Foreign Account Reporting Overview

In 2013, the U.S. Treasury has changed the reporting on foreign bank accounts.  The reports must now be electronically filed on the Treasury’s Financial Crimes Enforcement Network (FinCEN) website on FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR).  The Treasury no longer accepts paper-filed information reports.  Our firm electronically files a significant number if these reports for many of our clients.

The filing requirements pertain to United States Persons who:

The FinCEN Form 114 is due no later than June 30 of each year to avoid potential late filing penalties.

Additionally, you may be required to file Form 8938 if you are a Specified Individual (a U.S. citizen or a resident alien of the U.S.) and on the last day of the tax year your foreign financial assets exceed the threshold amount.  For a married couple, the threshold amount is more than $100,000 on the last day of the year or more than $150,000 at any time during the year.  For single persons the respective amounts are $200,000 (last day) and $300,000 (any time during).

Form 8938 is attached to your annual return and must be filed by the due date (including extensions) for that return.  There are also penalties for late filing of failure to file Form 8938.

You will note that Form 1040 identifies two types of dividends, ordinary and qualified. Why?

Because they are taxed at different tax rates. “Qualified” taxable dividends that are paid by a US domestic company or a qualified foreign company are taxed at either 15% or 20%.

Ordinary dividends are included as taxable income taxed at United States STEP TAX RATES as illustrated below. Details of Dividend income are included on Schedule B, Interest and Ordinary Dividends.

The tax rate on Qualified Dividends is the same as the Long Term Capital Gains rate for investments held more than one year.

Table 1: Tax rates of dividends and LT capital gain for individual taxpayer

Table 2: Tax rates of dividends and LT capital gain for trusts and estates

On January 17, 2015 the White House issued a FACT SHEET: A Simpler, Fairer Tax Code That Responsibly Invests in Middle Class Families.

One of the major recommendations included in this paper reads:
“Close the trust fund loophole – the single largest capital gains tax loophole – to ensure the wealthiest Americans pay their fair share on inherited assets. Hundreds of billions of dollars escape capital gains taxation each year because of the “stepped-up” basis loophole that lets the wealthy pass appreciated assets onto their heirs tax-free.”

Our first response is “What is this all about ?” Here is our understanding.
Under our current tax laws, when a person dies, his or her estate may have to pay an inheritance tax if the value of the net assets in the estate exceeds $5,340,000. The estate tax rate can be as high as 40% for an estate that has net assets in excess of the exclusion amount.
So why should this FACT SHEET say that escaping capital gains taxes is a loophole? Aren’t taxable estates subject to estate taxes which value taxable estates at fair value at the date of death, which includes unrealized appreciation, but are not at the same time subject to capital gains taxes on unrealized appreciation?

Under current tax laws, no capital gains taxes are charged on the difference between the basis (tax cost) and the fair market value of assets included in a taxable estate. This is known as a “step-up in basis” and has been in effect since 1980.

The “Fact Sheet” advocates that a capital gains tax be enacted “by treating bequests and gifts other than charitable organizations as realization events, like other cases where asset change hands.” And there is no mention of a capital gains exclusion in the amount of $5,340,000.
If we add the highest estate tax rate, 40% to a capital gains rate of 28%, we may have a combined tax rate of 68% on the difference between the fair value of assets at date of death and tax cost, otherwise known an “unrealized appreciation”. It seems to us that this is a form of double taxation.

Generally, most interest income is taxed at the same federal STEP TAX RATE as ordinary taxable income. Examples of taxable interest include interest on bank accounts, money market accounts, certificates of deposit, and deposited insurance dividends. Interest income from Treasury bills, notes and bonds is taxable as well.

However, taxpayer may be able to exclude some or part of interest from taxable income. For example:
• Interest redeemed from Series EE and Series I bonds issued after 1989 may be excluded from income if used to pay for qualified higher education expenses during the year and taxpayer meets other requirements for the Education Savings Bond Program. (IRS Topic 403)
• Interest income from municipal bonds is not taxable at the federal level.
• Interest on insurance dividends left on deposit with U.S. Department of Veterans Affairs is not taxable.

Nonresident aliens are not taxable on certain kinds of interest income as follows, per Internal Revenue Code subsections 871(h) and (i), provided that such interest income arises from one of the following sources and is not connected with a trade or business:
• A U.S. bank
• A U.S. savings and loan association.
• A U.S. credit union.
• A U.S. insurance company.
• Portfolio Interest.

Interest income from Massachusetts municipal bonds is not taxable in Massachusetts. In addition, certain interest defined as Massachusetts bank interest qualifies for an exemption of either $100 or $200 (depending on filing status) in Massachusetts return.

Employees during 2014 will receive an IRS Form W-2 by the end of January 2015. In addition to showing gross Federal taxable wages, income subject to Social Security, income subject to Medicare, and income subject to state and local taxes where applicable, the dollar amount of payroll tax withheld for each income category is disclosed.

There are more than 20 boxes on this form provide information regarding Deferred Compensation, Other Compensation, social and medicare taxes on tips, group term life insurance, non-taxable salary deferrals, non-taxable sick pay, non-taxable reimbursements for employee moving expenses, non-taxable combat pay, employer contributions to health insurance costs, and so on.

The information reported on the Form W-2 is shared by the Internal Revenue Service, the Social Security Administration, and various state and local governments, where applicable.

For an employer accurate preparation and issuance of Forms W-2 may not be easy process. Much of the non salaried data contained in the detail boxes will be reported on the employee’s Federal Income Tax return, Form 1040.

The United States Form 1040 Tax for Individuals can be considered a “Tax Score Sheet” and is required to be filed each year by individuals who are subject to United States income taxes. The Form 1040 has been used for tax returns since 1913, although its composition and line information has changed many times.

We have taken a blank FORM 1040 for 2014, and created a US FORM 1040 LINE REFERENCE SHEET. Beginning with 1040 LINE 7.01, Wages, salaries, tips, etc. We have assigned a FORM LABEL LINE for each line on the 2 page form. We are beginning a series of line definitions and commentaries on this website that will be labeled as follows:

FORM 1040 LINE 7.01 – Wages, salaries, tips, etc.

Various types of income and expense transactions are reported on the first page of Form 1040.  We will use the term MONEY TRANSACTIONS since certain transactions such as gifts, inheritances, and money transfers are not taxable, and therefore are not included.

Line 7.01 – 37.01: Income and Adjusted Gross Income
MONEY TRANSACTIONS subject to US tax income tax include wage income, taxable interest and dividends, business income (or loss), farm income (or loss) capital gains on investment transactions, taxable pension payments, rental and royalty income, unemployment compensation, and taxable social security payments. Income from Trusts, Partnerships, S Corporations, and Limited Liability Companies is also included. This list is not inclusive

Taxable income activities are shown on the US FORM 1040 LINE REFERENCE SHEET, from Line 7.01 through Line 21.02. 1040 FORM LINES 23.01 through 35.01 refer to various items that are excluded from TOTAL INCOME to arrive at ADJUSTED GROSS INCOME.

Line 37.01 is labeled ADJUSTED GROSS INCOME, a TAXSPEAK term. Many individual calculations of your income tax, and special exclusions are based on your AGI (Adjusted Gross Income), and in some cases MAGI (Modified Adjusted Gross Income).

Line 38.01 – 56.01: Tax and Credits
The line labeled 1040 LINE 43.01 is labeled TAXABLE INCOME.

INCOME TAXES BEFORE CREDITS is the sum of LINE 44.01 and Line 45.01. This presentation is confusing, since the real tax is the greater of the ALTERNATIVE MINIMUM TAX as computed on FORM 6251 or LINE 44.01. Form 1040 shows the regular tax plus the difference between the regular tax and the ALTERNATE MINIMUM TAX. 1040 LINES 48.01 THROUGH 54.01 list various credits that reduce your income tax liability. There is a significant difference between an AGI EXCLUSION, a page 2 itemized or standard deduction and a page 2 tax credit.

For example, if you have taxable income of $100,000 and AGI EXCLUSIONS of $30,000, this will reduce your taxable income by $30,000. If your average tax rate is 28 percent, the income tax will be reduced by $8,400. A tax credit reduces your income tax dollar for dollar.  For example, a $2,000 tax credit would reduce a tax liability of $16,000 to $14,000 whereas a $2,000 AGI EXCLUSION would reduce the tax liability by 28 percent times $2,000 which is $ 560.

1040 FORM LINE 56 is the amount of tax liability after subtracting the total credits summed on LINE 55. You will note that if the credits exceed the taxes shown on LINE 47, there is no net tax due, or a net credit in excess of the tax liability.

LINES 57.01 – 63.01: OTHER TAXES
LINES 57.01 through 62.01 cover OTHER TAXES, which are taxes not directly based on taxable income. They include self employment social security and Medicare taxes, withholding and social security taxes on household employees, Affordable Care health taxes, and additional Medicare and income taxes on “INVESTMENT INCOME.”

LINES 64.01 – 73.01: Payments
The FORM 1040 section labeled “PAYMENTS” is confusing regarding some of the constituent lines FORM LINE 64.01 through FORM LINE 73.01. Contrary to the zero tax liability no pay credit results on the credits summed in LINE 55.01, the credits shown in LINE 66.01, 67.01, 68.01, 69.01, 72.01, and 73.01 will be paid to the taxpayer even if there is no tax liability prior to the credits  and payments.

1040 FORM LINES 64.01, 65.01, 70.01 represent cash payments against the income and other tax liabilities. 1040 FORM LINE 75.01 shows an overpayment against the tax liability; 1040 FORM LINE 78.01, shows the net tax liability unpaid. If the liability payments have not been made on a timely basis, there may be an Estimated Tax Penalty on 1040 FORM 79.01.

How Does a Reverse Mortgage Work?
On many cable channels you see the advertisements where a movie personality such as Henry Winkler (Fonzi in Happy Days) speak enthusiastic about the benefits of a reverse mortgage.

A reverse mortgage, like a traditional mortgage, is a loan made by a lender to a homeowner using the home as security or collateral.

In a traditional mortgage, the bank may lend up to 90% of the property’s value to the homeowner. However the mortgage does not call for monthly payments of principal and interest. Thus the mortgage loan balance will increase over time because monthly payments are not required and the amount of unpaid interest keeps increasing.

A reverse mortgage loan generally does not require repayment until the last homeowner has passed away or moved out of the property. Consequently, life expectancy is a huge part of the lender’s calculation of how much to lend. A 62 year old homeowner can borrow a substantially lower percentage of their property’s value than an 80 year old homeowner. The lender expects the outstanding loan to be paid though a sale of the mortgaged property.

Income instead of outflow
With a reverse mortgage, the borrower gets cash instead of making payments to the lender. The cash may be received through a lump sum payment, a line of credit, or regular monthly advance. The loan is secured by your home, so reverse mortgages may be practical for homeowners whose home is not currently subject to a mortgage, that is your equity value approximates the fair value of your home.

Reverse Mortgages Insured by the Federal Housing Administration
Most reverse mortgages are Home Equity Conversion Mortgages (HECMs), which are offered by private lenders and insured by the FHA; borrowers must be at least age 62.

The Federal Housing Administration (FHA) has imposed more stringent requirements on reverse mortgages, making them increasingly difficult to obtain. For qualified borrowers, though, continued low rates and the spread of so-called “purchase loans” can make it worthwhile to consider this type of debt.

The amount you’ll receive will be determined by current interest rates, your age, and your home equity. Interest rates are relatively low now (around 5% for a fixed-rate loan and under 3% for a loan with a variable rate that adjusts monthly), but you’ll pay an added 1.25% of the balance for mortgage insurance. The older you are and the greater your home equity, the more you’ll be able to borrow on a reverse mortgage.

Updated Home Equity Conversion Mortgage (HECM) disclosure requirements.
As of January 13, 2014 the FHA has issued new regulations for reverse mortgage lenders which include a credit history analysis, a cash flow residual income analysis, documenting credit, income, assets, and property charges, for borrowers, evaluating the results of the borrower financial assessment in determining HECM eligibility.

Why does the lender care about FHA Regulations?
Without FHA compliance, there is no FHA mortgage insurance, and the lender bears all the risk arising from mortgage defaults.

Borrowing to buy
Reverse mortgages are aimed at seniors who wish to stay in their home as they grow older. In effect, they can use their home equity for added cash in retirement so they won’t have to move into an unfamiliar place, perhaps one that’s away from friends and family.

Tax Aspects of Reverse Mortgages
Because reverse mortgages are considered loan advances and not income, the amount you receive is not taxable.

Any interest accrued on a reverse mortgage is not deductible until the interest is actually paid, which is usually when the loan is paid off in full. Such a payment might be made by the borrower, by an heir, or by the borrower’s estate.

For the party repaying the loan, the deduction may be limited because a reverse mortgage loan generally is subject to the limit on home equity debt. That limit caps deductions to the interest on $100,000 of debt.