No Required Minimum Distribution from IRA’s and certain other retirement plans for people over 70 ½ years of age. ( for 2009 only ) Normally, if a person misses taking one of their required distributions, there is a 50% excise tax imposed in addition to any normal tax due. ( For example, if your required distribution was $5000.00 and you failed to take it, you would owe the IRS $2500.00 plus any normal tax due. ) During 2009 anyone can skip their RMD, if they wish, and pay no tax or penalty regarding it. This may save some people from paying tax on their social security if their RMD amount was what was causing the tax on their social security in the first place (many times it is )

The annual gift- tax rose to $13,000.00, up from $12,000.00 in 2008. You can give as much as $13,000 to anyone you wish and to as many as you wish and neither you nor they have to worry about taxes or filing any forms.

For us that live and work abroad, our foreign earned income exclusion for 2009 is $91,400.00, up from $87,600.00 in 2008. Remember, the foreign earned income exclusion only covers earned income ( wages, self-employment income, tips, etc. ) and not investment income, dividends, interest, rental income, etc. Neither does it exclude social security and Medicare taxes ( combined 15.3% ) for self-employment income above $400.00. Self-employed includes ( as far as the IRS is concerned ) clergy and missionaries whose church or church organization has chosen not to with hold social security and Medicare taxes.

Speaking of those of us living abroad, I am going to outline the criteria for needing to file a tax return for 2008 and not needing to file a return. If you are married filing jointly and your gross income ( all income – earned income, investment income, interest, rentals, etc. ) was at least $17,900.00 ( $18,950 if one spouse is over 65: $20,000 if both are over 65 ) then you must file a return. If you are single and your gross income was at least $8,950.00 ($10,300 if you are 65 or older ) then you must file. Married or single, you may not owe any tax due to the foreign earned income exclusion mentioned above ( if all of your income was earned income ) but there would still be a penalty for not filing.

If you are married filing jointly and all of your gross income plus one-half of your social security add up to more than $32,000.00 ( more than $25,000.00 if you are single ) then you have to start adding a portion of your social security to your gross income. How much depends on how far over those figures you are.

Finally, if there is self-employment income of $400.00 or more, then you must file due to owing social security and Medicare taxes ( even though you may not owe any income tax ).

After covering rules like these , I am always forced to wonder; did they just put a group of monkeys in a room and give them darts to throw at words and numbers pasted on the wall – or did they actually create this nonsense on purpose. Your guess is as good as mine.

It may surprise you to know that because of his investment in a fir tree farm in Montana some years back, Santa is a non-resident alien (for U. S. tax purposes) and does some tax planning in December himself.

Seriously, for a lot of people, a little time spent at the end of the year concerning taxes can save a load of money in taxes not owed.

Some of the things that can be done at the end of the year to reduce taxes:

1.Start an IRA (from earned income); the maximum this year is $5000.00 ( and another $5000.00 for the spouse). If you are age 50 or older the max is $6000.00 (and $6000.00 for the spouse). Even if you can’t afford to tie up the money for a long period of time, you can “cash out” the IRA after you file (which creates a taxable event for 2009, of course) and with possible tax planning in 2009, “cover” the “cash out” with deductions or the possibility of lower income in 2009. In the meantime, you have created a $5000.00 deduction in 2008($10,000.00 with a spouse). This strategy is particularly effective if it puts you in a lower tax bracket this year, but not in 2009. There is an old rule in tax planning; ALWAYS delay paying taxes as long as legally possible.

2. Turn that new hobby you started this year (raising scorpions – for fun and profit) into a business; especially if there is a first year loss, as there is in most new business’. Be aware that the IRS states that if a business isn’t profitable in three years out of five that they can deem it a hobby. Also be aware that the IRS lost their case in federal court when they tried to enforce that rule. The court did not agree with that concept, stating that we all have the right to attempt to succeed at business as long as we like.

That notwithstanding, I once worked with a couple who each had a separate business and it just happened to turn out, purely by circumstance, that while he had $20,000.00+ losses each of the first two years, she made a profit in her business both of those years ( $10.00 the first year and $28.00 the second year). Then her business took a bad turn and lost over $55,000.00 over the next two years while his turned around a bit and showed a $19.00 and $36.00 profit. The fifth year, as it happened, he made a profit of $16.00 while she made a profit of $119.00. 

The end result was the IRS rule was satisfied (even though legally, it did not have to be) and the couple racked up net deductions in excess of $95,000.00 over the five years. Most of the losses were items they might have purchased anyway (but would not have been deductible without a business) or involved travel costs that they deemed were business related and therefore deductible. Everything was covered with the proper receipts and bookkeeping (which I highly recommend). All accomplished with proper tax planning.

3. For those couples where one is a U.S. citizen and the other is a non-resident alien (for U.S. tax purposes), there is the decision to be made as to whether to choose to treat the non-resident spouse as a U.S. resident. If you make this choice, you and your spouse are treated for income tax purposes as residents of the U.S. for your entire tax year. Whether to make this choice or not would depend on your individual circumstances (refer to IRS Publication 519, U.S. Tax Guide for Aliens). As one example, if the non-resident spouse were subject to the 30% tax on fixed or determinable income, it might be wise to make the election described above.

4. Converting an IRA (or a part of an IRA) to a Roth IRA (this subject was discussed in the September issue of Revue). This decision must be made by December 31. However, if later on you feel you made the wrong decision ( more income than you expected showed up in the forms you receive in January and February), you can change it back to an IRA with no tax consequences. That is called a recharacterization and can be done on or before April 15 of the year following the year of conversion (October 15 if you file for an extention). 

Once again, I will end my writing with a quote; this time from the late Louis D. Brandeis, U.S. Supreme Court Justice :

“Where I live in Alexandria, Virginia, near the Supreme Court building, there is a toll bridge across the Potomac River. When in a rush I pay the toll and get home early. However I usually drive outside the downtown section of the city, and cross the Potomac on a free bridge. If I went over the toll bridge and through the toll without paying I would be guilty of tax evasion. However, if I go the extra mile and drive outside the city of Washington to the free bridge, I am using a legitimate, logical and suitable method of tax avoidance. And, I am providing a useful social service as well.” ( the italics are mine)

stevenpittser@yahoo.com
cell phone in Guatemala 502-4374-1199

“ I have had income every one of those years, so I guess I should file, right?” he continued.
He was confiding this to me because I am a retired tax specialist from the States currently residing in Guatemala. My specialty is showing retired persons and/or small business owners ( two diverse groups, I realize ) how to legally reduce and avoid taxes. I stress the words “legally” and “avoid”.
As I mentioned to the gentleman above, the difference between tax avoidance and tax evasion is 5 years ( in Leavenworth ).

I explained to my friend above, that a U.S. citizen is expected to file a tax return, no matter where he/she lives in the world, if there has been any taxable income during that year.

That does not necessarily mean that he/she will owe any taxes ( especially if the proper planning has been done ). After hearing his details, I assured my friend, for example, that in his case he would owe nothing. He would also get back almost all the money that had been withheld from his pay during one of those years. He was quite happy to hear that, of course.

In future articles I will cover methods and strategies for small business owners that reduce and eliminate taxes. There are various means, depending on whether the business owned is located in the U.S. or outside the U.S.

For the balance of this article I am going to focus on retired persons and what I consider to be the worst ( and most common ) tax problem for retired individuals ——“Qualified Plan Accounts”. That includes, for example, IRA’s, 401-k’s, 403-b’s, SEP’s, ect. Every dollar removed from one of these plans is taxable and in many cases, causes tax on Social Security. The amount withdrawn can also place an individual in a higher tax bracket,causing still more tax to be owed.
It was actually quite ingenious on our government’s part to encourage us to set aside money in a non-taxable account and give us a tax deduction for doing so ( albeit, a very measley one ), knowing that at the age of 70 ½ , they would be forcing us to withdraw much larger amounts which would not only be taxable, but in many cases, would cause tax on Social Security and/or put us in a higher tax bracket. ( So much for the promise from President Roosevelt that “we would never pay taxes on our Social Security” )

Our “wiley” government officials came up with another brilliant “tax creating” idea in 1998. It came in two parts.

First, they gave us a new “qualified plan” called the Roth IRA (sponcered by a Senator Roth ). If you contribute to a Roth IRA, you receive no tax deduction, but the account grows tax free AND you can take the money out TAX-FREE !

Allow me to emphasize that point: you DON’T pay taxes on withdrawals from a Roth account and it does NOT cause tax on other income ( ie: Social Security ) A Roth account also goes tax-free to your children ( or anyone you designate as an heir ) at your death.

The second thing the government said was, in addition to being able to contribute to a Roth (from earned income ), we could also “convert” any of our IRA money ( or any “qualified plan” money that had first been transferred to an IRA account ) in any amount to a Roth account. We would have to pay taxes, of course, on the amount we “converted”. They also told us that the taxes owed on any amount “converted” in the year 1998 could be paid over the next 4 years in four equal installments.

There were many people who “converted” their entire IRA to a Roth account in 1998. That was a BIG mistake on their part ( but it created a HUGH windfall amount of tax revenue for the government ).

Their mistake was not “converting” IRA to ROTH —– that is a GREAT idea! It was how they “converted” from IRA to Roth. By mistakenly “converting” the entire amount in one year, they not only paid ( or owed over the next 4 years ) the HIGHEST tax bracket amount ( assuming a typical IRA account is over $150,000.00 ), but they also put themselves in the highest tax bracket possible on their other taxable income that year.

Most people don’t know that the IRS code allows us to “split up “ an IRA account into as many separate IRA accounts as we would like. For example, a $200,000.00 IRA in 1998 could have been split into four $50,000.00 IRA’s and one  could have been “converted” each year for the next 4 years. The total tax paid over the 4 years would be much less than the tax created with the single $200,000.00 “conversion”, because of a much lower tax bracket.
Also, by using proper tax planning, we could have planned for exemptions and/or deductions to cover the $50,000.00 “conversions”, thereby eliminating ( or at least reducing ) any tax on the “conversion”.

Actually, after years of research, I have developed a planning strategy that allows one to “convert” any amount of IRA money to a tax-free  Roth account and legally pay no tax on the “conversion”. A detailed explanation of the strategy is beyond the scope of this article, but suffice to say I have helped hundreds of people “convert” hundreds of thousands of dollars of IRA money to tax-free Roth accounts without a dollar of tax owed.
In that respect, the government’s “brilliant” tax-creating idea has “back-fired” on them. Oh well, what goes around, comes around.

stevenpittser@yahoo.com
cell phone in Guatemala 502-4374-1199

For those of us who own businesses (or provide a service) the IRS has a different set of rules for “self-employment income.” If you are self employed, then every dollar over $400 is taxable (and, of course, you must file). The good news is that if you qualify for the foreign earned income exclusion, you still don’t owe any INCOME tax, unless you make more than $87,500.

But now the bad news: Unlike wages earned outside the U.S., self-employment income outside the U.S. IS subject to Social Security and Medicare tax (total of 15.3 percent) on every dollar above $400. And, worse yet, the foreign earned income exclusion does NOT apply to Social Security and Medicare tax..                                                                 

So, you have a little widget business and you netted $20,000. You do qualify for the foreign earned income exclusion, so you don’t owe any income tax. However, you do have to file AND send a check to the IRS for Social Security and Medicare taxes in the amount of $2,999. ($19,600.00 x 15.3 percent).                                                                                   

There are several ways to avoid this problem; one of the simpler methods is to form a corporation, have all checks made to the corporation, and have the corporation pay you as an employee. Now you are governed by the “wage” rule, not the “self-employed” rule.     

I have had a person tell me that they didn’t feel that was “playing fair” – that everyone should pay their “fair share” (of taxes). My first inclination was to tell them that under the present tax structure, there isn’t any amount that I consider to be “fair.” I believe in a flat tax system or, better yet, a national sales tax. Instead, I referred them to a quote from Judge Learned Hand: “Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the Treasury. There is not even a patriotic duty to increase one’s taxes. Over and over again the courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible.”                    

I also agree with Arthur Godfrey, who said: “I’m proud to pay taxes in the United  States; the only thing is, I would be just as proud for half the money.”

stevenpittser@yahoo.com
cell phone in Guatemala 502-4374-1199