Expat Tax Help Online

Several weeks ago this writer was in Spain consulting with a dual citizen of both the United States and France.  Happily Mme Palu announced that in 2004 she had inherited oil stock valued at $600,000 from her mother, a citizen of the United States.  Having sold the same stock last year, Mme Palu was now investing the proceeds in Spanish property which she intends to eventually pass on to her daughter.  ‘Now I don’t want to pay any taxes on this inheritance,’ she firmly said.

According to U.S. tax law, the value of a decedent’s bequest is its fair market value at the time of death.  So the price at which Mme Palu sold the stock in 2004 would have approximated its value on the open market.  Therefore, she would have experienced very little gain or loss on sale.  And since the value of mom’s estate in the United States was less than the Unified Credit of $1,500,000, her estate would also have incurred no estate taxes.

However, because Internal Revenue Service defines Gross Estate as ‘the value of all property in which you had an interest at the time of death,’ Mme Palu’s estate upon her death will have to include all of her world-wide property.  If she dies in 2005 with a world-wide estate valued at $3,000,000 after allowable deductions, IRS will assess $695,000 in estate taxes, which is just over 46 cents for every dollar after the Unified Credit is applied (3,000,000 - 1,500,000 x .4633 = 694,950).

Mme Palu will have to prepare an American Will designating her daughter as heir to her estate.  When the daughter inherits, she will be obliged to pay Spanish inheritance taxes on any property located in Spain.  The top marginal tax rate is 34% on estates valued above €797,555 plus €199,291 in taxes from the lower marginal rates.  In France, the inheritance tax is paid by inheritors of the estate of a French resident or the French assets of a non-French resident.  Therefore, as long as Mme Palu does not reside in France or owns no property in her native country, her daughter will owe no inheritance taxes there (the top rate of which is 40% of estates exceeding €1,700,000 in value).

Like Spain, Portugal applies inheritance taxes only on property located within its borders.  But expatriated Brits who have not acted to establish a new domicile outside their home country can be liable to 40% tax against the value of their world-wide estate above £263,000.  Internal Revenue Service will allow as credit any inheritance taxes paid to a foreign country.

Mme Palu, who was a bit astonished at the complexities of inheritance tax laws, will probably maintain property only in the U.S. and Spain in order to avoid too much confusion.  If she does some estate planning, she can protect her estate from being eroded by inheritance taxes.

‘One more thing,’ Mme Palu added.  ‘My mother gifted me the stock just before she died.  She acquired the stock from her husband’s estate when he passed away in 1965.’  OH DEAR!!  IRS has this to say about that:  To figure the basis of property you (mme Palu) receives as a gift, you must know its cost basis to the donor (Mme Palu’s mother) before it was given to you.

After some discussion, we estimated that original basis to be $50,000.  Therefore, Mme Palu will pay capital gains taxes on $550,000 ($600,000 - $50,000).  Why, oh why, didn’t her mom speak with a U.S. tax specialist?  She died within two months of gifting her stock.

For a number of years, Money Magazine would hold a contest between fifty tax preparers representing every state in the union. The publisher would provide each preparer with the same tax data in the role of a fictitious client. In most years, the results of each return were different – no two were identical.

In spite of the fact that each tax return was prepared using tax software, the differences in each return was because the judgment and training of no preparer was the same. Concepts of accounting can vary even among those who have studied the subject. What constitutes cash income and what expenses are deductible. Is income recognized in the year incurred or invoiced? Are expenses 100% deductible or must some formula be applied based on usage? Does the taxpayer materially participate in the activity? How are passive activity losses applied? When is a business declared a hobby and the deductions consequently denied? What are the qualifications for taking the foreign earned income exclusion? What happens when the exclusion amount is exceeded? What about medical costs related to a nursing home or elderly parent?

As there are over 1,700 pages in the Internal Revenue Code and perhaps three times this number in the Regulations, the challenges of tax preparation can be daunting. The best a tax preparer can do is prepare a tax return based on verifiable evidence provided by the client so that in the event of audit the return is defensible.

Not infrequently will an American expatriate prepare his or her own tax return. Tax software such as Turbo-tax costs around $20 to $35 and can be purchased on-line, or at www.amazon.com. It takes the novice step by step through the preparation process. Software or even manual preparation requiring little skill owing to a fewness of income flows is manageable. But throw in a few questions like those listed above and tax preparation can quickly turn unmanageable.

Any self-employed American expatriate can qualify for the Foreign Earned Income Exclusion.  Unlike an employed expat, however, a multitude of complex issues arise concerning what can be deductible against foreign income.  Consider tax home versus main home.  Suppose you provide a consulting service from your main home in your foreign country of residence, but your work takes you stateside where you work for six weeks in the offices of a client in Baltimore Maryland.  There you generate 80% of your earnings in 2007.  Do these earnings qualify for the Foreign Earned Income Exclusion.

As long as you report and pay taxes on these earnings to the foreign tax authority, they should qualify.  But what about expenses for lodging and meals?  If IRS considers Baltimore your tax home, these expenses are not deductible.  IRS publication 463 states: ‘Generally your tax home is your regular place of business or post of duty, regardless of where you maintain your family home. . . . your tax home (can be) your main place of business.’  But elsewhere IRS states:  If you expect an assignment or job to last for one year or less, it is temporary.  In this instance, those lodging and meal expenses would be deductible.  As long as the auditor agrees.

Residents of foreign countries, including American expatriates, are often required to report and pay taxes on world-wide income.  A resident is anyone who has been physically present for 183 days.  So even though foreign earnings up to the $87,500 foreign earned income exclusion (FEIE) are excluded from US taxation, most foreign countries will tax those and other earnings of residents.

Generally when reporting foreign earnings stateside, the best advantage is to apply FEIE rather than the Foreign Tax Credit (FTC) on foreign earnings below the FEIE threshold.  Once the threshold is met, FTC can then be applied against foreign taxes paid or accrued in order to avoid US taxation over $87,500.  But as income rises, the complex calculations to arrive at FTC for the tax year are not always enough to fully avoid being double taxed.  But for the moderately wealthy, FTC does its job 100%. 

Qualifying for the Foreign Earned Income Exclusion (FEIE) is relatively simple.  First, your tax home must be in a foreign country through a qualifying residency period.  Your tax home is where you are indefinitely engaged as an employee or self-employed person.  Second, you must have had foreign earned income:  salary, self-employment, and/or employer-provided meals, lodging or car. as well as certain allowances (Publ 54).  Third, under the Bona Fide Residency Test, you must have been residing in one or more foreign countries for the entire tax year (usually calendar).  Under the Physical Presence Test, you must have been physically present in one or more foreign countries for at least 330 days during the calendar or fiscal year or else 12 months starting or ending in 2007.  These rules apply to US citizens and US resident aliens.

Once foreign residency is established, earnings are considered foreign even if sourced from the United States.  Foreign income above the $87,500 threshold is subject to US taxation.

In determining whether to file a tax return, the Foreign Earned Income Exclusion does not count.  Although for 2007, $87,500 in foreign earned income can be excluded from taxation by the exclusion, the income earned in a foreign country is still counted against your Filing Status.  Suppose you are married and earned $80,000 abroad.  This income would be excluded from taxation by the foreign earned income exclusion but not from reporting on a tax return.  $80,000 exceeds the Filing Status amount of $17,500 for a couple who would file jointly.  Failure to report this income can result in IRS denying the foreign earned income exclusion and thus taxing this already taxed foreign income stateside.

A 2007 U.S. tax return must be filed if your world-wide gross income exceeds your Standard Deduction and Exemption amount(s) according to your filing status:

Single                                                $8,750
  65 or older                                     10,050
Head of Household                          11,250
  65 or older                                      12,550
Qualifying widow(er)                      14,100
  65 or older                                      15,150
Married filing jointly                       17,500
  One Spouse 65 or older                18,550
  Both Spouses 65 or older             19,600
Married Filing Separately               3,400