Happy New Year Everyone!
As is customary this time of year, we’ve been busy preparing for the upcoming tax filing season! This is also the time of year when we enjoy looking back and giving thanks for the many blessings we have received throughout. With great sincerity, thank you for your service to our country. I hope you enjoy a warm holiday season and a safe and prosperous 2019!
The 2018 tax filing season begins in just a few weeks. A list of the information we’ll need to prepare your taxes can be found at the end of this letter. For returning clients, we already have most of your personal information so we will just need your 2018 documents and an update of any important changes. As a reminder, we are frequently asked if we do tax work for those who have moved back to the U.S. or left the contracting world. We do! Regardless of where you are living or working in the world, we will do our best to minimize your tax bill and provide you with relevant advice. Please feel free to forward this to anyone you know who could use some tax assistance.
What follows are reminders, tax highlights and observations from 2018 and a look forward to how the major tax legislation that was passed in 2017 applies to contractors and expats.
• Our website is a good starting place for new clients to familiarize themselves with taxes for expats and contractors. It can be found here: www.HSTaxCPAs.com.
• FATCA (Foreign Account Tax Compliance Act) and FinCen Form 114 – If, in 2018, you had foreign bank accounts with a combined value in excess of $10k at any time or foreign financial holdings (or signature authority) in excess of $50k, you may have a separate filing requirement. Also, if in 2018, you received a gift or other transfer of funds or assets from a non-US person or entity (like a trust or corporation, etc.) you may have a reporting requirement. If any of these cases apply to you please let us know prior to the filing deadline of April 15, 2019.
• ACA (Affordable Care Act) – Absent any exemption, the ACA requires those individuals who did not carry minimum healthcare insurance coverage during the year to pay a penalty (this is referred to as the “individual mandate”). In 2018 the penalty is 2.5% of taxable income (unless the minimum is larger). There are many exemptions for the penalty. The biggest two affecting most of you will be whether or not you get care through the VA in which case you are exempt, or if were overseas long enough to claim the foreign earned income exclusion. Importantly, the recent tax legislation reduces the individual mandate penalty to zero beginning with the 2019 tax year.
• IRS notices – If we file your return and you get a notice, please send it to us. In most cases the IRS just needs some additional information from your employer to remove the charges and we don’t charge for this service.
• Identity theft and filing false tax returns – As in years past, the frequency of this abuse increases each year and 2019 will be no exception. Thieves steal personal info online or obtain it from taxpayers themselves and use it to file false refund claims. During the last few filing seasons, the IRS delayed issuing many early claims and larger refunds to double check them in an effort to minimize the number of false refund claims. In addition, they sent out many identification verification letters which caused additional delays of refunds. They have not indicated that the 2019 filing season will include the same delay but the IRS can make such a change at any time. As tax preparers, there is nothing we can do to avoid decisions like this but I would advise you to file as soon as you get all of your tax information together.
• To minimize the threat of ID theft, always use best practices by never clicking on any unsolicited emails from people you don’t know or strange ones from people you do. Also, the IRS will never call you or send you an email. Anyone who calls you and says they are from the IRS is running a scam. Do not provide any personal information to anyone who has reached out to you.
Hughes Szuberla CPAs will be a using a Secure Client Portal starting in 2019:
To help protect you going into the 2018 filing season we are incorporating a Client Portal. There are many benefits to using the Portal but the primary purpose is increased security. The Portal includes secure document transfer so we encourage all clients filing with us to use it going forward. Once you register your account you will be able to login through our website and upload your tax documents, pay invoices, sign e-file authorizations and schedule meetings with us. In addition, we will be able to send your final 2018 tax returns with the efile authorizations through the Portal. We will be sending links to clients that filed with us in 2017 the first two weeks of January. If you do not receive a link or would like it sent sooner please send a request to email@example.com.
Major tax legislation was passed on December 20, 2017. All changes have now taken effect. Additionally, most of the changes that affect individuals are temporary and will automatically expire after 2025. Here are a few highlights from the bill that may affect you:
• Doubles standard deduction ($12,000 for single filers and $24,000 for married), eliminates personal exemptions and increases the child tax credit to $2k per child.
• Changes income tax brackets and tax rates.
• Repeals deduction for moving expenses other than for Members of the Armed Forces.
• Limits state and local income tax and property tax deductions to $10k.
• Repeals deduction for tax preparation fees and unreimbursed employee expenses.
• S Corporation and Partnerships (LLCs) will be allowed a 20% deduction of business profits subject to certain limitations.
Audits and the IRS:
IRS audits of the foreign earned income exclusion generally remained low for 2018. We don’t know if or when they will be back so it is always a good idea to make sure you are able to substantiate the claims made on your return. Here are some best practices and reminders:
• It is critically important that you retain copies of your diplomatic passport and regular passport, overseas orders, travel itinerary confirmations, LOAs, overseas expense receipts or credit card statements, visas and anything else that can prove you were overseas and/or in a combat zone. Keep these for at least 5 years. Do not turn in your passports without making a scanned, color copy of them. Further, time spent in Canada and Mexico counts as foreign time but unless you fly into either country, you won’t get a passport stamp which will leave you unable to prove time spent in those countries without other evidence.
• Should they choose to do so under audit, the IRS has the ability to obtain an entry report from DHS to verify your time in the U.S. It is not always accurate. This is why you must keep your own evidence of travel dates/locations.
• As many of you are aware, the IRS announced in August 2018 that certain U.S. citizens or resident aliens working as contractors in designated combat zones may now qualify for the foreign earned income exclusion. However, the wording of the headline in their announcement has produced significant confusion. It is critically important that you understand that one must still have at least 330 days overseas or be a bonafide resident to qualify to claim the exclusion.
The sole purpose of the new law was to remove the ambiguity regarding having an “abode” in the US while meeting the 330 days overseas or bonafide residency test for those working in combat zones. Prior to this change, having an abode in the US precluded one from confidently making the claim because of the IRS’ faulty interpretation of “abode”. This change eliminated the IRS’ ability to deny a legitimate claim to the exclusion.
Foreign Tax Credit (Afghanistan, Iraq and Other Foreign Withholding Taxes)
• Tax paid to a foreign country can be claimed as a credit on your U.S. tax return (Form 1116).
• The credit can be combined with the exclusion if you qualify, but the foreign tax credit is partially reduced when both are used.
• Claiming both the foreign tax credit and the exclusion generally maximizes the tax benefit of working overseas. However, if you are not sure you can support the exclusion claim, you shouldn’t report it.
Answers to Frequently Asked Questions
This section will look familiar to many of you but for our newer clients, the following information should provide clarity on the most frequently asked questions we received this year (but feel free to visit the Resources – Frequently Asked Questions at www.HSTaxCPAs.com for more information):
1) For 2018, you should be eligible to receive up to the first $103,900 of your foreign earned income free of income tax provided that one of the following scenarios applies:
a. You were physically present in a country other than the U.S. for at least 330 full days during a 365 day period. This 365-day period does not have to be the same as the calendar year. When it is not, a prorated exclusion can be obtained by extending your tax return until the 330 day period lapses. Your income tax return will report all the income you received during the 2018 calendar year but your physical presence test period may run, as an example, from June 2018 to June 2019 or any other dates inside 365 days. You CANNOT have less than 330 days overseas during a 365 day period and still take a prorated exclusion based on this 330 day rule. This is a persistent myth that is absolutely untrue.
b. You were a bona fide resident of a country other than the U.S. during 2018. As in the past, many of you received residency visas from Iraq and Afghanistan this year, but this is not enough to qualify you as a bona fide resident under IRS guidelines. To file as a bona fide resident, you must be a foreign resident for the full year beginning Jan 1st. Based on our audit experience, this claim has attracted more scrutiny for those claiming a combat zone as their residence. Bona fide residency outside of a combat zone is not a high audit risk provided you otherwise qualify.
2) Form 673 is a withholding form only. It only authorizes your employer to stop federal income tax withholding on the first $103,900 paid to you in 2018. It is neither required nor does it qualify you to claim the exclusion. A better option to regulate tax withholding is to file Form W-4 with your payroll department and claim a large number of allowances on Line 5. Claiming between 9 and 15 allowances generally results in enough tax withholding to satisfy your tax bill if you’ll be able to claim the exclusion, although everyone’s situation varies.
3) Expenses – Many of you may have changed your work status either from an IC to an IE or vice versa. There is a vast difference in what can be deducted. As an IC, most work related expenses are deductible. As an IE, no expenses are deductible as of January 1, 2018.
4) If you’re working overseas for a long period of time and claim residency in a state with a high tax, you may want to consider becoming a resident of a state with either low or no tax to save money. The tax-free states are TX, FL, AK, NV, WA, SD, WY and TN. Changing state residency is more problematic if you have a house and family in a different state. The exclusion isn’t allowed at all in CA, AL, MA, NJ, PA and HI, so, if you otherwise qualify to claim the exclusion, live in one of these states and have the option to be a resident elsewhere, you may want to do so.
Independent Contractors (1099’s)
For those of you working as independent contractors, be reminded that the IRS will take 15.3% right off the top of your net income to fulfill your self-employment tax liability (Social Security and Medicare). You will also pay regular income tax on your earnings. In addition, the exclusion of $103,900 is not deductible when computing self-employment tax even though it is included in the income tax calculation. This may result in a very large and surprising tax bill. Be aware of this and plan accordingly. If you’re in this situation, controlling self-employment tax may be possible using an S corporation. If you don’t already have one set up and you’re interested in learning about this option, let us know. As noted above, please remember that S corporation and LLC/partnership returns are due March 15th which is a full month earlier than the individual filing deadline. If you own either type of entity please send your info to us with enough time to prepare the return before this deadline or let us know you would like to extend.