Daddy’s little tax benefit

Daddy's Little Tax Deduction Onesie
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Last week, my wife and I welcomed our second child to this world.  It was a wonderful experience and no less fascinating than the first time I bore witness to such an event.  Aside from all the good feelings and smiles, there are important tax implications of this birth that must be addressed.  We will explore the actual and potential impacts on our federal tax liability as a result of the arrival of our little angel.

Dependency Exemption:

Parents of a dependent child like us are entitled to take a dependency exemption on their tax return ($4,050 for 2017).  This is a direct reduction to taxable income.  Cha-ching!  However, this amount is subject to a phase-out for “high income” taxpayers (between $313,800 and $436,300 for Married Filing Joint).  To me and my wife, this translates to about $2,025 in tax savings (assuming a 25% bracket).

Child Tax Credit/Additional Child Tax Credit:

Subject to a 7-item test, many taxpayers can get up to $1,000 per child in the form of a tax credit.  Unfortunately, this credit is subject to a phase-out as well ($110,000 to $130,000).  In addition, the credit is refundable if you have sufficient earned income to cover any excess portion of the credit over your tax liability.  Many proud parents will get to knock a few dollars off of their tax bill.

Earned Income Tax Credit (EITC):

Certain “low income” taxpayers that had already been eligible may be able to take better advantage of the EITC by having an additional child.  There are different tiers for the credit for those that have from 0 to 3 or more children so your new arrival may put you into the next tier.  This will not benefit my family, but can be a significant boon for those that are eligible.

Child and Dependent Care Tax Credit/Flexible Spending Account:

Married taxpayers that both have earned income and have expenses paid to a care provider in excess of those paid by their employer for a dependent child can also receive a nonrefundable credit.  There are provisions in the credit that allow for spouse that is a student, seeking employment, and/or disabled to still be eligible to take the credit.  The amount of the credit is 20% to 35% of up to $3,000 (or $6,000 if you have 2 or more children) of the expenses paid, phased over $15,000 to $43,000 of income.  This sounds complicated, but bear with me – assuming we will hit the $3,000 cap for each child (and we will), this credit will be worth $1,200. It may not sound like much, but I’ll take any help I can get; the cost of daycare is painful.  Married taxpayers can also set aside up to $5,000 in pre-tax dollars to a flexible spending account.  It is important to note that those funds must be used on qualified expenses in the same year they are set aside or they are lost forever.

Aside from adjusting to sleepless nights and sibling rivalry, we also have to consider the tax ramifications of our fourth family member.  There are additional federal and state tax implications to consider, such as saving for college (hoping for scholarships… fingers crossed), student loan interest, and college tuition credits, but the latter two are down the road a ways.  For now, we will just have to recognize the advantages that are available to us to help us best plan for the future.  Please take this moment to appreciate the simple pleasure of sleeping through the night.


evan_2Evan Piccirillo, CPA is a Tax Supervisor in Raich Ende Malter & Co. LLP’s Long Island office. Evan specializes in high net worth individuals, as well as closely-held corporations, S-Corporations, and small businesses. Contact Evan at epiccirillo@rem-co.com or (516) 228-9000.

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Regarding That Disregarded Entity…

The Treasury Department has clamped down on a key reporting exemption that was previously enjoyed by foreign-owned, single-member limited liability companies (SMLLCs).  This cDisregard second thoughthange has significant impacts on any foreign person or entity with holdings in U.S. SMLLCs that are disregarded for federal income tax purposes.  Previously, these entities were exempt from the comprehensive record maintenance and associated compliance requirements that applied to 25% foreign-owned domestic corporations.  Now, substantially any transaction between U.S. domestic disregarded entities and their foreign owners, including any of the owner’s related entities, may be reportable.

These regulations are part of a larger effort by the Treasury Department to increase financial transparency.  Entities subject to these regulations will continue to be treated as disregarded for other federal tax purposes.  The Treasury Department explained that there is a class of foreign-owned U.S. entity (typically SMLLCs) that has no obligation to report information to the IRS or even obtain a tax identification number.  According to the government, these “disregarded entities” could be used to shield the foreign owners of non-U.S. assets or bank accounts.  By treating domestic disregarded entities that are wholly owned by a foreign person as a domestic corporation separate from its owner (for these limited reporting and compliance requirements), the regulations enable the IRS to determine the existence and magnitude of any tax liability and share information with tax authorities in other countries.

Requirements
Previously, certain disregarded entities and their foreign owners may not have had an obligation to file a tax return or obtain an Employer Identification Number (EIN).  The final regulations require foreign owned domestic disregarded entities to:

  • Obtain EINs from the IRS
  • Annually file Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business
  • Identify “reportable transactions” between the LLC and any related parties, including the LLC’s foreign owner
  • Maintain supporting books and records

Regulations
These rules treat U.S. disregarded entities as stand-alone foreign-owned domestic corporations.  Therefore, they are now required to file Form 5472 with respect to reportable transactions between the entity and its foreign owner or other foreign related parties. Transactions are reportable as if the entity were a corporation for U.S. tax purposes. These entities also are required to maintain records sufficient to establish the accuracy of the information return and the proper U.S. tax treatment of such transactions.

Please see the regulations for examples of reportable transactions that require reporting, elimination of certain reporting exemptions, and overlap rules affecting controlled foreign corporations and foreign sales corporations.

Tax Year
The final regulations require the domestic reporting corporations to have the same tax year as their foreign owner if that foreign owner has an existing U.S. reporting obligation. If the foreign owner has no U.S. return filing obligation, then the domestic reporting corporation must report on a calendar year basis.

Effective Date
The final regulations are effective December 13, 2016, and apply to tax years beginning on or after January 1, 2017, and ending on or after December 13, 2017.


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Lisa S. Goldman, CPA is Partner-in-Charge of Wealth Management at Raich Ende Malter & Co. LLP, with more than 20 years’ experience serving Fortune 500 corporations and privately-owned companies in the real estate, manufacturing, and consumer products industries. She specializes in international taxation and in providing services for high-net-worth individuals and their businesses. Ms. Goldman is a trust and estate practitioner (TEP) under the auspices of STEP and is a member of the NYSSCPA’s International Taxation Committee and the AICPA Tax Division. She frequently writes and lectures on international tax topics. Reach Lisa at 212-944-4433 or lgoldman@rem-co.com.

Voluntary Disclosure Programs: A Saving Grace

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Being a good tax citizen is important for businesses. However, businesses do not always adhere to that notion in practice. When a taxpayer does business in a jurisdiction, the decision to comply with applicable tax law is many times governed by the risk of exposure. This is especially true when businesses operate in multiple jurisdictions; compliance is assessed on a case-by-case basis. The cost burden of compliance resulting from registering to do business and filing tax returns in every required state can outweigh the benefits of the activities performed in those jurisdictions. Perhaps at that point, the decision not to register or not to file is made by the taxpayer and business goes on. However, over time the risk of exposure for not filing due to tax liability and mounting interest and penalties may grow to an unacceptable level. In addition, not registering to do business may have certain legal repercussions that can interfere with operations.

The questions then become:

  • Should I start filing now?
  • Should I have started filing already?
  • If I don’t file, will the tax man come after me?
  • What if the taxing authority requires me to have registered previously?
  • What if information requested from prior years reveals additional liability?

Luckily, many states have a viable answer: Voluntary Disclosure Programs. These programs allow a taxpayer to come to the taxing authority, with hat in hand, and diminish some of the exposure. Specifics vary by state, but generally the taxpayer is forgiven of penalties in exchange for payment of tax and interest due over the applicable look-back period. Look-back periods can also vary, but most fall into a 3- to 4-year range. Other conditions include, but are not limited to:

  • Registering to do business with the appropriate department
  • Continued future compliance
  • Not having been contacted in the past by that jurisdiction
  • Not currently being under audit

A taxpayer can anonymously apply to most programs through a representative (usually their accountant or lawyer). Once accepted, the taxing authority will set forth a timeline and list of what the applicant must do in order to complete the agreement. Generally, a signed document disclosing the identity of the taxpayer and outlining required compliance must be sent. The tax returns, tax due plus interest that apply to the look-back period must also be submitted.

Voluntary disclosure programs offer a path to compliance that can limit a significant amount of exposure. If you believe that you are noncompliant and your exposure risk is too high for comfort, you should consider entering into a voluntary disclosure program via a trusted representative.


evan_2Evan Piccirillo is a Tax Supervisor in Raich Ende Malter & Co. LLP’s Long Island office. Evan specializes in high net worth individuals, as well as closely-held corporations, S-Corporations, and small businesses.
Contact Evan at
epiccirillo@rem-co.com or (516) 228-9000.

The Dreaded “PFIC” Rules: How to Limit the Damage

Proceed with Caution
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In a world that is becoming smaller, money-making opportunities present themselves all over the globe.  However, with said opportunity comes the obligation to pay taxes.  Otherwise prudent investors can find themselves in a precarious tax situation when they discover that they have been investing in what the U.S. tax rules refer to as “PFICs,” or Passive Foreign Investment Companies.  PFIC investments come with a unique set of compliance rules, and failure to meet these requirements can come with a hefty tax bill and/or penalties.

What is a PFIC?

There are two tests to determine if a foreign corporation falls into the PFIC category:

  • The Income Test: 75% or more of the corporation’s gross income for the taxable year is passive income. Passive income includes, but is not limited to, dividends, interest, royalties, rents, and annuities
  • The Assets Test: 50% or more of the corporation’s total assets are passive assets (based on average market value, or adjusted basis if qualified and elected)

How is a PFIC taxed?

So you determine that the foreign corporation is subject to PFIC rules.  There are three main ways the U.S. Government can tax a PFIC investment:

  • “Excess Distributions” Regime
  • Qualifying Elected Fund “QEF” Election
  • “Mark-to-Market” Election

By default, a PFIC will fall under the excess distribution method.  Tax recognition under this regime is not triggered by income earned but rather by distributions received. An excess distribution is a distribution that is greater than the base amount, defined as 125% of the average actual distributions received from the three prior years (or less, if owned for less time).  Once the base amount is determined, any part of the current year distribution that is above the base amount is considered excess.  The base amount is taxed as ordinary dividends, but the excess distribution is allocated to the entire holding period and taxed at the highest tax bracket for each year, thereby eliminating the deferral of yearly tax amounts.  There is also an interest charge associated with the excess distribution, calculated at the underpayment rate, which is the AFR short term rate plus 3%.  This would be considered a penalty regime, since you have been deferring foreign income from the U.S. Government, and as such they charge you interest to make up for it.  This default method is complex and cumbersome, to say the least.

Limiting the damage

Generally, the reporting for a PFIC is the responsibility of the first U.S. taxpayer owning the investment.  If this is the first year owning the PFIC, you can (and should – depending on your tax situation) make the QEF election to report all income currently.  A QEF election will treat the investment in the manner similar to that of a domestic mutual fund.  Your pro rata share of interest and dividends will be taxed at ordinary income tax rates and capital gains at the capital gains rate, even if you did not receive any distributions for the year.  Any distributions that you receive subsequently from the previously taxed income would be received tax free to you.  Important: a QEF election can generally only be made in the first year owning the investment.  There are retroactive elections and ways to “purge the PFIC taint,” thereby regaining the ability to make a QEF election, but those concepts are outside of the scope of this blog.  You should, however, be aware that they are available as a potential tax strategy.

If the QEF election cannot be made, another possibility to limit the damage would be the “Mark-to-Market” election.  This election was created to extend the current year income treatment that the QEF election offers for those investors that were unable to elect QEF.  If the PFIC stock is marketable (that’s an important qualification), you can elect to pick up the excess in fair market value over adjusted basis of the stock as ordinary income in the taxable year.  Your basis in the stock adjusts  accordingly in the year the income is recognized.  If there is a decrease in fair market value, losses can be taken to the extent of prior “unreversed inclusions”.  Prior unreversed inclusions are prior year mark-to-market gains that were previously picked up as income.  Any losses above and beyond the unreversed inclusions are lost.

The PFIC rules are extremely complicated, and we’ve only scratched the surface of navigating potential compliance issues.  If you think that you may have investments subject to the PFIC rules, you should reach out to a trusted professional to discuss your options.


joe_6Joseph DeMartinis is a Tax Supervisor in the firm’s Long Island office. He specializes in taxation of small and medium size businesses, their owners, inpatriates, expatriates, and high net worth individuals.