to a subsequent tax year(s).

One of the expat advantages of a later tax filing due date - 16 June 2008 - for the 2007 US federal income tax return is the extra time to put together those papers related to foreign taxes.  This 16 June due date can even be extended to 15 October by filing Form 4868.  Because IRS wants to tax US citizens wherever they reside on world-wide income, expats should gather certain tax-related documents.  The IRS website - www.irs.gov - in its booklet of instructions for Form 1040, discusses the reportable income items. 

While some expats have some US source income, they should pay particular attention to items of foreign income and corresponding taxes paid or accrued.  As income items rise, the possibility of being taxed twice - by both the foreign country and IRS - increases dramatically. 

US taxes can be offset by applying the Foreign Earned Income Exclusion, the Foreign Tax Credit and the Treaty Based Return Position (Form 8833).  Pay particular attention to putting together the following documents:

  Foreign Country of Residence -
    Earnings statement from foreign employer
    Foreign taxes paid and/or accrued
    Foreign tax return
    Income and expenses from self-employment (sole proprietorships and partnerships)
    Income from investments in foreign corporations
    Interest earnings from investment accounts
    Sales of stocks
    Rental income and expenses
    Income from installaments
    Bonuses and reimbursements
    NOTE:  All foreign income and expense items must be reported in US dollars

US source income -
    W-2 wage statement
    Employee-related reimbursed and non-reimbursed expenses
   1099 Dividend and/or Interest Statements
   Refunds of state income taxes
   Alimony received
   Earnings from self-employment
   Sales of investments
   Sales prices, dates of sales, cost bases, dates of purchases
   Income from Rental activities
   Income from K-1s (trusts, partnerships, corporations)
   Gains from other sales
   Note: Sale of residence carries a life-time exclusion: $500,000 married filing joint; $250,000 single
   1099 Pension income
   IRA distributions
    Traditional or Roth?
   Farm income and expenses
   Unemployment compensation
   Social Security
   Other income - prizes, gambling winnings, jury pay (see 1040 instructions, p. 24)
 
Reductions to World-wide Income
  Foreign earned income exclusion (See How to Qualify)
  Foreign tax credit
  Form 8833
  Expenses
    Education, health savings, IRA, alimony paid, student loan interest
    Other
      Medical costs, charitable contributions, casualties, state income taxes, property taxes, mortgage interest, job search (if
        employed)
    Dependent exemptions (Social Security numbers required)  

Tax preparation can be complex and challenging.  Most Americans untrained in tax preparation who attempt to prepare their own tax returns commit one or more errors on their returns.  But if the income items involve a pension, social security and some investment income, then one is not so apt to make a mistake.