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U.S./Israeli Income Tax Update for Year 2018 (2017 Tax Year)

Photo by CPA of Miami

The 2018 U.S. and Israeli 'tax filing season' has commenced. Both the U.S. and Israel have introduced major tax legislation in recent months. President Trump signed into law the "Tax Cuts & Jobs Act" which will principally affect your tax situation for 2018 tax returns to be filed in 2019. This mammoth piece of legislation is the biggest tax overhaul of the Internal Revenue Code in the past forty years and potentially provides many tax savings opportunities for individuals and businesses alike. Israel also reintroduced its Tax Amnesty Program for Israeli Citizens who have not properly complied with reporting past income earned from abroad. As such, it is imperative that you familiarize yourself with the many recent changes to existing tax rules and regulations which permeate both the U.S. Internal Revenue Code and Israeli Tax Ordinance.

General Treatment of Crypto currencies (Bitcoin and other similar currencies) by the IRS and by Israel Tax Authority

Both the IRS and the Israel Tax Authority (ITA) have recently ruled that crypto currencies are considered property. Since crypto currency is not backed by any country in particular and can be extremely volatile, it will generally be treated as a capital asset and taxed at capital gains rates on the sale. This means that any purchase of goods or services using crypto currency will generally result in the sale of an asset, which must be reported on your tax return as such. In addition, if you regularly sell or trade crypto currency for profit it may result in your trading being taxed at regular income tax rates.

FATCA/ FBAR

FATCA is an Intergovernmental Agreement (IGA) that the US Department of Justice has signed with more than 120 partner countries. The purpose of the IGA is to provide the U.S. with knowledge about the financial income and balances of its citizens around the world. In essence, these agreements create a two-way transfer of information between the foreign country and the U.S. and from the U.S. to the partner country. In effect, the U.S. could demand income tax returns from delinquent or non-filers based upon information received from a partner country, since the U.S. taxes the worldwide income of its citizens. FATCA requires filing Form 8938 under certain circumstances.

Form 8938 (Statement of Foreign Financial Assets)

It must be filed with your U.S. income tax return (in addition to your FBARs), if you live in Israel (or abroad) and
i) The value in your foreign financial accounts exceeds $400,000 (filing joint) or $200,000 (filing single) on the last day of the year, or
ii) Your foreign financial accounts exceed $600,000 (filing joint) or $300,000 (filing single) at any time during the tax year.

Exchange of Information between U.S. and Israel

Under the Intergovernmental Agreement (IGA) signed between Israel and the United States, an exchange of tax information between the two countries was scheduled to begin during 2016. Israeli banks are now required to issue FORM 1099 to its customers who are U.S. citizens and also transmit these forms directly to the IRS. Reciprocally, in 2017, Israel was expected to begin receiving U.S. tax information on its citizens directly from the U.S. In addition, Israeli banks are obligated to receive a signed W-9 from all of their customers who are U.S. citizens. Failure to provide information requested by your bank could potentially lead to both your bank freezing your assets and the IRS imposing penalties.

FBARs

Under the Bank Secrecy Act, a Foreign Bank Account Report (FBAR) must be e-filed annually with the U.S. Treasury by April 15th each year (which may be extended to December 15th if you have a valid extension for your current income tax return), if the following criteria apply:

i) The person has a financial interest, signature authority or other authority that is comparable to a signature authority over one or more accounts in Israel or another foreign country. Shareholders who hold more than 50% of a foreign company's shares are considered as having a financial interest in the company's accounts.

ii) The aggregate value of all foreign financial accounts exceeds $10,000 or the equivalent amount in foreign currency (e.g. NIS 35,000 or more) at any time during the calendar year.

iii) Foreign financial accounts include, but are not limited to, both checking and savings accounts, Israeli pension accounts, brokerage accounts, mutual funds and unit trusts. Paper filings of FBARs (form TD F 90- 22.1) are no longer accepted by the U.S. Treasury and have been replaced by online filing of form FINCEN 114.

Revocation of U.S. Passports The U.S. Highway Funding legislation calls for potential revocation or denial of U.S. passports for U.S.taxpayers with an outstanding balance of over $50,000 to the IRS. Balances due to any State are not part of this legislation. The IRS must notify the taxpayer of this proceeding prior to facilitating a revocation of any U.S. passport. If payment arrangements have been made with the IRS, the taxpayer's passport would still be considered valid and will generally not be revoked. PFICs (Passive Foreign Investment Companies) are reported on Form 8621. Most investments in mutual funds registered outside the U.S. pose a potentially complicated tax and accounting issue for U.S. taxpayers. Whereas U.S. registered mutual funds report gains and losses annually to the IRS and to taxpayers, foreign mutual funds do not. The IRS has termed foreign mutual funds as PFICs. PFIC investments, when sold at a profit, have to report to the IRS the income earned subject to interest charges for each year that the investment was held. In effect, the IRS wants to recoup the taxes that would have been paid had the PFIC reported its activity annually. As such, Form(s) 8621, (Information Return by a Shareholder of a PFIC or Qualified Electing Fund), must be filed with the taxpayer's Federal income tax return every year. We recommend discussing this issue with your tax and investment advisor as there may be suitable alternative investments not subject to PFIC rules.

Revocation of U.S. Passports

The U.S. Highway Funding legislation calls for potential revocation or denial of U.S. passports for U.S. taxpayers with an outstanding balance of over $50,000 to the IRS. Balances due to any State are not part of this legislation. The IRS must notify the taxpayer of this proceeding prior to facilitating a revocation of any U.S. passport. If payment arrangements have been made with the IRS, the taxpayer's passport would still be considered valid and will generally not be revoked.

PFICs (Passive Foreign Investment Companies) are reported on Form 8621

Most investments in mutual funds registered outside the U.S. pose a potentially complicated tax and accounting issue for U.S. taxpayers. Whereas U.S. registered mutual funds report gains and losses annually to the IRS and to taxpayers, foreign mutual funds do not. The IRS has termed foreign mutual funds as PFICs. PFIC investments, when sold at a profit, have to report to the IRS the income earned subject to interest charges for each year that the investment was he ld. In effect, the IRS wants to recoup the taxes that would have been paid had the PFIC reported its activity annually. As such, Form(s) 8621, (Information

Return by a Shareholder of a PFIC or Qualified Electing Fund), must be filed with the taxpayer's Federal income tax return every year. We recommend discussing this issue with your tax and investment advisor as there may be suitable alternative investments not subject to PFIC rules.

Form W-9

Israeli banks, as well as some other financial institutions, are requiring customers to sign a U.S. form W-9 (or W8-BEN for non U.S. citizens) in order to open or continue banking or investing with your financial institution. In many cases, your Israeli bank may require a declaration that your last 3 years of U.S. income tax returns and FBARs have been duly filed. Not submitting the signed form can result in the bank freezing your Israeli account. Please note if your bank has not requested you to sign a W-9, you are still obligated to report your non-U.S. income and assets to the IRS and the U.S. Treasury.

Israeli Tax Update

In light of recent Israeli tax legislation and with the commencement of the 2017 tax year, you may require Israeli tax services during the year.

Israel has also changed its tax regime for reporting foreign (non-Israeli) income from 2003 in addition to the regular tax on Israeli source income and has an amnesty program for taxpayers who have failed to report income earned abroad (e.g. from work or investment income earned in the U.S. or any other foreign country). Proper tax planning and minimization of your taxes requires an analysis of many important issues, including the interplay between the Israeli and U.S. foreign income tax credit rules, the foreign earned income exclusion rules, and also how the applicable provisions of the U.S. – Israel income tax treaty (or with any other country that has an income tax treaty with Israel) affects your tax situation.

Herewith are the 2017 Israeli tax tables.

Marginal Tax Bracket Total income (₪) Total taxes (₪)
10%74,640 7,464
14%107,04012,000
20%171,84024,960
31%258,80045,718
35%496,920136,060
47%999,999,999

U.S. Child Tax Credit (recent changes)

Taxpayer identification number (SSN) is now required by due date of tax return. If you do not have a Social Security Number (SSN) for your dependent by the due date of your 2017 return (including extensions), you may not be able to claim the child tax credit (CTC) or the additional child tax credit (ACTC). This applies to your original or amended 2017 tax return, even if you get the SSN at a later date. (i.e. a child born in March, 2017 has until December 15, 2018 to receive a Social Security Number and still be eligible to claim the child credit.) Taxpayers who exclude earned income, currently up to $102,100 (per taxpayer) on their 2017 joint tax returns will not be eligible to receive a child credit even if only one taxpayer uses the exclusion. The credit may not be able to be claimed retroactively. If you claim the CTC or ACTC, but you are not eligible for either credit and it is later determined that your error was due to reckless or intentional disregard of the CTC or ACTC rules, you will not be allowed to claim either credit for 2 years. If it is determined that your error was due to fraud, you will not be allowed to claim either credit for 10 years. You may also have to pay interest and penalties to the IRS. We recommend applying for Social Security numbers immediately after your U.S. child is born.

For 2018 the child credit increases to $2,000 but the refundable portion is limited to $1,400. The phase-out also increases significantly, which will allow higher-income earners to qualify for the credit. More details will follow during 2018.

IRS Streamlined Procedures for Non-Compliant U.S. Taxpayers Living Abroad and Offshore Voluntary Disclosure Program (OVDI)

In recognition that some U.S. citizens living abroad have failed to file annual U.S. Federal income tax returns and foreign bank account reports (FBARs), the IRS has designed a streamlined procedure to allow taxpayers to enter the IRS tax filing system and then be considered in "good standing". Many factors and requirements apply, but primarily this procedure is available for U.S. taxpayers who have resided outside the U.S. since January 1, 2009 and have not filed U.S. income tax returns for at least 3 years. Among the strict requirements for being accepted under the IRS streamlined process are: a) filing three years of U.S. income tax returns, b) filing six years of FBARs, c) not spending more than 35 days in U.S. in one of the last 3 years, d) writing a detailed explanation under penalties of perjury, delineating your non-willfulness and delinquency, and attaching it to your tax returns. The IRS will expedite the review process and may not assess penalties for taxpayers filing under this procedure. Taxpayers not meeting the requirements of the streamlined process can avail themselves of the IRS Offshore Voluntary Disclosure Program.

ITIN's for Non Resident Aliens

Individual tax identification numbers are required on every tax return submitted to the IRS. U.S. citizens must have a Social Security number that is used for all tax filings. A non-U.S. citizen with a U.S. tax filing requirement must obtain an ITIN either before submitting his tax return or with the tax return submitted to the Internal Revenue Service.

ITIN's expire and have to be renewed. The IRS will generally notify you that your ITIN will be expiring and it will have to be renewed if you are still filing a current U.S. Income tax return. ITIN's that were not used to file a tax return at least once in the past 3 years will generally also expire. Expired ITIN's can be renewed through our office.

U.S. Income Tax Rates

The U.S. income tax rates for the current tax year are 10%, 15%, 25%, 28%, 33%, 35% and 39.6%. Under the "stacking rule", in order to determine your income tax bracket, income excluded on Form 2555 (Foreign Earned Income Exclusion) will be added back to adjusted gross income. As a result, investment income may potentially be taxed at a higher tax bracket.

Under the new tax bill, starting with tax year 2018, the tax rates have dropped to: 10%, 12%, 22%, 24%, 32%, 35%, & 37%.

U.S. Foreign Earned Income Exclusion

The foreign earned income exclusion has been adjusted for inflation and has increased to $102,100 per taxpayer. As such, married taxpayers filing jointly, who meet certain requirements, may potentially exclude up to $204,200 of foreign earned income per tax return. However, one spouse may not utilize the unused portion of the exclusion of the other spouse. If one taxpayer elects the exclusion on a joint return, starting with 2015 there will be no child credit available on that return. If you file separately, one spouse may claim the exclusion and one spouse may claim the child credit, which may result in a smaller refund than would have been on a joint return in a previous tax year (when it was permissible). The Foreign Earned Income

Exclusion applies only to work or self-employment income and does NOT apply to other passive income such as pension benefits, investment income, rental or any other non-earned income.

Foreign Tax Credits

A U.S. foreign tax credit may be used to reduce your U.S. tax if you have Israeli tax paid on income earned in Israel. Conversely, Israel will also recognize taxes paid to the U.S. and apply them as a credit against your Israeli income tax liability.

Social Security Benefits Received by a U.S. Citizen Residing in Israel

The U.S. - Israel Income Tax Treaty states that U.S. citizens who are Israeli residents are eligible to exclude U.S. Social Security benefits from their adjusted gross income. This provision may result in substantial tax savings.

The Affordable Care Act (aka ObamaCare)

This law begins affecting taxpayers for 2014. Under the individual shared responsibility provision of the law, taxpayers must have minimum essential coverage (health insurance) for the entire year or will have to make a shared responsibility payment (SRP) on their 2017 tax returns. For most U.S. citizens living abroad there is an exemption from the SRP provided that the taxpayer would qualify under the bona fide residence or physical presence tests to exclude their income. Even if their income is not excluded, taxpayers residing abroad would generally qualify for the exemption from the SRP. U.S. citizens who meet neither the physical presence nor residency requirements will need to maintain minimum essential coverage, qualify for a coverage exemption or make a shared responsibility payment for each month of the year. For this purpose, minimum essential coverage includes a group health plan provided by an overseas employer. One exemption that may be particularly relevant to U.S. citizens living abroad for a small part of a year is the exemption for a short coverage gap. This exemption provides that no shared responsibility payment will be due for a once- per-year gap in coverage that lasts less than three months. Please be advised that the new tax bill has rescinded this provision for years beginning Jan 1, 2019.

Long Term Capital Gains and Qualified Dividends

Rates on long term capital gains (whether derived in the U.S., in Israel or in another country) generally apply to assets held for more than one year. For single taxpayers with taxable income under $36,900 and for taxpayers filing jointly with taxable income under $73,800 a zero percent long term capital gains and qualified dividends rate will generally apply. Capital losses are still fully deductible against capital gains, and any capital losses in excess of capital gains may offset up to $3,000 of ordinary income if married filing jointly. Net capital losses in excess of $3,000 may be carried over indefinitely to future years.

U.S. Child Tax Credit

If applicable, $1,000 per eligible child may be available to offset any potential U.S. income tax liability or refunded. Taxpayers must have reportable earned income from wages (via Israeli Form 106 or similar foreign wage slip) or self-employment income in excess of $3,000. The earned income of both husband and wife can be combined even if one spouse is NOT a U.S. citizen. The non-citizen spouse requires a U.S. tax identification number (TIN), which can be acquired by filing U.S. Tax Form W-7. Children must be U.S. citizens aged 16 and below and must possess a U.S. Social Security number. Maximizing the child credit can be quite complicated since there are many factors to consider. In addition, the IRS has the ability to conduct income tax audits which may require verification of income and other information. Starting in 2018 the refundable child credit increases to $1,400. This will be expanded upon during 2018 in future updates.

Net Investment Taxes

In addition to the "Obamacare" tax rules, additional provisions of these rules are as follows: Beginning in 2013 the IRS has imposed an additional 3.8% tax on passive income for high-income individuals (see table below). For this purpose, passive income includes interest, dividends and capital gains. Part of the passive income subject to this tax, are dividends from your foreign-owned corporation. The tax on this income cannot be taken as a credit for Israeli tax purposes. Therefore, it may sometimes be advisable that taxpayers with Israeli corporations report earnings as additional salary rather than declaring a dividend. Earnings from salary are not subject to this tax.

Filing Status

Income Threshold Amount

Married filing jointly $250,000
Married filing separately$125,000
Single$200,000
Head of household (with qualifying person)$200,000

Qualifying widow(er) with dependent child

$250,000

Estates and Gifts

In 2017, the annual gifting limit per taxpayer & spouse individually of $14,000 to each eligible recipient includes children and grandchildren. The gifting limit is increasing to $15,000 in 2018. Gifting continues to be an excellent way to potentially reduce the value of your U.S. taxable estate as well as future U.S. estate income taxes. There is an inflation-adjusted exemption of $5,340,000 on U.S. estates. Starting January 1, 2018, the exemption increases to $11.2 million. Non-U.S. citizens investing directly in U.S. real estate or holding any other asset in the U.S. such as stocks and bonds etc. are only entitled to an Estate Tax Exclusion of $60,000. Any property valued above that amount would potentially have high estate taxes assessed before the asset can be distributed.

State and Local Tax Returns

Refunds may be available for taxpayers who may be unnecessarily filing resident U.S. State income tax returns after they moved to Israel. Maintaining a bank account, brokerage account or driver's license in a particular state does not automatically necessitate a tax filing in that particular State. However, if you own real estate, maintain a business, commute to and work in a particular State, or have any other activity considered nexus (strong connection) to a State, you would generally only file a non-resident income tax return in that state.

Standard Deduction

Standard Deduction amounts are: Single or Married Filing separately - $6,300; Married Filing Jointly - $12,600; Head of Household - $9,300. Taxpayers over the age of 65 may claim an additional deduction of $1,200 each, if married, or $1,550 if single. Taxpayers with qualifying deductions in excess of these amounts may generally itemize their deductions. Please note that bank mortgage interest, Israeli real estate tax (arnona), Israeli income taxes, and certain charitable contributions paid to Israeli sources may also qualify as itemized deductions. A phase out of itemized deductions will apply if income exceeds $311,300 (filing joint) and $259,400 (filing single). Starting January 1, 2018 the standard deduction is markedly increased to $24,000 for those filing as married filing jointly, and moves to $12,000 for single and married filing separately filers.

Personal Exemptions

A personal exemption of $4,150 per person is available for each individual listed on your tax return for 2017. A U.S. citizen may only be claimed as an exemption once during each tax year. In some cases, grandparents may sometimes claim their grandchildren as exemptions on their income tax returns if they provided at least half the support of the grandchild and the grandchild lived with the grandparent. Starting with your 2018 tax return, personal exemptions will be eliminated. They will be replaced by an additional $600 child credit for dependents and a $500 tax credit for non-child dependents. Both of these credits will only offset tax, but are not refundable.

Self-employment Income

In order to qualify for future U.S. Social Security retirement benefits a taxpayer must pay into the U.S. Social Security system a minimum of 40 quarters (credits). These credits can be earned even while residing in Israel. One can accrue a maximum of 4 quarters per year by generally earning in excess of $5,500 annually. This is primarily accomplished by:

i) Being self-employed in Israel and reporting Israeli self-employment income on your U.S. income tax return,

ii) Working in Israel for a U.S. entity and receiving a Form W-2 (employee) or Form 1099 (independent contractor),

iii) Traveling to the U.S. to work as an employee (W-2) or as a self-employed individual (1099).

Higher Education Credit

The American Opportunity credit (AOC) can be claimed for qualified tuition and related expenses for any of the first four years of a college or university degree. The credit is up to $2,500 for those paying $4,000 or more in qualifying expenses for an eligible student. Forty percent of the credit is refundable which allows a taxpayer to receive up to $1,000 cash back for each eligible student claimed on the tax return, even if no income tax is due. You cannot claim the credit and the tuition and fees deduction for the same student. The credit is generally available for U.S. universities and for certain foreign universities. The credit begins to phase out at $80,000 for taxpayers filing single or $160,000 for taxpayers filing jointly. To claim the AOC a domestic student must receive a Form 1098-T or equivalent that contains the Tax Identification Number of the university. Students at accredited universities outside of the U.S. will not receive a 1098-T, but can still claim the credit.

Automatic Extension, Estimated Tax Payments and Automatic Withdrawal

Automatic income tax return extensions are available until June 15, 2018 for U.S. taxpayers who reside outside of the U.S. If there is a balance due with your tax return, interest will be accrued from April 15, 2018 while penalties will begin to accrue after June 15, 2018. Filing an extension will extend the time to file until October 15, 2018. An additional extension may be granted until December 15, 2018 but certain restrictions may apply. It is strongly recommended that taxpayers who owe income tax but do not file by June 15th should make a payment with their extension. For the upcoming year, it is imperative that taxpayers pay estimated taxes on a timely basis in order to avoid underpayment of estimated tax penalties.

Tax Retirement Plans/Required Minimum Distributions (RMD)

Within 60 days of a distribution from an Individual Retirement Plan ("IRA") a taxpayer can roll over the distribution to another retirement plan tax-free. If no rollover is made within 60 days, the taxpayer is required to pay tax on the distribution at ordinary income tax rates. Once you reach age 70 1/2 you generally must begin to withdraw funds from traditional IRAs on an annual basis and pay the required income tax.

The amount of your RMD is calculated by using the IRS life expectancy tables. In addition, conversion to a Roth IRA can be a valuable tax planning tool for both U.S. and Israeli tax purposes.

Avoiding Early Withdrawal Penalties from Retirement Funds

An early IRA distribution may be made without being subject to the 10% early withdrawal penalty provided the funds are used to purchase a first home even in Israel. The distribution amount is limited to $10,000 per taxpayer and/or spouse from each individual's account. The early withdrawal penalty will also not apply in certain circumstances such as medical premium payments or higher educational expenses.

Corporations, LLC's, Trusts and Form 5471

Corporations may be excellent tax planning vehicles, especially for taxpayers working outside Israel and in light of Israeli tax reform. "C" Corporation tax rates are 15% on taxable income up to $50,000, 25% from $50,001 - $75,000 and 34% from $75,001 - $100,000, with higher rates for higher taxable incomes. Starting in 2018 the tax rate is a flat 21%.

"S" Corporations, Limited Liability Companies (LLC's) and certain Trusts are called pass-through entities. The pro-rata share of the pass-through entity's income must be reported on the taxpayer's personal income tax return and is taxed at the individual's personal income tax bracket. Starting in 2018, income from pass- through entities above $315,000 will be taxed at a maximum rate of 21%. There are adjustments to income that will have to be applied. Having an entity can be even more advantageous under the new tax law.

If you have a foreign corporation, you may be required to file form 5471 (Information Return of U.S. Persons with Respect to Certain Foreign Corporations) with your tax return (please contact our office for more details). The U.S. is shifting to a "territorial" tax system for corporations. For 2018, there will be a one-time repatriation tax on the Earnings & Profits of a foreign subsidiary or CFC at a rate of 15.5%. Going forward income not withdrawn from a corporation can generally remain in place. It will still be taxed when distributed as salary or as a dividend. 

 

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Wednesday, 23 September 2020

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