Foreign – Earned Income Exclusion

IRC Section 911.  Revenue Procedure 2010-40.  For 2011 a United States individual that is living abroad can exclude up to $92,900 of foreign-earned income.  To take this exclusion the taxpayer must satisfy one of two tests.

The bona fide foreign residence test or the foreign physical presence test.

The exclusion applies separately to spouses.  Therefore, if both of the spouses are qualified individuals, the two spouses together can exclude up to $185,800, as adjusted for inflation, from their income.

Remember, that all United States Citizens are taxed on a World Wide basis and must report their income and prepare a United States Income Tax Return.  If United States citizens have foreign bank accounts they must be disclosed to avoid criminal and civil penalties.  These issues are not the focus of this article, but foreign based United States Citizens must be aware of these issues.

Exclusion of Disability Income for Police Officer

IRC Section 104 provides that compensation for injuries and sickness are not taxable and are excluded from income.  In Bakken v. Commissioner, TCS 2011-55, the court concluded that the disability income of a police officer who was injured in the line of duty and became permanently disabled remained nontaxable under Section 104 when he reached the eligible retirement age under the plan.

Officer Bakken served on the police force for 18 years and was injured in the line of duty, becoming permanently disabled and unable to perform the duties of a police officer.  The Austin Policemen’s Benefit Association approved his application for a disability pension as a result of his injuries.  He was not qualified for retirement due to his age at the time the benefit was granted by the Association.  He was given the same benefit as someone that would have retired at the regular retirement age.  Once the officer reached retirement age the Association converted the payments to a pension payment and issued Bakken a 1099-R showing the payments as taxable.

The Tax Court held that since Bakken had completed less than 20 years of service when he attained age 50, he remained ineligible for retirement.  Thus, the character of the payments remained unchanged, and he was entitled to exclude his pension distribution from income.

Exclusion of Disability Income for Police Officer

IRC Section 104 provides that compensation for injuries and sickness are not taxable and are excluded from income.  In Bakken v. Commissioner, TCS 2011-55, the court concluded that the disability income of a police officer who was injured in the line of duty and became permanently disabled remained nontaxable under Section 104 when he reached the eligible retirement age under the plan.

Officer Bakken served on the police force for 18 years and was injured in the line of duty, becoming permanently disabled and unable to perform the duties of a police officer.  The Austin Policemen’s Benefit Association approved his application for a disability pension as a result of his injuries.  He was not qualified for retirement due to his age at the time the benefit was granted by the Association.  He was given the same benefit as someone that would have retired at the regular retirement age.  Once the officer reached retirement age the Association converted the payments to a pension payment and issued Bakken a 1099-R showing the payments as taxable.

The Tax Court held that since Bakken had completed less than 20 years of service when he attained age 50, he remained ineligible for retirement.  Thus, the character of the payments remained unchanged, and he was entitled to exclude his pension distribution from income.

IRS STILL FOCUSED ON FOREIGN INVESTMENTS IN THE COMING YEAR

The IRS has set its priorities for the coming year.  It is no secret, they are going after those who evade their responsibility to pay their taxes.  Foreign banks in bank secrecy jurisdictions have turned over literally thousands of names to the IRS to settle civil lawsuits brought by the United States Department of Justice in an effort to catch those that use foreign institutions to evade U.S. Tax obligations.
The IRS has given these types of taxpayers two opportunities to come forward voluntarily with voluntary disclosure initiatives which were done to give taxpayers fair notice that the IRS would no longer tolerate these types of foreign arrangements,
Approximately 19,000 taxpayers came forward and disclosed their foreign relationships through these two programs.
Now, the IRS plans a renewed effort to uncover hidden assets with new laws, new international information exchange agreements, and further use of the courts.  The IRS has found that there is approximately 96 percent compliance with the tax laws where there is accurate information reporting, and only 50 percent compliance where there is not.  It is a high priority of the United States to close this gap.
So beware and if you are one of the remaining taxpayers that has a foreign account that is not disclosed, see a tax attorney immediately to discuss your options.  Remember that the IRS intends to criminally prosecute these offenders in the future that did not come forward when they had the opportunity.

Potential of "Clawback" of Gifts made in 2011 and 2012

The President signed into law on December 17, 2010 the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010.  The Act reunified the Gift and Estate Tax when the maximum tax rate for both Gifts and Estates was set at 35 percent, and provided for a $5 Million applicable exclusion amount for both gift and estate tax purposes.  This new Act has the same problem as the old Act.  It has an automatic sunset provision and the law will then revert back to pre-Economic Growth and Tax Relief Reconciliation Act of 2001. 
If this happens the Gift and Estate tax rate will revert back to 55 percent with and applicable exclusion amount of $1,000,000 for gift and estate taxes.  The problem with this is that a clawback provision could be imposed for taxpayers that took advantage of the $5,000,000 gift tax exclusion in 2011 or 2012. 
If a clawback provision is applied in later years because the applicable exclusion amount goes down, the taxpayer will have to pay tax at the then current estate rate on gifts made in 2011 and 2012 on the difference between the $5 Million exclusion used in those years and the then current exclusion amount.
This is an uncertain area of the law and practitioners and their clients must be made aware of the potential for this to occur in the future.  It is likely that Congress did not intend for a clawback to occur, but this does not change the fact that those that might be affected should address the issue in their estate plans. 
We still do not have guidance from Congress in this area of the law, and until we do there will be uncertainty in the markets.  Hopefully, Congress will see the light and clarify this issue.

Transferee Liability - Paying Someone Elses Taxes!

It is bad enough these days paying our own taxes, but being responsible for someone elses taxes - how could that be.  Yet, it is true that you can be held responsible to pay someone elses taxes and sometimes without even knowing that this could happen to you.
Section 6901 of the Internal Revenue Code provides a method for the IRS to collect on an unpaid tax liability "at law or in equity" of a transferee of property.  This allows the IRS to proceed to collect the tax that the transferror owed from the transferee in the same manner as that of a delinquent taxpayer pursuant to the provisions of IRC Section 6901.  How the IRS actually uses this provision will depend on your state law regarding transferee liability.
As mentioned, the liability can be established "at law or in equity."  In reality, the most common approach for the IRS is in equity.  The transferee liability in equity is based on the law of fraudulent conveyances.  To find transferee liability in equity, the IRS must prove the following elements:  1) the taxpayer - transferror transferred property to the transferee for less than full and adequate consideration; 2) at the time of the transfer and at the time transferee liability is asserted, the taxpayer-transferror was liable for the tax; 3) the transfer was made after liability for the tax accrued, whether or not the tax was actually assessed at the time of the transfer; 4) the taxpayer - transferor was insolvent at the time of the transfer or the transfer left the taxpayer-transferor insolvent; and 5) the IRS has exhausted all reasonable remedies against the taxpayer - transferor.
If these elements are met the IRS can assert transferee liability and proceed to collect the tax due from the transferee.

Tax Implications of Short Sales and Foreclosures

Mr. Lively will be presenting "Tax Implications of Short Sales and Foreclosures" on Wednesday, May 18, 2011 before a group of realtors.  The focus of the presentation will be:

• How to deal with cancellation of debt issues
• Understanding the difference between recourse and non-recourse debt
• Computation of the potential capital gain on a short sale
• Various other tax aspects of short sales

This seminar is sponsored by Bank of America and the Kevin Budde Team.