The 2011 tax-filing season has commenced with a host of new and renewed legislation. As such, it is imperative that you familiarize yourselves with certain concepts regarding both US and Israeli income tax law and how they may affect your personal situation. Proper tax planning and minimization of your taxes requires an analysis of many important issues, including the interplay between the US and Israeli foreign income tax credit rules, the foreign earned income exclusion rules, and also how the applicable provisions of the US – Israel income tax treaty affects you.
Delineated below are some areas of current US tax law, which may have an impact on your US tax return filings due in 2011. Please note that under the US child credit rules, you may be eligible to receive FREE, from the US Treasury, up to $1000 per child per year. In addition, under the Making Work Pay Credit each spouse on a joint filing may be eligible to receive up to $400. (As always, many restrictions apply and a tax advisor should be consulted in order to plan properly).
The US Child Tax Credit of up to $1,000 per eligible child potentially results in FREE money to you courtesy of the US federal government via a US check or direct deposit to your US bank account, even if no US income tax is due. If applicable, this credit may also be available to offset any potential US income tax liability. Taxpayers must have reportable earned income from wages or self-employment generated in Israel or in the US in excess of $3,000 depending on the year you are filing. The earned income of both husband and wife can be combined even if one spouse is not a US citizen. The non-citizen spouse requires a US tax identification number (TIN), which can be acquired by filing US Tax Form W-7. Children must be US citizens aged 16 and below and must possess a US Social Security number. Maximizing the child credit can be quite complicated since there are many factors to consider. In addition, the IRS has been conducting audits which may require verification of income. Amended returns may be filed back to the tax year 2007 (2007 amended returns must generally be filed by April 18, 2011).
The American Opportunity Credit expands and renames the existing Hope Credit. It can be claimed for qualified tuition and related expenses for any of the first four years of post-secondary education. The credit is up to $2,500 for those paying $4,000 or more in qualifying expenses for an eligible student. The credit begins to phase out for single taxpayers earning over $80,000 and for married taxpayers earning over $160,000. Forty percent of the credit is refundable which allows a taxpayer to receive up to $1,000 cash back for each eligible student even if no tax is due. You cannot claim the credit and the tuition and fees deduction in the same year. The credit is generally available for US universities and for certain foreign universities.
US Income Tax Rates are 10%, 15%, 25%, 28%, 33% and 35% respectively. The lower rates of 10% and 15% are available for the following taxable income levels: Single: up to $34,000; Married Filing Joint: up to $68,000. Under US tax rules enacted in the past few years, (often referred to as the "stacking rule"), investment income may be taxed at a higher bracket, especially, if the foreign earned income exclusion has been used.
Foreign Tax Credits may generally be utilized a) when Israeli or other non-US earned income exceeds the US foreign earned income exclusion, b) for Israeli investment or other income that is also taxed in the US (and vice versa), or c) if you are filing for the US Child Tax Credit. Conversely, since Israel also taxes worldwide income, the Israeli income tax authorities will generally provide you with a foreign tax credit on income that was sourced and first taxed in the US or in another country.
The Foreign Earned Income Exclusion has been inflation adjusted and rises to $91,500 per taxpayer. Thus, married taxpayers filing jointly, who meet certain requirements, may potentially exclude up to $183,000 of foreign earned income per tax return. However, one spouse may not utilize the unused portion of the exclusion of the other spouse and by electing the exclusion you may preclude eligibility for the US Child Credit. This exclusion applies only to work or self-employed income and does not apply to pension, investment income, rental or any other non-work income.
Self-employed Individuals need 40 credits (quarters) in order to qualify for future US Social Security retirement benefits. These credits can be earned even while living in Israel. If a taxpayer earns in excess of $5,000 during the tax year he/she can earn a maximum of 4 credits. This is primarily accomplished by:
i) being self-employed in Israel and reporting Israeli self-employment income on your US income tax return,
ii) working in Israel for a US entity and receiving a Form W-2 (employee) or Form 1099 (independent contractor),
iii) going to the US to work as an employee (W-2) or as a self-employed individual (1099).
Automatic Extensions are available until June 15, 2011 for taxpayers who reside overseas. Interest will be charged, however, from April 18, 2011 if there is a balance due on your US income tax return and penalties are calculated from June 15, 2011. Filing an extension will extend the time to file until October 15, 2011. It is strongly recommended that taxpayers, who owe income tax but do not file by June 15, pay their estimated tax balance due by said date, along with the filing of the extension. For the upcoming year, it is imperative that taxpayers pay estimated taxes on a timely basis in order to avoid estimated tax penalties.
The US - Israel Income Tax Treaty states that US citizens living as residents in Israel are generally eligible to exclude from their adjusted gross income US Social Security benefits received. This provision may result in substantial tax savings and even large refunds on your prior 3 years' income tax returns if you originally included Social Security benefits as taxable.
State and Local Tax Refunds may be available for taxpayers who may be unnecessarily filing resident State income tax returns after they moved to Israel. Having a bank account, brokerage account or driver’s license in a particular State does not automatically necessitate a tax filing in that State. However, if you have real estate, maintain a business, commute to and work in a particular State, or have any other activity considered a nexus (strong connection) to a State, you would generally only file a non-resident income tax return in that State. Big refunds for current or prior years may be available.
Alternative Minimum Tax (AMT) paid in prior years may be available as a refundable tax credit for those taxpayers who previously paid AMT or had a minimum tax carry forward to 2010.
Long Term Capital Gains (whether derived in the US, in Israel or in another country) apply to assets held for more than one year. The 2011 maximum tax rate is 15% (for 2010 the 5% rate for taxpayers in either the 10% or 15% income tax bracket drops to 0%). Capital losses are still fully deductible against capital gains, and any capital losses in excess of capital gains may fully offset up to $3,000 of ordinary income. Net capital losses in excess of $3,000 may be carried over indefinitely to future years. With the recent extension of former President Bush's tax cuts, these rates will remain in effect for 2011 and 2012. Israeli capital gains tax rules are significantly different than US rules.
Qualified Dividends are taxed from 0% to 15%, the same as long-term capital gains. Generally, US taxes paid on US investment income may be used to offset Israeli taxes (and vice versa) thus potentially avoiding double taxation. In order to realize your savings from qualified dividends, you should compare the US tax on your dividend income, which is taxed at 5% to 15%, versus the US tax on your interest income which may be taxed at up to the highest US marginal tax rate. With the recent extension of former President Bush's tax cuts, these rates will remain in effect for 2011 and 2012.
Standard Deduction amounts are: Single - $5,700; Married Filing Jointly - $11,400; Head of Household - $8,400. Taxpayers over the age of 65 may claim an additional deduction of $1,100 each, if married, or $1,400 if single. Taxpayers with qualifying deductions in excess of these amounts may itemize their deductions. Mortgage interest, real estate tax (arnona), Israeli income taxes, and certain charitable contributions paid to Israel sources may qualify as itemized deductions.
The Personal Exemption amount remains $3,650. In some cases, grandparents may claim their grandchildren as exemptions on their income tax returns if they provided at least half the support of the grandchild and the grandchild lived with the grandparent. In 2010 there is no limit for personal exemptions and itemized deduction, regardless of the amount of your AGI.
Gifting of up to $13,000 annually to your children or grandchildren is an excellent way to potentially reduce the value of your US taxable estate as well as future US estate income taxes. The gifting limit is $26,000 if your spouse joins you in making the gift. Due to recent changes in the US tax law, the Federal estate tax has been reinstated for 2010. The estate exemption amount will be $5 million per person in 2010 and 2011 with a top tax rate of 35%.
Tax Retirement Plans still exist in the form of traditional IRA’s (Individual Retirement Account) and Roth IRAs, as well as other types of savings plans. Traditional and Roth IRA's allow for contributions of up to $5,000 per year ($6,000 if you are age 50 or over). Contributions to Roth IRAs can be made even after age 70 1/2. Roth IRA withdrawals are generally tax free if certain conditions are met and include a 5-year holding period and an age requirement of 59 1/2. Potentially deductible IRA contributions can be made for taxpayers reporting compensation on their US income tax return, including those taxpayers who are filing for the US Child Credit.
Starting in the 2010 Tax Year there is no AGI (Adjusted Gross Income) limit for converting a traditional IRA to a Roth IRA. Conversions are fully taxable at your regular tax rate; however, under a special rule made for the year 2010, the tax due can be spread out over two years (half in 2011 and half in 2012).
"First Time" Homebuyers may still make an IRA withdrawal of up to $10,000 if single, and $20,000 on a jointly filed tax return ($10,000 for each spouse’s account) and still not be subject to the 10% early withdrawal penalty. The penalty will generally not apply if the funds are used within 120 days to buy, construct, or reconstruct a personal residence. (In addition, there are other situations, such as for medical or educational reasons when penalties may also be avoided).
Corporations are excellent tax planning vehicles, especially for taxpayers working outside Israel and in light of Israeli tax reform. "C" Corporation tax rates are 15% on taxable income up to $50,000, 25% from $50,001 - $75,000 and 34% from $75,001 - $100,000, with higher rates for higher taxable incomes. "S" Corporations and Limited Liability Companies ("LLCs") are called pass-thru entities and your pro-rata share of the entity's income is taxed at your individual income tax bracket.
A Foreign Bank Account Report (FBAR) must be filed yearly if you own or have authority over a foreign financial account, including a bank account, brokerage account, mutual fund, unit trust, or any other type of financial account. Under the Bank Secrecy Act, each United States person must file a Report of Foreign Bank and Financial Accounts (FBAR), with the US Treasury if
- The person has a financial interest in, or signature authority (or other authority that is comparable to signature authority) over one or more accounts in a foreign country, and
- The aggregate value of all foreign financial accounts exceeds $10,000 at any time during the calendar year.
Beginning in the 2011 Tax Year, under a new section of the Internal Revenue Code any individual with an interest in a foreign financial asset is required to attach a disclosure statement to their tax return if the total value of the foreign asset(s) exceeds $50,000. This would include financial accounts, foreign stocks and securities, interest in foreign entities and other financial instruments and contracts. You may be subject to a penalty of $10,000 for nondisclosure. This new form must be filed in addition to the Foreign Bank Account Report Form (FBAR).