U.S. Income Update

Presented by: Robert L. WolffP.O. Box 381

Dumaguete City, Negros OrientalPhilippines 6200

wolff2000@earthlink.netNY (518) 325-6015PH 09266485273

Disclaimer

I am not an attorney admitted to practice law in the Philippines. I am an attorney admitted to practice law in New York. That and 45 pesos gets me a cup of coffee at McDonalds. Fortunately I have a friend who is a Philippine lawyer that can give advice.The following is not a legal advice, but rather comments and observations.For answers to legal issues raised by this presentation, you need to consult an attorney admitted to practice law in the Philippines.

Are You A US Retiree living in the Philippines?

If your answer is yes, you most likely will need to file a US income tax return to keep your US tax status intact.

In addition to the 1040, there are number of other IRS Forms that may need to be filed.

Most of these IRS Forms are informational, meaning that you will pay NO tax. However, not filing can result in IRS penalties.

The following is a discussion of some(but not all) the forms that may need to be filed.

United States – Philippines Tax Treaty

The U.S. and the Philippines tax their taxpayers on a worldwide basis. The U.S. - PH Tax Treaty helps to avoid double income taxation. The following are some of the provisions important to U.S. persons living in the Philippines:Rental income is taxed in the country where the real property is located.Capital gains on the sale of real property is taxed where the real property is located.Capital gains – the treaty generally provides that capital gains derived by a resident of one country will be exempt from tax by the other country. However there are many exceptions to this rule.Annuities paid to residents of one country are exempt from tax by the other country.

United States – Philippines Tax Treaty

Child support payments paid by a resident of one country to a resident of the other are exempt in the recipient’s country.

Social Security and other public pensions paid by one country to residents of the other are taxable only in the source country.

Dividends -- each country may tax dividends paid by its companies to shareholders residing in the other.

Interest – each country may tax interest income of its residents arising in the other country.

There are many other important provisions of the Tax Treaty NOT discussed herein.

Taxation of Income Earned In The Philippines

The United States taxes U.S. citizens and resident aliens on their worldwide income, even when they live and work abroad for an extended period of time.

There is an exclusion of foreign earned income from income subject to U.S. income taxes up to a set amount. Therefore not all income earned outside the U.S. is taxed.

Exclusion From Income

The maximum amount of exclusion for 2015 is $100,800, in 2014 it was $99,200. Note - there are also housing and other exclusions from income.

If foreign taxes are paid and the foreign earned income exceeds $100,800, the taxpayer must also file a Form 1116 to claim foreign tax credits to avoid double taxation.

Very important, you must file for the income exclusion before being contacted by the IRS to be able to claim the income exclusion.

The Big Two

FBAR and FATCAWhy You Need to CareBecause NOT Caring may

result in problems with the IRS

Foreign Bank and Financial Account (FBAR) notices – Who Must

FileAny US person with a foreign bank or

financial account aggregating more than $10,000 at any time during the year must report that account on an FBAR Notice.

How are accounts valued?

$10,000 is met if At any time of the year Aggregate value of all foreign accounts Are in excess of $10,000 Regardless of whether accounts generated

income or dividends If non-liquid asset, 12/31 value If asset sold during year, value at date of sale All values must be converted to U.S. dollars.

Filing Requirements For FBAR

Filing Requirements applies to any:

U.S. Person with a Financial Interest (or) Signature Authority ( or) Other Authority

Over a Foreign Financial Account: more than $10,000 (in aggregate) any time during the year.

Who is a U.S. Person?

Individual (i.e., citizen and resident aliens in the US with regard to their own accounts, or owns

more than 50% of the shares of a Foreign corporation

more than 50% of the profits of a Foreign partnership

U.S. Domestic Trusts & Estates

U.S. Domestic Corporations

U.S. Domestic Partnerships

What Is A Foreign Financial Account

A Foreign Financial Account is a financial account located outside of the United States.

For example, an account maintained with the Bank of Dumaguete branch in New York City, New York – no filing requirement.

An account maintained with the Bank of USA branch in Dumaguete City, Philippines – may have a filing requirement.

There are exceptions not discussed herein.

FBAR – Penalties

There are three types of penalties applicable for failing to file FBAR reports;

Due to Negligence,Non-Willful, andWillful.

It should be noted that the penalties are assessed per account and not per FBAR filing.

FBAR – Penalties

Penalties for failing to file an FBAR can be harsh. Imposition of penalties that generally applies to corporations rather than individuals

If a failure to file is due to NEGLIGENCE, a civil penalty up to $500 per account may be assessed.

If there has been a pattern of negligent failures to file FBARs, a civil penalty up to $50,000 per account may apply.

FBAR –Penalties

Non-Willful PenaltyUp to $10,000 for each negligent violation No Criminal Penalties Assessed

Willful PenaltyUp to the GREATER of $100,000 or 50% of the amount in the account at the time of the violation Criminal Penalties of up to $250,000 or 5 years in jail or bothIt is difficult for most U.S. persons to avoid the willful penalty

Willful Penalty While Violating Certain Other LawsUp to the GREATER of $100,000 or 50% of the amount in the account at the time of the violationCriminal Penalties of up to $500,000 or 10 years in jail or both

Deadline for Filing the FBAR Notice

The FBAR notice must be received by the IRS Detroit Service Center by June 30.

No extensions.

Must be filed electronically.

Potential FBAR Filers

Example #1

Big John is a U.S. citizen who stays in the Philippines from December to March each year. For his convenience he opens an account with the Bank of Manila. Does he have to file an FBAR notice with respect to this account? Maybe, it depends if his account is more than $10,000 at anytime during the year.

BJ US

U.S.

Dec. Mar

Philippines

Example #2

Big John, a U.S. citizen has retired in the Philippines. For his convenience, Big John opens an account at the Bank of Manila. At its peak, the account balance is $15,000, but on December 31 the balance is only $8,000. Because the account’s highest balance of $15,000 during the year was above $10,000, Big John must file an FBAR.

B JUS

U.S

$15,000 to $8,000 bank balance

Philippines

Multiple Account

Multiple accounts are aggregated to determine whether they meet the $10,000 threshold.

Example #3

Big John, a U.S. citizen, lives in the Philippines and has two bank accounts in the Philippines. The first account, at the Bank of Dumaguete City, has a peak balance of $2,500 and a year-end balance of $55. The second account, at the Bank of Manila, has a peak balance of $8,000 and a year-end balance of $3,000. Total end of year balance of both accounts is $3,055. Because the aggregate of the peak balances exceed $10,000 ($2,500 plus $8,000 is $10,500), Big John must file an FBAR for the two accounts.

Bank of Dumaguete City

Peak: $2,50012/31: $55

Bank of ManilaPeak: $8,00012/31:$3,000

U.S

Philippines

B JUS

Ownership in a Foreign Corporation

A U.S. person also has to file an FBAR if he or she owns more than 50% of a foreign corporation that has a foreign bank account in excess of $10,000.

Example #4

Betsy Smith owns a 90% of BS, Inc., which wholly owns a Philippine subsidiary called Phil Co. Phil Co. has a bank account with a dollar equivalence of $25,000 at the Bank of Manila. Betsy Smith and BS Inc., both must file an FBAR with respect to Phil Co. account at Bank of Manila.

BS

US

Philippines

Phil Co.

$25,000 in Bank of Manila

Non-Compliance – What to Do?

6694 Issue - understatement of taxpayer’s liability? Are there other tax compliance issues?

Do nothing – tax fraud? Amnesty program - file delinquent returns?What to do - file your FBAR Notice, so you don't

have to ask yourself these questions.

Enough FBAR Gloom and Doom. Lets move onto FATCA – One of Obama's

Gifts To U.S. Taxpayers

26

FATCA -The Foreign Account Tax Compliance Act

FATCA was enacted March 18, 2010, as part of the Hiring Incentives to Restore Employment (HIRE) Act. Many of the FATCA rules become effictive July 1, 2014.

FATCA carries far-reaching disclosure and reporting requirements for U.S. taxpayers with foreign accounts and assets.

As well as disclosure and reporting requirements for foreign financial institutions with accounts owned by U.S. taxpayers.

FATCA’s Filing Requirements

FATCA’s filing requirements are similar to those of FBAR requirements, except it is filed with the taxpayers tax return. FBAR is filed with the Treasury Department independently of tax returns

FATCA’s definition of a U.S. person, who is referred to as a Specified Person, is similar to the FBAR rules.

FATCA And FBAR RULES Over Lap

A U.S. person who is not subject to FBAR filing requirements maybe subject to the FATCA filing requirements

For example, a U.S. person who owns stock in a Philippine corporation held in the Philippines with a value in excess of $50,000, does not have an FBAR filing requirement, but they may have an FATCA filing requirement.

FATCA Filing Thresholds

Filing Status Living in the U.S. Living Abroad

SingleSFFAs valued at more than $50,000 on the last day of the year or more than $75,000 at anytime during the year.

SFFAs valued at more than $200,000 on the last day of the year or more than $300,000 at anytime during the year.

Married filing jointlySFFAs valued at more than $100,000 on the last day of the year or more than $150,000 at anytime during the year.

SFFA valued at more than $400,000 on the last day of the year or more than $600,000 at anytime during the year

Married filing separately

SFFAs valued at more than $50,000 on the last day of the year or more than $75,000 at anytime during the year.

SFFAs valued at more than $200,000 on the last day of the year or more than $300,000 at anytime during the year.

The Minimum Penalty

The minimum penalty for failure without reasonable cause to submit the required disclosure is $10,000.

Ninety days after notification from the Treasury Department of a failure to submit the required disclosure, the penalty increases by $10,000 for every 30 days of continued failure to submit the disclosure up to a maximum of $50,000.

FATCA Penalties

Under FATCA, there may also be an additional penalty of 40% for substantial understatement of income, negligence or disregard of the FATCA rules, not attributable to fraud (for which a 75% penalty applies).

FATCA also extends the statute of limitations from 3 to 6 years for omissions of accounts of more than $5,000.

The following are FORMS that may need to Be filed For Trusts

Form 3520 - Annual return to report the creation of or transfers to Foreign Trusts

Form 3520-A - Annual return of Foreign Trust with U.S. Beneficiaries

Corporations Formed In the Philippines And The Transfer Of Assets to Philippine Corporations

If you form a corporation in the Philippines or transfer money or property to a Philippine Corporation you MAY need to file one or more forms with the IRS if:

If the corporation is deemed to be a Controlled Foreign Corporation (CFC) or;

If there are transfers of cash and/or property to a Philippine Corporation.

U.S. Controlled Foreign Corporations

The two types of U.S. taxpayer that need to be concerned about the Controlled Foreign Corporations (CFC) rules:

Those that create a corporation in the Philippines

U.S. taxpayer that inherits stock of a Philippine corporation

Test to be a CFC

For a foreign corporation to be a CFC, the following facts must be present:

oOne or more U.S. shareholders must own 10% or more of the total combined voting power of all classes of stock entitled to vote, and the 10% U.S. shareholders must collectively own more than 50% of the total combined voting power of the corporation’s outstanding stock or more than 50% of the total value of the stock of the corporation.

oIf both facts exist, the corporation is a CFC.

oIf either one of the facts do not exist, the corporation is not a CFC.

CFC Penalty For Failure To File

The penalty for failure to file with regard to a CFC is $10,000, with an additional $10,000 for each month that the failure continues, following a period of 90 days after the taxpayer is notified of the failure by IRS, to a cap of $50,000 per return.

Note – A 10% U.S. shareholder of a CFC is subject to U.S. income tax on the shareholder’s proportionate share of the CFC’s Subpart F income whether or not the CFC distributes the income.

Note – there may also be FBAR and FATCA filing requirements.

Transfers Of Cash and Property To Corporations In

The Philippines

A U.S. person that transfers cash or property to a Philippine corporation must report the transfer, if;

Immediately after the transfer the person holds directly or indirectly at least 10% of the total voting power or the value of the foreign corporation; or

The amount of cash transferred by the U.S. person to the foreign corporation during the 12-month period ending on the date of the transfer exceeds $100,000.

Penalty For Not Reporting A Transfer To A Philippine Corporation

The penalty for not reporting the transfer is 10% of the fair market value of the property transferred.

The penalty is limited to $100,000, unless the failure to comply was due to intentional disregard of the filing requirement.

Note- there may also be FBAR and FATCA filing requirements. Plus there maybe a CFC filing requirement.

ITIN NumbersWhen claiming spousal tax benefits or exemptions for dependents on your income tax return:

You must generally list on your income tax return the SSN of your spouse or the person for whom the exemption is claimed.

If your dependent or spouse does not have or cannot get an SSN, then you need an ITIN.

What is an ITIN?An ITIN or Individual Taxpayer Identification

Number is a tax processing number that is used when an individual can not get an SSN.

An ITIN is obtained by filing a form and the required information with the IRS.

To obtain the ITIN, documentation must be provided to the IRS to substantiate foreign status and identity of the individual applying.

Benefit of the ITINAssumption No.1 Single Taxpayer, Taxable income $50,000 Tax Liabilities: Income $50,000 Standard Deduction $( 6,100) Personal Exemption $(3,900) Taxable Income $40,000 Tax Liability $6,375

Assumption No. 2 Some Facts, except Married filing a Joint Return.

Income $50,000 Standard Deduction $(12,200) Personal Exemption $(7,800) Taxable Income $30,000 Tax Liability $4,500 Tax savings $1,875

Other Penalties To Watch Out For

Fraud Penalties – underpayment of tax due to fraud are subject to a penalty of 75 percent of understatement of income or underpayment of taxes;Failure to file tax return – this penalty may be imposed in certain circumstances, amounting to 5 percent of the net tax amount required to be shown on the tax return for each month or fraction thereof with a cap of 25 percent.Failure to pay the tax due, a late payment penalty may be imposed equal to a .5 percent of the late payment monthly with a cap of 25 percent;Accuracy related penalty – A penalty of 20 percent may be imposed on any underpayment attributable to negligence or substantial understatement of income

Other Forms

There are other forms that may need to be filed not discussed herein.

The presentation attempts to identify the more common forms other than Form 1040 that may need to be filed by U.S. taxpayers living in the Philippines.

Summary of Tax Issues

The United States and the Philippines subject their citizens and residents to income and estate taxes on a worldwide basis.

There is a U.S./Philippines Income Tax Treaty which eliminates many income tax issues, but there is no U.S./Philippines Estate Tax Treaty.

If you are a U.S. citizen or resident residing in the Philippines, the IRS wants to know if you have any accounts or assets in the Philippines. Therefore, there are various forms that may need to be filed such as the FBAR filing.

The U.S. is becoming more aggressive in identifying foreign assets and taxing them. Who is to say the Philippines will not become more aggressive in collecting income and estate taxes outside the Philippines.

Filing the Required Notices

Most notices and forms required to be filed by the IRS are not complex forms or that difficult to prepare. However, failure to file a required notice or form can prove to be expensive and trigger other problems with the IRS.

Remember, if your buddy, advisor, accountant, etc., is telling you not to worry about a notice or form that needs to be filed, such as the FBAR notice, because they think the IRS will never find your account or asset in the Philippines, it is you -not them- who will incur the wrath of the IRS for failure to file.

Not complying with many of these filing requirements such as the FBAR notice can cause financial ruin due to the penalities, even if no tax is due.

IRS Circular 230

Pursuant to Internal Revenue Service Circular 230, we hereby inform you that the advice set forth herein with respect to U.S. federal tax issues was not intended or written by the law firm of Robert L. Wolff to be used, and cannot be used, by you or any taxpayer, for the purpose of (i) avoiding any penalties that may be imposed on you or any other person under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor.