Year-end tax planning tips & new tax law highlights for 2014

Josh Bennett talks with Ted Bauman for “Offshore Millionaire” about preparing for this year’s taxes, October 2014

Ted Bauman:
Welcome, listeners, to this month’s "Offshore Millionaire" call. I’m here with our good friend and Sovereign Society Advisor Josh Bennett who’s been a long-time participant in our Offshore Confidential series, and we’re here today talking about last-minute tax preparation. Josh, welcome. How are you doing?
Josh Bennett:
Fine. Thank you, Ted. Good morning.
Ted Bauman:
How’s things down in South Florida?
Josh Bennett:
Very, very nice. Our weather finally changed. The long, hot summer is finally over and it’s been a lot cooler the past couple of days. Everybody needs to come down and start their vacation here in South Florida.
Ted Bauman:
All right. I’m guessing you’re not down into the frost level like we were this morning in Atlanta. But, anyway, take his advice and go down into South Florida, folks.

We’re here talking about last-minute tax preparation. And, Josh, I know it’s never too late to do things to reduce your taxable income and reduce your tax obligations for the calendar year. But let’s start looking at any changes in this year. We know that the last couple of years have been pretty meager in terms of legislative change. Has anything happened this year on the legislative front, regulatory front? Any court rulings that we should know about?

Josh Bennett:
Well, I think the biggest change is the implementation by the government of the Foreign Account Tax Compliance Act (FATCA), also known as the “Fear and Total Confusion Act.”
Ted Bauman:
[Laughs]
That’s a good one. I hadn’t heard that, but that sounds about right.
Josh Bennett:
And that’s gone online, and it’s going to be much more difficult for US persons with foreign accounts not to comply and report their worldwide income, because now the foreign banks and the foreign trust companies, foreign financial institutions and foreign non-financial institutions, are withholding agents for the IRS; and they also have a duty to do their due diligence with regard to each client and foreign structure, and dig out all the US beneficial owners.

So as a result of FATCA going online, there also have been changes to the IRS Tax Amnesty program. There is a limited amnesty program if you meet certain requirements; namely, if the IRS does not contact you before petitioning the IRS to enter into the amnesty program, then you can come clean and report your income and pay penalties, file delinquent returns, and become compliant without potential prosecution. So we definitely would recommend the amnesty program.

There also was another change to the amnesty program which is important to note. Even though the penalty framework for the non-reporting of a foreign account increased from 27.5 percent plus other failure to file and interest penalties — failure to file the return penalties, the additional excise tax and post-penalty for failure to report the foreign account to the IRS was increased from 27.5 percent to 50 percent. But, what the IRS did, what the government did with this new amnesty program which we think was a good move and it was definitely needed, there’s a reduced 5 percent penalty as opposed to the 50 percent penalty for taxpayers who are non-willful. And the willful standard, like the rest of the IRS tax laws, is difficult for a taxpayer to prove that he wasn’t willful. But taxpayers who, let’s say, were born in the US or have a US passport, and as you’re aware, citizenship and a US passport, comes with it the worldwide tax reporting obligation, right?

Ted Bauman:
Right.
Josh Bennett:
So, for example, let’s say someone was born in the US. They have a US passport, and at a very young age, they move to a foreign country, and they work in the foreign country, and they haven’t filed tax returns, and they generate their income in the foreign country, and they really have no connection with the US, and we’re not aware of their worldwide income reporting responsibilities under the US tax code and filing the information returns, and if they didn’t open up an account in one of the designated Swiss banks where there’s a per se willfulness requirement assumed, then they might subject to the 5 percent reduced penalty.

So this is also something that one should explore, and the rules are such you only have to go back three years instead of eight years to file all the returns; and it’s streamlined. So I think that was a very, very good thing that the government realized that not every individual that’s a US citizen had the willful intent to avoid paying US tax and not reporting income on certain items or categories of foreign source income. So that was a very good thing.

There are also some other key changes for 2014 and beyond relating to Obamacare tax subsidies and how the credits work; also tax penalties for individuals not buying health insurance. The IRS gave some guidance on how they’re going to be assessed. Also, there are changes to certain key deductions in credits which won’t be available for 2014. One of those changes is an increase in the threshold for deducting medical expenses; and that was brought about by the Affordable Care Act too. Under the old rule, taxpayers who itemized could deduct medical expenses exceeding 7.5 percent of their AGI (adjusted gross income), and Obama Care has increased this threshold to 10 percent. That’s a change.

And there are also changes to individuals that have IRAs, and we also lost other popular tax breaks at the end of 2013. The higher education tuition deduction which allowed taxpayers to deduct between $2,000 and $4,000 of qualified tuition expense expired at the end of 2013, as did the health coverage care tax credit. Also, individual retirement account owners age 70-and-a-half and older can no longer distribute up to $100,000 of IRA funds tax free to charitable organizations. As of 2014, these distributions must be taxed as ordinary income to the account owner before they can go to the charity. Teachers are also losing an above the line deduction of up to $250.00 for unreversed educational expenses.

Ted Bauman:
That’ll hit my wife who is a teacher this year, so I’ll make note of that. Thank you.
Josh Bennett:
Also, homeowners might feel the pinch, and as of 2014, homeowners can no longer deduct mortgage insurance premiums as “interest.” The mortgage debt exclusion has expired, which allowed underwater homeowners to exclude from taxable income the amount of any mortgage debt forgiveness granted to them by a bank under Section 108 of the Internal Revenue Code. Cancellation of income by a bank or by a borrower has always been considered income since the early 1900s. A seminal Supreme Court case is US v. Kirby Lumber. But there were certain exceptions if the taxpayer was insolvent; or if the taxpayer filed for bankruptcy, then they didn’t have to recognize the cancellation of debt as income. One of the other exceptions was vis-à-vis, their principal interest deduction on their principal residence. And now, like I said, that exclusion has expired.
Ted Bauman:
Wow, wow.
Josh Bennett:
There are a few of the new laws and changes that have taken place in the tax world in 2014.
Ted Bauman:
How many of those are due to simple congressional inaction? Are there any of them that might be changed before the end of the year? I’ve heard some talk about that.
Josh Bennett:
For example, you mean —
Ted Bauman:
Well, I know that some of the problems — or some of the issues relate to the fact that Congress had not extended some of the tax provisions, and that there was some rumor that they might actually go back and extend them before the end of the year. You think there’s any truth to that?
Josh Bennett:
Oh, sure. That’s happened several years in a row, for example. Certain tax breaks like the homeowners that could deduct mortgage insurance premiums or the mortgage debt exclusion under Section 108 of the Internal Revenue Code, the cancellation of indebtedness extension. Congress could renew that in a flurry of legislation by year-end.
Ted Bauman:
So it sounds to me like it’s a good idea to pay attention to last minute developments at this stage.
Josh Bennett:
No doubt about it. No doubt about it. I mean there’s several planning tools that are tried and true that one can engage in on property taxes.
Ted Bauman:
On that score, with only a couple of months left to the end of the year, what should our listeners be doing right now to prepare for tax season? Assuming getting in touch with your tax attorney or tax accountant is probably number one. What should they be doing?
Josh Bennett:
The goal of tax planning is to arrange your financial affairs to minimize your taxes, right?
Ted Bauman:
Right.
Josh Bennett:
So there are three basic ways to reduce your taxes, and each methodology has several variations. So like you said, I would definitely arrange to meet with your accountant before year-end and try to do that sooner rather than later, because the accountants usually get very busy. Tax attorneys and accountants get very busy by year-end, so it’s something you don’t want to procrastinate. Adjusted gross income is a key element in determining your taxes, so you can try to reduce your income, contribute to IRA plans or 401(k) or similar retirement plans that work. This is always an excellent tool, and your contribution reduces your wages and lowers your tax bill.

You can also reduce your adjusted gross income through various adjustments to income. And adjustments are deductions, but you don’t have to itemize them on Schedule A of your 1040. Instead, you can reduce your adjusted gross income or AGI other ways. Like I said, adjustments include contributions to an IRA, student loan interest paid, accelerate expenses, alimony paid, and classroom-related expenses, and other business expenses which are deductible. So that’s a good way to try to reduce income, which then of course will reduce your tax liability.

Again, you can try to increase your deductions; and itemized deductions include expenses for health care, state and local taxes, personal property taxes such as car registration fees, mortgage interest, gifts to charity, job-related expenses, tax preparation fees, and investment-related expenses might be deductible subject to counsel from your tax advisor. One key tax planning strategy is to keep track of your itemized expenses throughout the year using a spreadsheet or a simple personal finance program. And the best strategies for reducing your taxable income is to itemize your deductions. And in summation, the three biggest deductions are the mortgage interest, state taxes, and gifts to charity.

Ted Bauman:
Right, right. What about prepaying 2015 expenses? Is there any scope to reduce 2014 taxable income by prepaying anything for next year?
Josh Bennett:
Well, what you could do is in addition to reducing your taxable income by accelerating your deductions, your tax deductions. And once you tweak your taxable income in such a way, it might be a good idea to focus on various tax credits or prepayments. Tax credits do reduce your tax, and there are tax credits for certain college expenses, and for saving for retirement, and adopting children. The best tax credits are for adoption and college expenses. Not everyone is in a position to adopt a child, but maybe they could take advantage of certain higher education classes and related tax credit. Again, I would probably avoid any early withdraw from an IRA or a 401(k) retirement plan because the amount you withdraw will become part of your taxable income; and on top of that, you might be subject to additional ten percent excise tax.
Ted Bauman:
Now we’ve spoken about opportunities to reduce tax. But what about the most common mistakes? Really, there must be some things that people get wrong. And what are the ones people should be watching out for now?
Josh Bennett:
I would just make sure that if you can, don’t accelerate income in 2014 if you had a banner year and you’re going to be paying increased taxes. If you can legally defer it until the following year, that might be an option. There are all these acceleration of income rules and when you’re in possession that you need to be aware of. Also, a good thing to do might be to increase your withholding so that you’ll have more taken out of your paycheck and you’ll get a bigger refund, but then you’ll decrease your wages that way. So that’s another way to reduce your tax bill. And I think most importantly, you want to make sure that all of the expenses are deductions that you’re contemplating taking are deductible expenses.
Ted Bauman:
I’m no expert, but I have heard a little bit about tax planning related to gifts versus estate taxes, particularly involving the tax basis of gifts versus things that go through your estate. Can you tell us a little bit about that?
Josh Bennett:
Yeah. This is an excellent time to engage in gift giving or by reducing your estate by setting up certain types of trusts: irrevocable gifts, family limited partnerships. There’s a whole slew of tax planning in the gift and estate tax arena. Credit shelter exemption amount from an individual’s estate and gift taxes is $5.3 million for 2014. So that would be $10.6 million for a married couple. This is a very, very high threshold.

So what does that mean? That means if properly utilized and both individuals, both married — I’m assuming that the people are married because you can maximize your gift by being married because you have 10.6 as opposed to 5.3. And at one time, I remember when I started practicing, the exemption amount was a million dollars and even less — $600,000 actually — and now it’s $5.3 million. So that means estate tax won’t be imposed upon an estate valued over the $10.6 million. There’s also portability which means if one spouse doesn’t use their entire $5.3 million; if an election is made, a timely election is made upon the first spouse’s death, the surviving spouse will be able to use the balance of the credit shelter or estate tax credit that wasn’t used by the pre-deceasing spouse.

Also, there are family limited partnerships, and different trusts and evaluations where you might be able to maximize that and use various insurance products to be able to maximize that gift and multiply it substantially by taking advantage of certain discounts: fraction ability of ownership interests, or it’s more difficult to sell, or minority interest credits. There are all these different credits that you could take and you might be able to get another 20 or 30 percent added onto the estate tax credits. But you want to make sure that you see an estate planner that is familiar with federal estate and gift tax planning. And also if you reside in an estate where there’s an estate and gift tax or an income tax, you want to make sure that you check or you seek estate planning counsel in your home state to make sure you’re minimizing legally your home state’s estate in gift or income tax liabilities upon that.

But it’s very, very important to be able to maximize the credits because there are a bunch of other credits to come into play; and if not planned properly, you’re going to lose one credit. That might make a difference when it comes upon the death of the second to die. Also, if you have a foreign spouse, there is other planning that we need to do. So there still is a myriad of estate and gift tax planning for people with sizable estates that they really need to seek professional advice.

Ted Bauman:
Gotcha. Now as you know, Josh, one of the things that I’ve written about in the upcoming Offshore Confidential report is deferred variable annuities; and we’d spoken about this earlier and you mentioned some of the differences between offshore and onshore annuities, and some of the things that aren’t different. Is there any advantage to setting up an offshore as opposed to onshore annuity?
Josh Bennett:
Well, I think annuities are excellent planning tools for a number of reasons. First of all, annuities and life insurance have true estate planning benefits where you could get tax qualified treatment when establishing the annuity, or buying the life insurance product and achieving legal deferral, whether it’s domestic or foreign, until a distribution is made. You also have to be very careful when you acquire offshore life insurance and annuity products because the tax treatment is different than onshore. So you really need to make certain that you work with a professional who understands insurance products, which knows what the responsibility is under the Internal Revenue Code, the sections, the code provisions dealing with insurance, to make sure that all the requirements and qualifications are met so you can achieve those tax objectives.

What I also like about offshore life insurance and domestic life insurance in annuity products; if you reside in a state like Florida and many other states, insurance and annuity products are exempt from credit or attack subject to fraudulent conveyance concerns. So the policy, and also the proceeds and the distribution or payments made from these policies are exempt from creditors’ claims. So I like the offshore products because that’s another layer of asset protection because of the annuity or insurance product is offshore, which makes it even more difficult for creditors to challenge. Life insurance and annuity products can offer increased investment options and flexibility otherwise not generally available to US persons as well as a coordinated investment strategy for you to achieve your international investment objectives. So you want to make sure though, like I said, that you deal with a foreign, if you’re going to buy these products, you want to make sure you deal with an insurance and annuity foreign company that their products are tested, they have a legal opinion relating to the tax deferral of their products, and that they qualify as life insurance for US tax purposes, and make sure that the differing tax treatment is managed.

There’s no better way to really provide greater asset protection. Also, you get the benefit of the tax-free buildup, and you also get the benefit of tax-free access to policy values and tax-free shifting among investment types, and tax-free death benefits for portfolio assets, and the true insurance benefit. They’re great products and I recommend them highly. Setting up an offshore trust which provides great asset protection and having that trust acquired annuity product, or an insurance product, or an annuity wrapper is an excellent way to achieve deferral until a distribution is made. And then when it goes through the trust, it’s a good way to get the payments back to the granter who might live in the US. If they have a creditor problem at said time in insurance products and annuity, distributions are usually exempt from creditors’ claims in most states.

So I can’t recommend the product highly enough. You just want to make sure that you’re tax compliant, fill out all the forms that are required. And there still most likely is going to be a foreign bank account reporting form or a FinCEN 114 informational return required in addition to a Form 8938 even if you’re able to legally achieve deferral.

Ted Bauman:
As a final question to you, Josh, you mentioned FATCA at the beginning of our conversation; and, clearly, one of the things that anybody with offshore accounts has got to do is not just be aware of the law in general, but there’s a filing requirement, isn’t there? It’s a form — I forget the number. Is that something that people need to be thinking about this year as well?
Josh Bennett:
FATCA is definitely on the books, it’s alive and well, and as far as the IRS and the US Government’s concerned, it’s one of the most important tax compliance enforcing tools in their arsenal. There are a bevy of forms which need to be required. And as I said earlier, the foreign financial institution or the foreign nonfinancial institution, the foreign trust company, for example, are all required to participate with the IRS and obtain a FICA taxpayer ID number to file all the forms and withhold 30 percent of US sourced income generated by a foreign entity with US beneficial owners, unless they are a cooperating FICA agent with the IRA or an intergovernmental agency agreement has been entered into between the US and the foreign country where the trust company or bank is established. But there definitely are a bevy of forms, and requirements, and know-your-customer rules which have to be complied with.

I recommend that any US person who goes offshore and does business offshore deal with a FICA-compliant offshore trust company or an offshore bank, because I think the problems are going to be grave if they deal with a nonparticipating fact of foreign institution. There could be potential withholding that shouldn’t apply even though the taxpayer is compliant and a bevy of other unintentional or intentional withholding that would be very difficult for them to get the funds back.

So we live in a transparent world. Everything needs to be reported and disclosed to the proper authorities. When going offshore, everybody needs to go through the myriad of anti-money laundering, and know-your-customer rules imposed by these foreign institutions in order to get an account open.

Ted Bauman:
Right, right, right. Well, folks, we’ve been talking to Josh Bennett, Esquire, a good friend of ours and advisor to Offshore Confidential about this year’s taxes, and how to reduce them, how to prepare for them. Josh, thanks very much for talking to us; and let’s hope business is good for you between now and the end of the year.
Josh Bennett:
Thank you, and I appreciate it, Ted, and God bless. Thank you.
Ted Bauman:
All right, take care.
Josh Bennett:
Bye, bye.
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