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How investment in real estate can save on taxes?

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How investment in real estate can save on taxes?

Investing in real estate offers a multitude of tax benefits that can significantly reduce an investor’s tax liability. This article explores the various tax advantages associated with real estate investments, including depreciation, mortgage interest deductions, 1031 exchanges, capital gains exclusions, the impact of holding periods on tax rates, passive activity loss rules, the benefits of real estate professional status, and relevant tax credits or deductions.

Depreciation

Depreciation is a powerful tax benefit that allows real estate investors to deduct the cost of the property over its useful life. Under the Modified Accelerated Cost Recovery System (MACRS), residential rental property is depreciated over 27.5 years, while nonresidential real property is depreciated over 39 years. The Tax Cuts and Jobs Act (TCJA) introduced a new class of depreciable property known as “qualified improvement property” (QIP), which includes improvements to the interior of nonresidential buildings. QIP is depreciated over 15 years under the General Depreciation System (GDS) and 20 years under the Alternative Depreciation System (ADS) [4].

Mortgage Interest Deductions

Mortgage interest on loans used to acquire, construct, or substantially improve a qualified residence is deductible. For tax years 2018 through 2025, the mortgage interest deduction is limited to interest on acquisition indebtedness up to $750,000 for married taxpayers filing jointly ($375,000 for married individuals filing separately) [5]. This deduction can significantly reduce taxable income, especially for high-value properties.

1031 Exchanges

Section 1031 of the Internal Revenue Code allows real estate investors to defer capital gains taxes on the exchange of like-kind properties. To qualify, the properties exchanged must be held for productive use in a trade or business or for investment, and the exchange must be completed within 180 days of the transfer of the relinquished property [1]. This deferral can be a powerful tool for investors looking to reinvest their gains into new properties without immediate tax consequences.

Capital Gains Exclusions

The sale of a principal residence can qualify for a capital gains exclusion under Section 121 of the Internal Revenue Code. Taxpayers can exclude up to $250,000 of gain ($500,000 for married couples filing jointly) if they have owned and used the home as their principal residence for at least two of the five years preceding the sale [5]. This exclusion does not apply to vacation homes or rental properties unless specific conditions are met.

Impact of Holding Periods on Tax Rates

The holding period of a property affects the tax rate applied to capital gains. Short-term capital gains (on properties held for one year or less) are taxed at ordinary income tax rates, while long-term capital gains (on properties held for more than one year) benefit from lower tax rates, typically 0%, 15%, or 20%, depending on the taxpayer’s income level [7].

Passive Activity Loss Rules

Under Section 469 of the Internal Revenue Code, rental real estate activities are generally considered passive activities, and losses from these activities can only offset passive income. However, there are exceptions. For example, taxpayers who actively participate in rental real estate activities can deduct up to $25,000 of passive losses against non-passive income, subject to phase-out rules based on adjusted gross income [5].

Real Estate Professional Status

Real estate professionals can fully deduct rental real estate losses against other income, bypassing the passive activity loss limitations. To qualify, more than half of the taxpayer’s personal services must be performed in real property trades or businesses, and they must perform more than 750 hours of services in these activities during the tax year [5].

Relevant Tax Credits and Deductions

Several tax credits and deductions can benefit real estate investors:

  • Low-Income Housing Tax Credit (LIHTC): This credit incentivizes the development of affordable rental housing for low-income tenants.
  • Historic Rehabilitation Tax Credit: This credit provides a 20% credit for the rehabilitation of certified historic structures [4].
  • Energy Efficiency Deductions: Deductions are available for energy-efficient commercial buildings under Section 179D.

Conclusion

Real estate investments offer numerous tax benefits that can significantly reduce an investor’s tax liability. By understanding and utilizing depreciation, mortgage interest deductions, 1031 exchanges, capital gains exclusions, and the impact of holding periods on tax rates, investors can optimize their tax positions. Additionally, navigating passive activity loss rules, achieving real estate professional status, and leveraging relevant tax credits and deductions can further enhance the tax efficiency of real estate investments.

Author of this article Jack Chaudhary specializes in Individual, Corporate Tax returns, Foreign Taxes, Expats, Non-resident Taxes, Payroll, Crypto and e-Commerce. With the Enrolled Agent credential, Jack represents taxpayers before the IRS and state taxing authorities. He zealously advocates for his clients to ensure the best results are achieved. Book an appointment here with him for a consultation call.

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U.S. Tax impact for the Sale of Foreign Real Estate

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U.S. Tax impact for the Sale of Foreign Real Estate

The sale of foreign real estate by U.S. taxpayers involves several intricate tax considerations under U.S. tax law. This article will explore how such sales are treated, the reporting requirements, the application of the Foreign Tax Credit (FTC), the impact of currency exchange rates, the treatment of capital gains, relevant tax treaties, and the implications of the Foreign Account Tax Compliance Act (FATCA) and the Foreign Bank and Financial Accounts (FBAR) form.

Treatment of the Sale of Foreign Real Estate Under U.S. Tax Law

Under U.S. tax law, the sale of foreign real estate by a U.S. taxpayer is treated similarly to the sale of domestic real estate. The taxpayer must report the sale on their U.S. tax return and calculate the gain or loss from the sale. The gain or loss is determined by subtracting the adjusted basis of the property (original purchase price plus improvements and less depreciation, if applicable) from the amount realized on the sale (sale price minus selling expenses).

Reporting Requirements for U.S. Taxpayers

U.S. taxpayers must report the sale of foreign real estate on Form 1040, Schedule D (Capital Gains and Losses), and Form 8949 (Sales and Other Dispositions of Capital Assets). If the property was used for business or rental purposes, the sale must also be reported on Form 4797 (Sales of Business Property).

Application of the Foreign Tax Credit (FTC)

To mitigate double taxation, U.S. taxpayers can claim a Foreign Tax Credit (FTC) for foreign taxes paid on the sale of the real estate. The FTC is claimed on Form 1116 (Foreign Tax Credit). The credit is limited to the lesser of the foreign taxes paid or the U.S. tax liability on the foreign-source income. This ensures that the taxpayer does not pay more tax than they would have if the income were earned in the U.S.

Impact of Currency Exchange Rates on the Calculation of Gain or Loss

The gain or loss from the sale of foreign real estate must be calculated in U.S. dollars. This involves converting the purchase price, improvements, selling expenses, and sale proceeds from the foreign currency to U.S. dollars using the exchange rates in effect on the respective dates of the transactions. Fluctuations in exchange rates can significantly impact the reported gain or loss.

Treatment of Capital Gains and Applicable Tax Rates

Capital gains from the sale of foreign real estate are generally treated as long-term or short-term capital gains, depending on the holding period of the property. If the property was held for more than one year, the gain is considered long-term and is subject to preferential tax rates of 0%, 15%, or 20%, depending on the taxpayer’s income level. Short-term capital gains, for property held one year or less, are taxed at ordinary income tax rates.

Relevant Tax Treaties

Tax treaties between the U.S. and other countries can affect the taxation of the sale of foreign real estate. These treaties often provide relief from double taxation and may allow for the deferral of U.S. tax until the foreign tax is paid. Taxpayers should consult the specific tax treaty between the U.S. and the country where the property is located to determine the applicable provisions.

Implications of FATCA and Form 8938

The Foreign Account Tax Compliance Act (FATCA) requires U.S. taxpayers to report foreign financial assets, including foreign real estate held through a foreign entity, on Form 8938 (Statement of Specified Foreign Financial Assets). This form is filed with the taxpayer’s annual tax return if the total value of the foreign assets exceeds certain thresholds ($50,000 on the last day of the tax year or $75,000 at any time during the tax year for single filers; higher thresholds apply for married taxpayers filing jointly).

Requirement to Report on FBAR

If the foreign real estate is held through a foreign bank account or other financial account, the taxpayer may also need to report the account on the Foreign Bank and Financial Accounts (FBAR) form, FinCEN Form 114. The FBAR must be filed if the aggregate value of all foreign financial accounts exceeds $10,000 at any time during the calendar year.

Conclusion

The sale of foreign real estate by U.S. taxpayers involves complex tax considerations, including reporting requirements, the application of the Foreign Tax Credit, the impact of currency exchange rates, and the treatment of capital gains. Taxpayers must also be aware of the implications of FATCA and the requirement to report foreign financial assets on Form 8938 and the FBAR form. Consulting with a tax professional familiar with international tax issues is advisable to ensure compliance and optimize tax outcomes.

Author of this article Jack Chaudhary specializes in Individual, Corporate Tax returns, Foreign Taxes, Expats, Non-resident Taxes, Payroll, Crypto and e-Commerce. With the Enrolled Agent credential, Jack represents taxpayers before the IRS and state taxing authorities. He zealously advocates for his clients to ensure the best results are achieved. Book an appointment here with him for a consultation call.

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How are foreign pension funds taxed for US citizens ?

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How are foreign pension funds taxed for US citizens ?

Foreign pension funds are subject to complex tax rules for U.S. citizens, encompassing the tax treatment of contributions, earnings, and distributions, as well as the impact of tax treaties and reporting requirements. This article provides a comprehensive overview of these aspects, drawing on relevant sections of the Internal Revenue Code (IRC) and Treasury Regulations.

Tax Treatment of Contributions

Contributions to Exempt Trusts

For U.S. tax purposes, contributions to foreign pension funds that do not qualify as exempt trusts under IRC § 401(a) and are not exempt from tax under IRC § 501(a) are generally included in the gross income of the employee in accordance with IRC § 83. Specifically, IRC § 402(b)(1) states that contributions made by an employer to a nonexempt employees’ trust are included in the employee’s gross income when the employee’s interest in the trust becomes substantially vested [1].

Contributions to Nonexempt Trusts

If the foreign pension fund is treated as a nonexempt employees’ trust, the contributions are taxed under IRC § 402(b). Contributions made by the employer are included in the employee’s gross income when they become vested, as per IRC § 83. The value of the employee’s interest in the trust is substituted for the fair market value of the property for purposes of applying IRC § 83 [1].

Tax Treatment of Earnings

Earnings in Exempt Trusts

Earnings within a foreign pension fund that qualifies as an exempt trust under IRC § 401(a) and is exempt from tax under IRC § 501(a) are generally not taxed until distributed. This deferral of tax on earnings is a significant benefit of qualifying as an exempt trust [1].

Earnings in Nonexempt Trusts

For nonexempt employees’ trusts, earnings are generally includable in the employee’s gross income when distributed or made available, as per IRC § 402(b)(2). However, if the trust is discriminatory and fails to meet the requirements of IRC § 410(b), highly compensated employees may have to include the vested accrued benefit in their gross income annually [1].

Tax Treatment of Distributions

Distributions from Exempt Trusts

Distributions from an exempt trust are generally taxed under IRC § 72, which deals with annuities. The amount distributed is included in the gross income of the distributee in the year it is distributed [1].

Distributions from Nonexempt Trusts

Distributions from nonexempt employees’ trusts are also taxed under IRC § 72. However, distributions of income from the trust before the annuity starting date are included in the gross income of the employee without regard to IRC § 72(e)(5) [1].

Relevant Tax Treaties

Tax treaties can significantly affect the taxation of foreign pension funds. For instance, the U.S.-U.K. tax treaty provides that distributions from U.K.-based pension plans to U.S. residents are generally taxable only in the United States. The treaty also allows for certain amounts to be received tax-free if they would be exempt from tax in the U.K. [4].

Reporting Requirements

Form 3520 and Form 3520-A

U.S. persons with interests in foreign trusts, including foreign pension funds treated as trusts, must file Form 3520 and Form 3520-A. These forms report transactions with foreign trusts and the receipt of certain foreign gifts [6].

Form 8938

Specified foreign financial assets, including interests in foreign pension funds, must be reported on Form 8938 if the total value exceeds certain thresholds. This form is filed with the taxpayer’s annual income tax return [6].

FBAR (FinCEN Form 114)

U.S. persons with a financial interest in or signature authority over foreign financial accounts, including foreign pension funds, must file an FBAR if the aggregate value of the accounts exceeds $10,000 at any time during the calendar year [6].

Conclusion

The taxation of foreign pension funds for U.S. citizens involves intricate rules regarding contributions, earnings, and distributions. Tax treaties can provide relief and modify the general tax treatment, but compliance with reporting requirements is crucial to avoid significant penalties. Understanding these rules and seeking professional advice is essential for U.S. citizens with interests in foreign pension funds.

Author of this article Jack Chaudhary specializes in Individual, Corporate Tax returns, Foreign Taxes, Expats, Non-resident Taxes, Payroll, Crypto and e-Commerce. With the Enrolled Agent credential, Jack represents taxpayers before the IRS and state taxing authorities. He zealously advocates for his clients to ensure the best results are achieved. Book an appointment here with him for a consultation call.

 

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Expat Income Taxation in the U.S. and Form 2555 Exclusions

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Expat Income Taxation in the U.S. and Form 2555 Exclusions

Introduction

U.S. citizens and resident aliens living abroad are subject to U.S. income tax on their worldwide income, regardless of where they reside. This can lead to double taxation, where income is taxed both by the United States and the host country. To mitigate this, the Internal Revenue Code (IRC) provides mechanisms such as the foreign earned income exclusion and the foreign housing exclusion or deduction, which can be claimed using Form 2555. This article explores how expat income is taxed in the U.S. and the specifics of Form 2555 exclusions.

Taxation of Expat Income

Worldwide Income

U.S. citizens and resident aliens are taxed on their worldwide income. This includes wages, salaries, and other compensation for services performed abroad, as well as income from investments and other sources. The U.S. tax system requires these individuals to file annual tax returns and report all income, regardless of where it is earned.

Double Taxation Relief

To alleviate the burden of double taxation, the IRC offers two primary mechanisms:

  1. Foreign Earned Income Exclusion (FEIE): Allows qualifying individuals to exclude a certain amount of foreign earned income from their U.S. taxable income.
  2. Foreign Tax Credit (FTC): Provides a credit for foreign taxes paid on income that is also subject to U.S. tax.

Foreign Earned Income Exclusion (FEIE)

Eligibility

To qualify for the FEIE, an individual must meet the following criteria:

  1. Tax Home in a Foreign Country: The individual’s tax home must be in a foreign country. A tax home is generally the location of the individual’s main place of business or employment.
  2. Bona Fide Residence Test or Physical Presence Test:
  • Bona Fide Residence Test: The individual must be a bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year.
  • Physical Presence Test: The individual must be physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.

Exclusion Amount

For 2023, the maximum exclusion amount is $120,000. This amount is adjusted annually for inflation. If an individual qualifies under either the bona fide residence test or the physical presence test for only part of the year, the exclusion amount is prorated based on the number of qualifying days.

Foreign Housing Exclusion or Deduction

Housing Amount

The housing amount is the excess of the individual’s housing expenses over a base amount. Housing expenses include rent, utilities (excluding telephone charges), real and personal property insurance, and other reasonable expenses related to housing.

Base Housing Amount

The base housing amount is 16% of the maximum foreign earned income exclusion, calculated on a daily basis. For 2023, this amount is $19,200 annually or $56.60 per day.

Limits on Housing Expenses

The maximum amount of housing expenses eligible for the exclusion or deduction is generally 30% of the maximum foreign earned income exclusion, calculated on a daily basis. For 2023, this is $36,000 annually or $98.63 per day. However, this limit can vary depending on the location of the foreign tax home.

Form 2555: Foreign Earned Income

Purpose

Form 2555 is used to claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction. It helps determine the amount of foreign earned income and housing costs that can be excluded or deducted from U.S. taxable income.

Filing Requirements

To claim the exclusions or deductions, individuals must file Form 2555 with their annual tax return (Form 1040 or 1040-SR). The form must be completed and attached to the tax return to substantiate the claim.

Key Sections of Form 2555

  • Part I: General Information: Includes personal information, tax home details, and the type of exclusion or deduction being claimed.
  • Part II: Bona Fide Residence Test: Documents the period of bona fide residence in a foreign country.
  • Part III: Physical Presence Test: Documents the period of physical presence in a foreign country.
  • Part IV: Foreign Earned Income: Details the amount of foreign earned income received during the tax year.
  • Part VI: Foreign Housing Exclusion or Deduction: Calculates the housing exclusion or deduction based on housing expenses and the base housing amount.

Tax on Non-Excluded Income

If an individual claims the foreign earned income exclusion or the housing exclusion, they must figure the tax on their non-excluded income using the tax rates that would have applied had they not claimed the exclusions. This is known as the “stacking rule” and ensures that the excluded income does not push the non-excluded income into a lower tax bracket.

Conclusion

U.S. citizens and resident aliens living abroad can benefit from the foreign earned income exclusion and the foreign housing exclusion or deduction to reduce their U.S. taxable income. Form 2555 is essential for claiming these benefits and must be filed with the annual tax return. By understanding and utilizing these provisions, expatriates can effectively manage their U.S. tax obligations while living and working abroad.

Author of this article Jack Chaudhary specializes in Individual, Corporate Tax returns, Foreign Taxes, Expats, Non-resident Taxes, Payroll, Crypto and e-Commerce. With the Enrolled Agent credential, Jack represents taxpayers before the IRS and state taxing authorities. He zealously advocates for his clients to ensure the best results are achieved. Book an appointment here with him for a consultation call.

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Retirement Contribution Options for S-Corporation and LLC Owners

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Retirement Contribution Options for S-Corporation and LLC Owners

Retirement planning is a crucial aspect of financial management for business owners. S-corporation and LLC (Limited Liability Company) owners have several retirement contribution options, each with its own set of rules, benefits, and limitations. This article explores the various retirement plans available to these business structures, helping owners make informed decisions about their retirement contributions.

SEP-IRA Contributions for S-Corporations

Contribution Limits: For SEP-IRAs, the contribution limit is the lesser of 25% of the employee’s compensation or $66,000 for 2023, increasing to $69,000 for 2024. This allows significant contributions, especially beneficial for high-income earners.

Compensation Cap: The compensation cap for calculating contributions is $330,000 for 2023 and $345,000 for 2024. This cap ensures that contributions are proportional to the employee’s earnings.

Special Considerations for Self-Employed Individuals: For shareholder-employees of S-corporations, contributions are based on W-2 wages. Self-employed individuals must calculate their contributions based on net earnings from self-employment, considering the deduction for one-half of the self-employment tax.

Uniform Contributions Requirement: SEP-IRAs require uniform contributions for all eligible employees, meaning the same percentage of compensation must be contributed for each employee. This ensures fairness and compliance with IRS regulations.

Deductibility of Contributions: Contributions to SEP-IRAs are deductible as a business expense, reducing the taxable income of the S-corporation. This provides a dual benefit of saving for retirement while lowering current tax liabilities.

Retirement Contribution Options for LLCs

SEP-IRA: LLCs can also utilize SEP-IRAs with similar rules as S-corporations. The contribution limits, compensation caps, and uniform contribution requirements apply equally to LLCs.

SIMPLE IRA:

  1. Contribution Limits: Employees can defer up to $15,500 for 2023, increasing to $16,000 for 2024. Those aged 50 or older can make additional catch-up contributions of $3,500.
  2. Employer Matching Requirements: Employers must either match employee contributions dollar-for-dollar up to 3% of compensation or make a non-elective contribution of 2% of compensation for all eligible employees.
  3. Eligibility Criteria: SIMPLE IRAs are available to businesses with 100 or fewer employees who earned at least $5,000 in compensation in the preceding year.

Solo 401(k):

  1. Contribution Limits: Solo 401(k) plans allow for both employee deferral and employer profit-sharing contributions. For 2023, the total contribution limit is $66,000, increasing to $69,000 for 2024, with an additional $7,500 catch-up contribution for those aged 50 or older.
  2. Special Rules for Owner-Only Businesses: Solo 401(k) plans are ideal for owner-only businesses, providing high contribution limits and flexibility in contributions.

Defined Benefit Plans:

  1. Contribution Limits: Contributions are based on actuarial calculations and can be significantly higher than other plans, making them suitable for high-income earners.
  2. Benefits for High-Income Earners: These plans promise a specific benefit at retirement, which can be particularly advantageous for owners looking to maximize their retirement savings.
  3. Administrative Complexities: Defined benefit plans require ongoing actuarial assessments and are more complex to administer, often necessitating professional assistance.

Comparison of Options

Pros and Cons:

  1. SEP-IRA: 
    Pros: High contribution limits, simple administration, and tax-deductible contributions.
  • SEP-IRA:
  • Pros: High contribution limits, simple administration, and tax-deductible contributions.
  • Cons: Requires uniform contributions for all employees, which can be costly for businesses with many employees.
  • SIMPLE IRA:
  • Pros: Lower administrative burden, employer matching contributions, and eligibility for small businesses.
  • Cons: Lower contribution limits compared to SEP-IRAs and Solo 401(k)s.
  • Solo 401(k):
  • Pros: High contribution limits, flexibility in contributions, and suitable for owner-only businesses.
  • Cons: More complex administration compared to SEP-IRAs and SIMPLE IRAs.
  • Defined Benefit Plans:
  • Pros: Highest contribution limits, predictable retirement benefits, and significant tax advantages for high-income earners.
  • Cons: High administrative costs and complexity, requiring actuarial services.

Tax Advantages and Potential Deductions: All these plans offer tax-deductible contributions, reducing taxable income. SEP-IRAs and Solo 401(k)s provide significant tax deferral opportunities, while defined benefit plans offer the highest potential deductions.

Administrative Requirements and Costs: SEP-IRAs and SIMPLE IRAs are relatively easy to administer, with lower costs. Solo 401(k)s and defined benefit plans require more complex administration and higher costs, often necessitating professional management.

Flexibility in Contribution Amounts and Investment Choices: Solo 401(k)s and SEP-IRAs offer flexibility in contribution amounts and a wide range of investment choices. Defined benefit plans, while offering high contributions, are less flexible due to their structured benefit promises.

Conclusion

Choosing the right retirement plan depends on the business structure, size, income levels, and retirement goals of the owner. For S-corporations and LLCs, SEP-IRAs and Solo 401(k)s offer high contribution limits and flexibility, making them suitable for high-income earners and owner-only businesses. SIMPLE IRAs are ideal for small businesses with lower administrative needs, while defined benefit plans provide the highest contribution limits and predictable benefits for those willing to manage the complexity.

By understanding the options and their respective benefits and limitations, S-corporation and LLC owners can make informed decisions to secure their financial future and achieve their retirement goals.

Author of this article Jack Chaudhary specializes in Individual, Corporate Tax returns, Foreign Taxes, Expats, Non-resident Taxes, Payroll, Crypto and e-Commerce. With the Enrolled Agent credential, Jack represents taxpayers before the IRS and state taxing authorities. He zealously advocates for his clients to ensure the best results are achieved. Book an appointment here with him for a consultation call.

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When U.S. Citizens Inherit from Non-Resident Parents: Navigating the Tax Landscape

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When U.S. Citizens Inherit from Non-Resident Parents: Navigating the Tax Landscape

Inheriting assets from non-resident parents can be a complex process for U.S. citizens, involving a myriad of tax implications and legal requirements. Understanding these intricacies is crucial to ensure compliance with U.S. tax laws and to optimize the financial benefits of the inheritance. This article delves into the key considerations and steps U.S. citizens should take when inheriting from non-resident parents.

Understanding U.S. Estate and Gift Tax Rules

The U.S. tax system imposes estate and gift taxes on the worldwide assets of U.S. citizens and residents. However, non-resident aliens (NRAs) are subject to U.S. estate tax only on their U.S.-situs assets. These include real estate and tangible personal property located in the United States, shares of U.S. corporations, and certain debt obligations of U.S. persons.

Estate Tax Exemption for Non-Residents

Non-resident decedents are granted a limited estate tax exemption of $60,000 for their U.S.-situs assets. Any value exceeding this threshold is subject to U.S. estate tax, which can reach up to 40% for estates valued over $1 million. This exemption is significantly lower than the $12.92 million exemption available to U.S. citizens and residents in 2023.

Transfer Certificates and U.S. Bank Accounts

To transfer U.S.-situs assets from a non-resident decedent, a transfer certificate from the IRS is often required. This certificate assures that any applicable U.S. estate taxes have been paid or that no tax is due. Without this certificate, U.S. financial institutions may freeze the decedent’s assets to avoid potential liability for unpaid estate taxes.

Obtaining a Transfer Certificate

To obtain a transfer certificate, the executor or heir must submit Form 706-NA, “United States Estate (and Generation-Skipping Transfer) Tax Return (Estate of Nonresident Not a Citizen of the United States),” along with supporting documents. These documents typically include:

  1. A copy of the decedent’s will and any codicils.
  2. Death certificates.
  3. A detailed list of the decedent’s U.S.-situs assets and their values at the date of death.
  4. Any foreign death tax or inheritance tax returns filed.

The IRS generally processes these requests within six to nine months.

Income Tax Considerations

Inheriting assets from non-resident parents can also have income tax implications. U.S. citizens must report and pay taxes on any income generated by the inherited assets. This includes dividends, interest, and rental income from U.S.-situs properties.

Basis Step-Up

One significant benefit for heirs is the step-up in basis for inherited property. Under IRC Section 1014, the basis of inherited property is generally stepped up to its fair market value at the date of the decedent’s death. This step-up can significantly reduce capital gains taxes if the property is later sold. However, the application of this rule can be complex when dealing with foreign estates, especially if the property is not included in the decedent’s U.S. taxable estate.

Reporting Requirements

U.S. citizens inheriting from non-resident parents must comply with various reporting requirements to avoid penalties. Key forms include:

  1. Form 3520: This form is used to report the receipt of large gifts or bequests from foreign persons. Failure to file can result in significant penalties.
  2. Form 8938: This form is required for reporting specified foreign financial assets if the total value exceeds certain thresholds.
  3. FBAR (FinCEN Form 114): U.S. persons must file an FBAR if they have a financial interest in or signature authority over foreign financial accounts exceeding $10,000 in aggregate value at any time during the calendar year.

Estate Planning Strategies

To minimize U.S. tax liabilities, non-resident parents can employ various estate planning strategies. These may include:

  1. Gifting Assets During Lifetime: Non-resident parents can gift assets to their U.S. children during their lifetime, taking advantage of the annual gift tax exclusion ($17,000 per recipient in 2023). Gifts of intangible assets, such as stocks in non-U.S. corporations, are not subject to U.S. gift tax.
  2. Using Foreign Trusts: Establishing a foreign trust can provide tax benefits and asset protection. However, the trust must be carefully structured to comply with U.S. tax laws and avoid adverse tax consequences for the U.S. beneficiaries.
  3. Life Insurance: Proceeds from life insurance policies are generally not subject to U.S. estate tax, making them an effective tool for transferring wealth.

Conclusion

Inheriting from non-resident parents involves navigating a complex web of U.S. tax laws and reporting requirements. U.S. citizens should seek the guidance of experienced tax professionals to ensure compliance and optimize their financial outcomes. Proper planning and understanding of the relevant tax rules can help mitigate potential tax liabilities and ensure a smooth transfer of assets.

Author of this article Jack Chaudhary specializes in Individual, Corporate Tax returns, Foreign Taxes, Expats, Non-resident Taxes, Payroll, Crypto and e-Commerce. With the Enrolled Agent credential, Jack represents taxpayers before the IRS and state taxing authorities. He zealously advocates for his clients to ensure the best results are achieved. Book an appointment here with him for a consultation call.

Beneficial Ownership Information

Beneficial Ownership Information

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New Federal Reporting Requirements for Some Companies

This blog is to make you aware of reporting requirements that went into effect on Jan. 1, 2024, that may require a business entity to report its beneficial ownership information (BOI) to the federal government. Beginning Jan. 1, 2024, many companies in the United States will have to report information about their beneficial owners (the individuals who ultimately own or control the company) and company applicants (the individual(s) who directly files or is primarily responsible for the filing of the document that creates or registers the company). They will have to report the information to the Financial Crimes Enforcement Network (FinCEN). FinCEN is a bureau of the U.S. Department of the Treasury.

Do I need to report?

Most businesses are small businesses that may need to file. Your company may need to report information about its beneficial owners if it is: 

• A corporation, a limited liability company (LLC) or was otherwise created in the United States by filing a document with a secretary of state or any similar office under the law of a state or Indian tribe; or 

• A foreign company and was registered to do business in any U.S. state or Indian tribe by such a filing. Some entities are exempt from reporting. The BOI Small Entity Compliance Guide as lists exempt entities. Exemptions are based on business type, company size and whether it is an inactive entity.

How do I report?

Reporting companies will have to report beneficial ownership information electronically through FinCEN. Jain Consulting can help you remain in compliance and do the reporting. Please reach out to us here if you wish to avail our service.

When must I report?

Reports will be accepted starting on Jan. 1, 2024.

• If your company was created or registered before Jan. 1, 2024, you will have until Jan. 1, 2025, to report BOI.

• If your company is created or registered on or after Jan. 1, 2024, and before Jan. 1, 2025, you must report BOI within 90 days of notice of creation or registration.

• If your company is created or registered on or after Jan. 1, 2025, you must report BOI within 30 days of notice of creation or registration.

• If there is any change to the required information about your company or its beneficial owners in a BOI report that your company filed, your company must file an updated BOI report no later than 30 days after the date on which the change occurred.  

There are significant penalties for missing filing deadlines, including criminal (fines and/or imprisonment) or civil (monetary) penalties. There is a $500 per day penalty, up to $10,000, and imprisonment of up to two years for the willful failure to timely file initial or updated reports. It will be your exclusive responsibility to comply with CTA, including its BOI reporting requirements. 

Jain Consulting can help you remain in compliance and do the reporting. Please reach out to us here if you wish to avail our service.

IRA

Individual Retirement Account

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An individual retirement account (IRA) allows you to save money for retirement in a tax-advantaged way. An IRA is an account set up at a financial institution that allows an individual to save for retirement with tax-free growth or on a tax-deferred basis.

Not everyone has access to an employer-sponsored retirement plan. Even if you do have a retirement plan through work, like a 401(k), you may want to save additional money beyond the annual 401(k) contribution limits. If that’s the case, some of the best retirement plans for saving on your own are Individual Retirement Accounts (IRAs) and annuities.

There are several types of IRAs available:

  •  
TypesWHO IS IT BEST FOR?ELIGIBILITYKEY ADVANTAGES
Traditional IRAPeople who’d like to save on their own or supplement their retirement savings.Any individuals with taxable income.

• Contributions may be tax-deductible.

• Earnings grow tax-deferred.

Roth IRAPeople who want tax-free withdrawals in retirement.Any individuals with taxable income who earn $140,000 or less per year (or $208,000 if married filing jointly).

• Withdrawals and earnings are tax-free.

• You can withdraw your contributions before retirement without penalty.

 

Traditional 401(k)

Employees of for-profit companies.Qualifying employees designated by employer. Federal requirements determine who employer must offer plan to.

 

• Contributions are made on a pre-tax basis.

• Earnings grow tax-deferred.

• Some employers match your contributions.

Roth 401(k)Employees of for-profit companies.Qualifying employees designated by employer. Federal requirements determine who employer must offer plan to.

• Income earned on your contributions is tax-free.

• You can make withdrawals tax-free when you retire.

• Some employers match your contributions.

SIMPLE IRASmall businesses.Small businesses without access to another retirement plan.

• Employee contributions aren’t required.

• Employee is always 100% vested.

• Employer contributions are tax-deductible.

SEP IRASmall businesses and self-employed individuals.Any small business with one or more employees or anyone with freelance income.

• Higher contribution limits than other IRAs.

• Only employer makes contributions.

• Contributions are tax-deductible as a business expense.

More Details on each type of retirement investment Option:

Traditional IRA :

  • An upfront tax break of up to $6,000 in 2020 and 2021, plus an extra $1,000 catch-up contribution if you’re age 50 or older: Contributions may be deductible, thus lowering your taxable income for the year. It all depends on your current income plus whether you or your spouse has a workplace retirement plan.
  • Investment earnings are not taxed as long as the money remains in the protection of the account.
  • Withdrawals in retirement are taxed at your tax rate at that time.
  • Best for : Those who are in a higher tax bracket now than they think they’ll be in during retirement, as well as workers who do not have access to (or are not eligible to contribute to) a workplace-sponsored retirement plan. Here is our rundown of the best IRA accounts.

2021 — You are covered by a retirement plan at work

Filing Status

Modified adjusted gross income (MAGI)

Deduction Limit

Single individuals

≤ $66,000

Full deduction up to the amount of your contribution limit

> $66,000 but < $76,000

Partial deduction (calculate)

≥ $76,000

No deduction

Married (filing joint returns)

≤ $105,000

Full deduction up to the amount of your contribution limit

> $105,000 but < $125,000

Partial deduction (calculate)

≥ $125,000

No deduction

Married (filing separately)*

 

 

< $10,000

Partial deduction

≥ $10,000

No deduction

2021 — You are NOT covered by a retirement plan at work

Filing Status

Modified adjusted gross income (MAGI)

Deduction Limit

Single, head of household, or qualifying widow(er)

any amount

A full deduction up to the amount of your contribution limit

Married filing jointly or separately with a spouse who is not covered by a plan at work

any amount

A full deduction up to the amount of your contribution limit

Married filing jointly with a spouse who is covered by a plan at work

$198,000 or less

A full deduction up to the amount of your contribution limit

> $198,000 but < $208,000

A partial deduction (calculate)

≥ $208,000 or more

No deduction

Married filing separately with a spouse who is covered by a plan at work

 

 

< $10,000

Partial deduction

≥ $10,000

No deduction

  • Roth IRA :
  • While contributions are not deductible — meaning there’s no upfront tax break — withdrawals in retirement are completely tax-free.
  • The maximum annual contribution is $6,000 ($7,000 if age 50+). Eligibility to contribute to a Roth is based on your income
  • Roth IRA withdrawal rules are more lenient, allowing tax- and penalty-free withdrawals of contributions at any time. Taxes and penalties apply to withdrawing earnings before retirement, with a few exceptions.
  • Best for: Savers who anticipate being in a higher tax bracket in retirement, to take advantage of those tax-free withdrawals. A Roth is also a better choice than a traditional IRA if you might need to access some of the money before retirement age, although dipping into retirement savings early is not a good idea.

  • 2021

    Filing Status

    Modified adjusted gross income (MAGI)

    Contribution Limit

    Single individuals

    < $125,000

    $6,000

    ≥ $125,000 but < $140,000

    Partial contribution (calculate)

    ≥ $140,000

    Not eligible

    Married (filing joint returns)

    < $198,000

    $6,000

    ≥ $198,000 but < $208,000

    Partial contribution (calculate)

    ≥ $208,000

    Not eligible

    Married (filing separately) *

    Not eligible

    $6,000

    < $10,000

    Partial contribution (calculate)

    ≥ $10,000

    Not eligible

  • SEP IRA :
  • The first three letters stand for simplified employee pension. Even though it’s a type of traditional IRA, it is set up and funded for employees by an employer, who gets tax benefits for the effort. Within a SEP IRA, earnings grow tax-free and distributions in retirement are taxed. Other highlights:
  • Annual contribution limits are much higher than what’s allowed in other tax-favored retirement accounts — the lesser of up to 25% of employee compensation or $57,000 in 2020 and $58,000 in 2021
  • An employer must contribute equally (on a percentage basis of salary) to all employee accounts, including their own.
  • Contribution size may vary year to year based on the business’s cash flow but must always be equal for all eligible workers.
  • Employees are not allowed to contribute to the plan via salary deferral; must have worked for the employer in at least three of the last five years; and must have earned at least $600 in compensation during the year to be eligible.
  • Sole proprietors (aka Employee No. 1 and only) can open a SEP IRA for themselves.
  • Catch-up contributions for workers 50 and older are not allowed.
  • Best for : Small-business owners who want to avoid the startup and operating costs of a conventional retirement plan, as well as the ability to supersize their retirement stash and get a tax deduction on any contributions made for employees. Just be aware that if you’re both the employer and employee, it’s important to follow SEP IRA rules to avoid running afoul of the IRS

 

  • Spousal IRA :
  • IRS rules state that a person must have earned income to be eligible to contribute to an IRA. But there’s a workaround for married taxpayers: If one half of the twosome isn’t working — or brings in a very low income — you still can both contribute to your own separate IRAs (either Roth or traditional).
  • Couples must file a joint tax return and have taxable compensation to be eligible.
  • Contribution limits are the same as for a traditional or Roth IRA: the nonworking spouse can contribute up to $6,000, or $7,000 for those 50 or older, in 2020 and 2021. The working spouse can contribute the same amount to his or her own IRA.The total amount contributed to both IRAs must be the lesser of your joint taxable income or double the annual IRA contribution limit (e.g., $12,000 for those under 50).
  • The account can be funded with money from either spouse’s earnings but must be opened in the nonworking spouse’s name using his or her Social Security number.
  • Best for: Low-income or nonworking individuals married to someone who has earned income.
  • SIMPLE IRA :
  • The SIMPLE IRA (Savings Incentive Match Plan for Employees) is similar in many ways to an employer-sponsored 401(k). It primarily exists for small companies and the self-employed. Unlike the SEP IRA, employees are allowed to contribute to the account via salary deferral. Some plans even allow an employee to select the financial institution they want to use to hold their account. Tax-wise, SIMPLE IRA rules are much like those that apply to traditional IRAs. Other considerations:
  • Contribution limits are lower than for 401(k)s — $13,500 versus $19,500 in 2020 and 2021.
  • Employers are generally required to kick in up to a 3% matching contribution or a fixed contribution of 2% of each eligible employee’s compensation.
  • To qualify to participate in a SIMPLE IRA, an employee must have earned at least $5,000 during any two years before the current calendar year and expect to receive at least that amount in the current year.
  • Unlike the SEP, catch-up contributions are allowed: If you’re 50 or older, you can save an additional $3,000.
  • Unlike most workplace plans, participants can roll the money from the account into a traditional IRA after two years of participation in the SIMPLE IRA plan.
  • Early withdrawals from a SIMPLE IRA within the first two years of contributing to the account may be subject to a punishing 25% penalty (on top of regular income taxes).
  • Best for: Smaller companies with fewer than 100 employees. If you’re self-employed, you may be better off opening a SEP IRA for the higher contribution limits.
  • Self-directed IRA :
  • Self-directed IRAs (in the traditional and Roth flavors) are governed by the same eligibility and contribution rules as traditional and Roth IRAs except for one big difference: What goes in the account.
  • The other IRAs covered in this article typically limit investments in the account to common vehicles like stocks, bonds and mutual funds. In a self-directed IRA, you’re allowed to own assets such as real estate, hard assets like gold and privately held companies.
  • Some must-knows:
  • Setting one up requires a trustee or custodian who specializes in the less typical types of investments you’re interested in holding in the account.
  • The IRS does not allow holding things like collectibles and life insurance in the account.
  • There are many prohibited “self-dealing” transactions within a self-directed IRA (e.g., mowing the lawn or fixing the faucet in a rental property owned in the IRA) that the IRS deems equivalent to taking a distribution. These can trigger taxes and penalties on the entire account.
  • Best for: Experienced investors who want access to alternative investments such as real estate and nontraditional businesses. While there are benefits to using this type of account to save for retirement (mostly the potential for higher returns), do not pass go until understanding the risks of self-directed IRAs.

What Happens If You Contribute Too Much to an IRA?

If you aren’t careful with your IRA contributions, you can exceed the annual limits. People who are juggling multiple IRA accounts or set automated contributions too high could end up putting too much money in a Roth IRA or a traditional IRA.

If you’ve exceeded contribution limits, the IRS charges a 6% tax each year on the excess contributions in your account, unless you fix the situation. If you realize your error before you file your tax return, you may withdraw the excess contributions—including earnings—ahead of the tax filing deadline to avoid the 6% tax.

However, you may have to pay income taxes on the earnings and an additional 10% early withdrawal penalty on the amount of extra contributions you withdraw if you are under the age of 59 ½.  If you don’t catch the problem until after you’ve filed your tax return for the year, you can remove the excess contributions and file an amended return by October 15. If you miss the later deadline, you can still fix it by reducing next year’s contributions by the excess amount. But you’ll have to pay the 6% penalty until the excess contributions are corrected.

If you contributed too much to your IRA, it might be a good idea to talk with a tax professional or a financial advisor about setting up better ways to manage your contributions.

NOTE: For 2021, 2020 and 2019, the total contributions you make each year to all of your Traditional IRA’s and Roth IRAs can’t be more than:

$6000 ($7,000 if you’re age 50 or older), or If less, your taxable compensation for the year.

The IRA contribution limit does not apply to:

  • Rollover contributions
  • Qualified Reservist repayments

IRA contributions after age 70½

  • For 2020 and later, there is no age limit on making regular contributions to traditional or Roth IRAs.
  • For 2019, if you’re 70 ½ or older, you can’t make a regular contribution to a traditional IRA. However, you can still contribute to a Roth IRA and make rollover contributions to a Roth or traditional IRA regardless of your age.

 

Can I Withdraw Money Early from an IRA?

You can if your need is urgent but be prepared for a whopping 10% tax penalty on top of the income taxes due on the balance.That said, there are allowable withdrawals for certain expenses, like a first-time home purchase or educational expenses.18

IRAs are meant to be long-term retirement savings accounts. If you take money out early, you’re robbing your own retirement assets.

What Investments Can I Hold in an IRA?

Your choice is vast, with banks, investment companies, and brokerages all vying for your business. Each will offer a selection of IRA accounts, each made up of a mix of investments that may include mutual funds, stocks, exchange-traded funds (ETFs), bonds, and more.

You also have the option of opening a self-directed account that allows you to make all the investment choices. The IRS forbids only the riskiest types of investments like collectibles and precious metals.

What Happens to My IRA When I Die?

All IRA accounts require a named beneficiary. If you die before your IRA assets are exhausted, they will pass to your beneficiary. (For a married couple, the beneficiary is the holder’s spouse, unless the spouse agrees in writing that another beneficiary is named.)

If the beneficiary is under retirement age, they will be subject to the same IRA distribution and withdrawal rules.

Conclusion:

The shift of the private sector retirement system from one based predominately on traditional DB pension plans to one based mainly on DC plans would not have been workable without IRAs. Traditional IRAs are essential for preserving the tax-deferred status of assets in DC plans upon job change or retirement. They, and increasingly Roth IRAs, allow individuals to save for retirement or augment employer-sponsored retirement income arrangements. This adds greatly to the retirement security of millions of American families.

SEP-IRAs and SIMPLE-IRAs allow small employers without another pension plan to provide a retirement income plan without the administrative hassle and considerable cost of a regular ERISA covered pension arrangement. This allows them to compete for and retain high-quality employees.