Author: Mark Mountney
Source: articleage.com
At Rose Financial Services, being recognised as a specialist mortgage brokerage and independent financial adviser, we receive enquiries from people from all walks of life. And it is no surprise then that the volume of enquiries sees a repetition of requirements.
The following guide has been produced to answer many of the standard questions that clients ask of Rose FS on a day to basis with regard to raising a mortgage secured on a property in Spain. It is in 3 parts, so make sure you collect them all to provide a broad based understanding of how mortgages work in Spain.
1) Are 'Interest Only' mortgages available?
Yes, and the term for the 'Interest Only' (IO) period ranges from 1 year to a full term of 25 years. However, the schemes offering longer term IO (10 to 25 years) are far more restrictive than those for shorter terms (1 to 5 years) as the Spanish lending market has yet to adjust to the British way of thinking in this respect.
After the initial IO period the mortgage automatically switches to a Repayment or Capital and Interest type for the remainder of the mortgage term. For example, if a mortgage is arranged over say, 20 years with an IO period of 2 years, from Year 3 the mortgage will switch to a Reapyment over the remainder of 18 years. The rate of interest will still be the same i.e. annually fixed, but you will be asked to start repaying the capital as well as the interest.
At this stage, we have various choices open to us and it is a good idea for you to review matters with Rose FS;
i) Allow the mortgage to transfer to a Repayment type and start to repay the capital. However, this is not always good IHT planning (see Question 2) below).
ii) Ask the bank to extend the IO period. There is no guarantee that they will allow this but market conditions then may make them find in your favour.
iii) Consider a remortgage and switch to another lender. The downside to this, of course, will be the costs attached in doing so. It is therefore important to consider your long term requirements when planning the detail of your mortgage
2) Why would I want an 'Interest Only' mortgage as opposed to a Repayment (Capital and Interest) mortgage?
The mental approach to this is different than the normal rationale applied to borrowing in the UK. The benefits are often very different;
I) In Spain there is a 'sleeping giant' of an issue which most home owners are simply unaware of: Inheritance Tax (IHT). Go to Question 12) for a guide to this VERY IMPORTANT issue.
It is so important that any property acquisition in Spain cannot adequately be considered unless this subject is understood.
Ii) Interest rates for mortgages in Spain are low by comparison to the UK and, in most cases, the capital and income employed to either meet interest payments or repayments emanates from a ฃ income or capital base.
That being so, there is a benefit to retain as much capital as possible in ฃ and invest it for a higher return. For example, even cautious investment into a deposit account can generate an interest rate return of 5% as at the date of writing. With an average Euro mortgage rate of say, 3.5% the net return is at least 1.5% per annum. Over a standard term of 25 years, that will gross up to 37.5% of capital employed. If the mortgage is for €150,000 by way of example, that equates to a massive extra income of €56250 or approximately ฃ40,000.
Iii) Interest paid is normally allowable against income received for the purpose of calculating Income Tax. Therefore, the longer an IO period is run, the greater the interest paid and hence, the tax saving. Remember, that there is also an added income via the reduction of capital employed as mentioned above.
Iv) There is a potential exchange rate risk in holding an asset (your Spanish property) in a foreign currency (Euros) against the natural income and capital base (normally ฃ for the majority of our clients).
Therefore, by keeping the liability (your Euro mortgage) as high as possible for as long as possible, there is an offset which can mitigate against negative exchange rate movements.
3) What is the normal interest rate payable for a Spanish Euro mortgage?
Rates are normally set against the European Central Bank annual rate (Euribor) or the Spanish Cajas rate with a margin and re-fixed annually. This helps cash flow projections. It is often common to see a discount offered for the first year.
Hence, the current first year rate will range from sub 3% for low IO terms and Repayment mortgages. For longer IO periods a premium is charged by the lenders, so that the average rate will be circa 3.3% to 3.6%.
4) What documents do I need to show?
ID. Passport and either a
Residencia Card (for Residents) or an
NIE (ID number for Non Residents). Rose FS will assist in arranging any NIE needed.
Proof of Income Pay slips x 3 months
P 60
Pension Letters
Rental income contracts
Tax Assessment (Self Employed)
Trading Accounts (Self Employed)
Accountant's Statement of Affairs (Self Employed)
Bank Statements x 3 months (for all bank accounts, UK and Spain)
Existing mortgages x 3 months statements
Remortgages Existing Escritura
Original Compraventa (Purchase contract)
Recent valuations
Quotations for any works being financed or property being purchased
Latest existing mortgage or loan statements being consolidated
Purchases Compraventa (Purchase contract)
Property details
Solicitor contact details
Estate Agent details
That all sounds a lot but, in most cases, many of the documents will not apply.
Also, Rose FS need only COPY documents and not the originals. However, the original passport, NIE or Residencia will be needed at the legal completion of the process.
The application process can be actioned from a distance via post, fax and e mail. You do not physically need to meet a mortgage adviser and we will complete the process of determining your needs by phone.
5) What are the costs of arranging a mortgage?
Arranging a mortgage in Spain is slightly more expensive than in the UK and broadly you should allow 5% of the mortgage amount needed as follows;
1% Lender fee
1% Rose FS fee (minimum €1,000)
1% Notary/Registration
1.6% AJD Mortgage tax
0.15% Valuation fee Up Front
€300 Booking fee Up Front
As you can see the only monies needed by Rose FS to apply for the mortgage are the Valuation and Booking fees. All other costs are due at completion and will be deducted from the mortgages advance over the new current account with the lender.
6) What is the cost of repaying the mortgage early?
Redemption penalties, as they are formally called, are relatively inexpensive in Spain. The norm is for 0.5% for partial repayment and 1% full repayment. However, a common ploy in repaying a mortgage is never to redeem it in full but to leave a small balance outstanding.
7) Do I need to use a specialist Spanish and English speaking solicitor?
For Remortgages, where you are switching lenders, or simply releasing capital/equity from your home or debt consolidating, no! The process is relatively simple and does not warrant the extra cost of using a solicitor.
However, for a Purchase, using such a professional is STRONGLY recommended. Rose FS will happily recommend a firm.
8) Do I need to be in attendance at legal completion of the mortgage and/or purchase.
The short answer is no, although this is always recommended.
The legal completion is known as 'Notarisation' as the relevant deeds or 'escrituras' will be executed by a Notary. He or she will be a government appointed officer with the authority to witness and sign legally binding agreements.
If you cannot or do not want to be in attendance at the Notary it will be necessary for a 'Power of Attorney' agreement to be given to a trusted third party. Rose FS will happily act on your behalf although, for Purchases, we would request that your solicitor act for you. Also, for Purchases, a 'General Power of Attorney' is recommended as this gives much broader powers (for example, to open and run a bank account) rather than a standard limited power.
9) Do I need a Spanish bank account for a mortgage?
Yes. All banks insist on opening a Current Account to sit alongside the mortgage in order to receive monies in and pay the mortgage.
As part of the process heading towards Notarisation, you will need to execute the account opening forms. The sooner this is done, of course, the better.
10) Are their any mandatory or suggested insurances for a mortgage?
Yes. The only mandatory protection or insurance policy required by all banks (and this is the same in the UK) is Buildings Insurance. All banks will want to see this in place and will even insist upon arranging it themselves.
In addition, it is STRONGLY recommended that all mortgages are protected by a) Life Assurance and b) Income Protection to ensure that the mortgage and underlying asset, your home, is adequately protected.
You will not want to buy a property and only lose it from an accident , illness or disability beyond your control!
All Rose FS clients will be interviewed by our own Independent Financial Advisor in this respect.
11) What if my income is low or I cannot prove my income?
This is not an uncommon problem but there are normally aways around the issue and requirements of the lender.
Lenders look at 2 risks when determining whether a mortgage application is acceptable to them;
i) You and your ability to meet monthly mortgage payments.
This translates into a) the credit worthiness of the applicant (the lender will run checks) and b) provable, regular income.
ii) The Property.
This translates to a) the percentage they lend you against the valuation that they will carry out and b) the property state, type, etc.
For the Self Employed proof can sometimes be difficult because a good Accountant, in preparing the books of accounts, will try to keep net profits and hence, tax as low as possible. However, the combination of the latest books, Tax Assessment and a Letter of Comfort or Statement of Affairs from the Accountant, with sight of recent banks statements, will normally do the job.
If your income is low still, or because of a low wage, pension, rental or investment income, we can look to use a third party (normally a working child, sibling or parent) to add the weight of their own income acting either as a co-applicant on the mortgage or as a 'Guarantor'. Again, they do not need to come to Spain to execute any legal documents; this can achieved via a Power of Attorney from a distance. Rose FS will arrange this.
It is important to mention two things here;
i) The co-applicant(s) is at risk, as are you, if you do not keep up the repayments of the mortgage. That needs careful explaining to them.
However, often, the addition of a Guarantor actually diminishes such a risk as mortgage payments can be normally extended over a longer period, especially where the majn applicants are elderly.
ii) The Guarantor does NOT need to be added to the property deed. In other words, the ownership of your property need not be undermined by you using a third party to financially support your appllcation.
12) Am I too old for a mortgage and what is the maximum term to repay?
Many elderly clients think they are too old to apply for a mortgage, despite the fact that maximum age for repayment is 75. This is not so.
By using a third party to either come onto the application or to act as a Guarantor (as above) the emphasis of the lending assessment of risk is taken away from the more elderly applicants to rely on the added third party (normally a child).
This is often good Inheritance Tax planning as any debt outstanding on a death reduces the tax payable.
So, if you are in the position of 'wanting' or 'needing' access to some of the capital locked into your home, or wish to buy and are worried about either age or income, this option has to be considered.
13) Do I need to be worried about Spanish Inheritance Tax?
Worried, no! Concerned, yes! Understanding the issue and how to overcome it is more than half of the battle!
The vast majority of people that buy in Spain, especially the British, make an assumption that the IHT regime in Spain is the same as in the UK. This is simply not so. It is massively different and to understand a) the issues and it's potential impact on you and your family and b) how it is so easy to address, is a danger to say the least!
The primary differences between Spanish and UK IHT regimes are threefold;
i) There is no spouse exemption on the family home
ii) The IHT allowances lie with the beneficiary(ies) and not the deceased
iii) The standard personal allowance in Spain is just €15,958 versus ฃ275,000 in the UK. A huge difference.
The effect of IHT means that, as most people buying in Spain are non- resident for tax, the risk of having to pay IHT is high.
However, IHT is levied on the 'net worth' of the recipient and the benefit being received, so by keeping the mortgage at a high a level as possible, the taxable exposure is reduced. A Repayment mortgage decreases over time which has the directly opposite effect of increasing IHT exposure.
Even if the preference is for a Repayment it is wise to consider IO as an alternative for the IHT mitigation as above, and indeed to consider as long a term as possible, perhaps by bringing would-be beneficiaries onto the mortgage so that they, in turn, can benefit when the property passes to them on death of the current owners.
There are various routes to resolving the problem or IHT mitigation that can and should be considered;
i) Maximise the Interest Only mortgage (as above)
ii) Effect Life Assurance (normally Whole of Life). This is normally written in Trust in favour of the end beneficiaries not to not avoid tax but rather to make sure that funds are available to meet the tax bill.
iii) Add beneficiaries to the property deed. Because tax is calculated according to the distribution of the deceased's share of the property (or other assets) and the classification of the beneficiaries, it can make sense to add the beneficiaries early so that each person has a smaller share and, hence the tax exposure reduced.
The issues arising by doing this though are several;
i) By changing the owners of a property there may be a Capital Gains Tax payable. So timing is important.
ii) You may not be comfortable in gifting part of your home away, even to your children! Having said that the concern could be overcome, at least to a degree, by taking a 'General Power of Attorney from them so that control lies with you. But these powers can be cancelled at any time so you need to be comfortable with whom the arrangement is made.
Finally, it is critical that your effect a Will here in Spain. This is because there is a default mechanism that will decide the fate of your estate if you die without one. That could mean that people may benefit in a way that you had not intended! Rose FS will recommend a solicitor to assist.
I hope that this FAQ series has been useful. However, if you have an enquiry of a different nature please do not hesitate to contact us.
Mark Mountney is a partner in Rose Financial Services, a specialist mortgage brokerage and Independent Financial Advisor based in the Parque Comercial, Mojacar. He is a fully qualified mortgage and financial adviser in the UK with some 10 years experience in managing his own firm. Mark was also a founder of The Association of Mortgage Advisors, the trade association for mortgage intermediaries with 13,000 members.
Showing posts with label income. Show all posts
Showing posts with label income. Show all posts
Monday, December 21, 2009
Sunday, November 22, 2009
Unreported Offshore Income? Take Action Now With the IRS
Author: Ron Cohen
Source: ezinearticles.com
The world is changing. A tax evader should seriously consider what may be the only way to stop an illegal bad situation from becoming a life-destroying criminal prosecution. Consider a Voluntary Disclosure to clean-up the past.
Based on tax law precedent going back to the 1940s, the I.R.S. and many state tax authorities have a standing polciy that, generally, they will NOT pursue criminal prosecution of tax evasion in cases where the tax evading taxpayer comes forward BEFORE they are contacted by the tax authority.
As an I.R.S. District Counsel (prosecuting attorney) once told me after a 13 week course on I.R.S. internal procedures as part of my Masters Degree program in Taxation: "If you learn nothing else in this class, remember this: If your client is in tax trouble, you need to find me before I find you."
He went on to explain that the I.R.S. wants people to be able to come back from the non-filing and non-paying underworld and get clean without fear of criminal prosecution...otherwise, tax evaders have no way to re-enter the tax system without the threat of losing not only large sums of money but also lose their liberty and living standard if they suffer criminal prosecution, versus civil (money) penalties.
Alternatively, if the I.R.S. finds or contacts a taxpayer via an audit, non-filing notices, the Form 1099 Matching Program, referrals from other non-tax prosecutions or otherwise becomes aware of significant criminal tax violations, then, their frame of mind changes. They often try to make a public example of the taxpayer and pursue criminal prosecution and jail sentences to the extent allowed by law.
It is my experience that taxpayers have to almost force the I.R.S. (by repeated bad behavior) to prosecute, as the I.R.S. has a lack of resources. They would much rather use civil penalties, liens, levies and wage garnishments which can quickly be triggered by the I.R.S. computer system to collect unpaid tax and force the taxpayer back into filing returns. But when the taxpayer ignores I.R.S. letters, disappears or is non-responsive, is under other criminal prosecution (like an arrested drug dealer) or argues the tax system is illegal or unconstitutional, the case gets elevated to where I.R.S. lawyers and criminal investigators are assigned.
At that point, the I.R.S. people involved, like all of us, want to be successful in their work; and success for them is often a criminal prosecution and a conviction. A taxpayer in that situation needs the immediate help of qualified legal counsel specializing in tax cases.
Specifically, regarding unreported offshore Income, in my opinion, you are running out of time.
Technology, the Federal and State deficits and the political winds are now all working against tax evasion with regards to unreported offshore income.
The technology is improving to catch tax evaders who often establish an offshore bank account in a country that does not share account information with the I.R.S. An A.T.M. card is often used allowing access to the funds at any A.T.M. machine in the U.S. that is in the offshore bank's A.T.M. network. The U.S. bank through which the A.T.M. withdrawal is processed becomes a legal party to the transaction. The I.R.S. has a significant project underway to drill-through the U.S. bank and find the offshore account and the U.S. taxpayer/evader.
Banks are being required to increase internal audit controls to stop inadvertently assisting tax evaders.
Recently in the news, the I.R.S. is pressuring Liechtenstein and Swiss banks to provide information on U.S. taxpayers suspected of tax evasion. Banks in the Cayman Islands and Bermuda continue to come under pressure from U.S. and European tax authorities.
Now, with the economic crisis of the last 6 months, the U.S. President and Congress and the tax authority of many countries and states see unreported income of tax evaders as "low-hanging fruit." As voters have no sympathy for offshore tax evaders, it is clear more laws and resources will be applied to pursue this unreported income.
As a result, the world is changing. A tax evader should seriously consider what may be the only way to stop an illegal bad situation from becoming a life-destroying criminal prosecution. Consider a Voluntary Disclosure to clean-up the past.
How Does A Taxpayer make a "Voluntary Disclosure?"
With regards to the I.R.S., a specific process exists for taxpayers who approach the I.R.S. with the intent to clean-up old returns. I provide five comments:
It will take many months to resolve unfiled, unreported income. Be patient!
Use complete honesty and complete disclosure in every contact with the I.R.S. or any tax authority. Remember, you are trying to avoid CRIMINAL PROSECUTION. This is not a game. Don't try playing games with partial disclosures. The worst thing you can do is hold back information at this point and be accused of lying. They have seen it all before, and they know what you are thinking, often before you do. You are coming to them for help, so provide complete cooperation. They are usually very cooperative with people who take this approach.
Keep a copy of everything you give the I.R.S. and keep a written record of every telephone conversation.
Consider getting assistance from a C.P.A., Enrolled Agent or Tax Attorney.
Don't forget the state taxes that might be involved. The I.R.S. WILL communicate the information you provide to the state tax authorities.
The starting point for a Voluntary Disclosure is no surprise. Put together your tax information for each taxable year just as if you would to originally file your tax return. Again, consider consulting with a C.P.A., and Enrolled Agent and/or a bookkeeper if you need help to get your information together.
If you can't find records, then call banks, or businesses, etc. to collect as much documentation as you can. YOU DON'T NEED TO BE PERFECT OR HAVE EVERYTHING IF IT DOES NOT EXIST. The I.R.S. understands that records from years ago may be unavailable. Reasonable estimates are fine if there is no alternative. Don't get caught in the mental trap of not filing, or waiting longer just because you can't find every record, Form 1099, receipt, bank statement or invoice.
If your return was originally filed, however, offshore (or any other type of income) was not reported, an amended tax return needs to be prepared. That is I.R.S. Form 1040X for individual taxpayers.
When you are as ready as you can be (and sooner is always better than later) to contact the I.R.S., mail everything to the I.R.S. Service Center, just as if you were filing a normal tax return, but with a cover letter. Absolutely mail it certified mail, return receipt requested and keep copies of everything and all postmarked documents (seriously) for the rest of your life. I'll skip explaining why, here.
Under Internal Revenue Manual Sec. 9.5.3.3.1.2.1, a voluntary disclosure occurs when:
The communication (tax return and/or related letter) is truthful, timely and complete. This includes:
the taxpayer shows a willingness to cooperate (and does in fact cooperate) with the IRS in determining his or her correct tax liability; and the taxpayer makes good faith arrangements with the IRS to pay in full, the tax, interest, and any penalties determined by the IRS to be applicable.
At this point, the I.R.S.sends the tax return[s] to a special unit that deals with amended or late returns. Over two months may pass before the taxpayer receives any reply. Pay in as much of the estimated tax, interest and penalties as possible with the returns. Make sure to indicate what year each payment should be applied to. Otherwise, it will be applied to the current tax year - which is a hassle to correct.
The I.R.S. has additional triggers they consider when evaluating the situation.
How many tax years are involved?
What is the amount involved? Clearly, a $1 million unreported amount may get a different response than a $10,000 unreported amount.
What prior filing history does the taxpayer have? Is this the first issue, or part of a long history of problems?
Often, if no special issues come up, the taxpayer will receive a straightforward letter simply saying the return was received and the following tax, interest and penalties is owed. In all my experiences, if the taxpayer pays any amount due within the 30 days allowed after receiving that letter, it is very normal to never again hear from the I.R.S. with regards to that tax return for that particular year. However, nothing in this article guarantees this result.
The moral to this story is that I.R.S. policy and case law clearly MOVES TO THE SIDE OF THE TAXPAYER toward avoiding criminal prosecution the moment the taxpayer mails the unfiled or amended tax returns and pay as much of the unpaid balance due as possible.
NOTE: The Voluntary Disclosure policy does NOT apply to illegal source income. For example, unreported drug trafficking income will not qualify for the Voluntary Disclosure procedure, as that type of income is illegal under other (non-tax) laws. In contrast, there is nothing illegal about earning interest income from a Swiss bank account, so it is not illegal "source" income. However, the failure to report such income on your tax return can be a tax crime. Therefore, the Voluntary Disclosure policy can apply to the Swiss interest income.
WHEN IS THE VOLUNTARY DISCLOSURE POLICY NOT AVAILABLE?
It is important to note when a taxpayer is considered "contacted" by the I.R.S.: Again from Internal Revenue Manual Sec. 9.5.3.3.1.2.1
A disclosure is timely if it is received before:
the IRS has initiated a civil examination or criminal investigation of the taxpayer, or has notified the taxpayer that it intends to commence such an examination or investigation; the IRS has received information from a third party (e.g., informant, other governmental agency, or the media) alerting the IRS to the specific taxpayer's noncompliance; the IRS has initiated a civil examination or criminal investigation which is directly related to the specific liability of the taxpayer; or the IRS has acquired information directly related to the specific liability of the taxpayer from a criminal enforcement action (e.g., search warrant, grand jury subpoena).
If the above has occurred, please consult a tax attorney. You may actually do more harm than good by sending in a tax return (or amended return) to the IRS Service Center at this point, as the I.R.S. may consider that an attempt to work around the tax examiner who contacted you, to gain a legal advantage.
A tax evader never knows when a, b, c, or d above may occur or when an I.R.S. letter will show up in their mail box. At that moment, the opportunity to avoid criminal prosecution may be lost forever. It is an "on/off" switch for which there is precedent in I.R.S. policy and case law.
So please, if you are in this situation, get to them before they get to you, and please consider seeking competent tax advice before doing so.
The policy of most state, local and European tax authorities is similar, although you should seek advice competent in the policy of each tax authority before taking any action.
Also, assuming you have legally avoided criminal prosecution, many people try to negotiate unpaid taxes, interest and penalties. Please be very skeptical of companies that promise to negotiate your tax liability. In reality, only the bankrupt or near bankrupt qualify for these programs, and many, many people have given me feedback on how some firms take an upfront fee and then do nothing, or even make matters worse. Please be careful.
With regard to penalties to be assessed, a complete review is beyond the scope of this article except to say, they will be very significant.
Source: ezinearticles.com
The world is changing. A tax evader should seriously consider what may be the only way to stop an illegal bad situation from becoming a life-destroying criminal prosecution. Consider a Voluntary Disclosure to clean-up the past.
Based on tax law precedent going back to the 1940s, the I.R.S. and many state tax authorities have a standing polciy that, generally, they will NOT pursue criminal prosecution of tax evasion in cases where the tax evading taxpayer comes forward BEFORE they are contacted by the tax authority.
As an I.R.S. District Counsel (prosecuting attorney) once told me after a 13 week course on I.R.S. internal procedures as part of my Masters Degree program in Taxation: "If you learn nothing else in this class, remember this: If your client is in tax trouble, you need to find me before I find you."
He went on to explain that the I.R.S. wants people to be able to come back from the non-filing and non-paying underworld and get clean without fear of criminal prosecution...otherwise, tax evaders have no way to re-enter the tax system without the threat of losing not only large sums of money but also lose their liberty and living standard if they suffer criminal prosecution, versus civil (money) penalties.
Alternatively, if the I.R.S. finds or contacts a taxpayer via an audit, non-filing notices, the Form 1099 Matching Program, referrals from other non-tax prosecutions or otherwise becomes aware of significant criminal tax violations, then, their frame of mind changes. They often try to make a public example of the taxpayer and pursue criminal prosecution and jail sentences to the extent allowed by law.
It is my experience that taxpayers have to almost force the I.R.S. (by repeated bad behavior) to prosecute, as the I.R.S. has a lack of resources. They would much rather use civil penalties, liens, levies and wage garnishments which can quickly be triggered by the I.R.S. computer system to collect unpaid tax and force the taxpayer back into filing returns. But when the taxpayer ignores I.R.S. letters, disappears or is non-responsive, is under other criminal prosecution (like an arrested drug dealer) or argues the tax system is illegal or unconstitutional, the case gets elevated to where I.R.S. lawyers and criminal investigators are assigned.
At that point, the I.R.S. people involved, like all of us, want to be successful in their work; and success for them is often a criminal prosecution and a conviction. A taxpayer in that situation needs the immediate help of qualified legal counsel specializing in tax cases.
Specifically, regarding unreported offshore Income, in my opinion, you are running out of time.
Technology, the Federal and State deficits and the political winds are now all working against tax evasion with regards to unreported offshore income.
The technology is improving to catch tax evaders who often establish an offshore bank account in a country that does not share account information with the I.R.S. An A.T.M. card is often used allowing access to the funds at any A.T.M. machine in the U.S. that is in the offshore bank's A.T.M. network. The U.S. bank through which the A.T.M. withdrawal is processed becomes a legal party to the transaction. The I.R.S. has a significant project underway to drill-through the U.S. bank and find the offshore account and the U.S. taxpayer/evader.
Banks are being required to increase internal audit controls to stop inadvertently assisting tax evaders.
Recently in the news, the I.R.S. is pressuring Liechtenstein and Swiss banks to provide information on U.S. taxpayers suspected of tax evasion. Banks in the Cayman Islands and Bermuda continue to come under pressure from U.S. and European tax authorities.
Now, with the economic crisis of the last 6 months, the U.S. President and Congress and the tax authority of many countries and states see unreported income of tax evaders as "low-hanging fruit." As voters have no sympathy for offshore tax evaders, it is clear more laws and resources will be applied to pursue this unreported income.
As a result, the world is changing. A tax evader should seriously consider what may be the only way to stop an illegal bad situation from becoming a life-destroying criminal prosecution. Consider a Voluntary Disclosure to clean-up the past.
How Does A Taxpayer make a "Voluntary Disclosure?"
With regards to the I.R.S., a specific process exists for taxpayers who approach the I.R.S. with the intent to clean-up old returns. I provide five comments:
It will take many months to resolve unfiled, unreported income. Be patient!
Use complete honesty and complete disclosure in every contact with the I.R.S. or any tax authority. Remember, you are trying to avoid CRIMINAL PROSECUTION. This is not a game. Don't try playing games with partial disclosures. The worst thing you can do is hold back information at this point and be accused of lying. They have seen it all before, and they know what you are thinking, often before you do. You are coming to them for help, so provide complete cooperation. They are usually very cooperative with people who take this approach.
Keep a copy of everything you give the I.R.S. and keep a written record of every telephone conversation.
Consider getting assistance from a C.P.A., Enrolled Agent or Tax Attorney.
Don't forget the state taxes that might be involved. The I.R.S. WILL communicate the information you provide to the state tax authorities.
The starting point for a Voluntary Disclosure is no surprise. Put together your tax information for each taxable year just as if you would to originally file your tax return. Again, consider consulting with a C.P.A., and Enrolled Agent and/or a bookkeeper if you need help to get your information together.
If you can't find records, then call banks, or businesses, etc. to collect as much documentation as you can. YOU DON'T NEED TO BE PERFECT OR HAVE EVERYTHING IF IT DOES NOT EXIST. The I.R.S. understands that records from years ago may be unavailable. Reasonable estimates are fine if there is no alternative. Don't get caught in the mental trap of not filing, or waiting longer just because you can't find every record, Form 1099, receipt, bank statement or invoice.
If your return was originally filed, however, offshore (or any other type of income) was not reported, an amended tax return needs to be prepared. That is I.R.S. Form 1040X for individual taxpayers.
When you are as ready as you can be (and sooner is always better than later) to contact the I.R.S., mail everything to the I.R.S. Service Center, just as if you were filing a normal tax return, but with a cover letter. Absolutely mail it certified mail, return receipt requested and keep copies of everything and all postmarked documents (seriously) for the rest of your life. I'll skip explaining why, here.
Under Internal Revenue Manual Sec. 9.5.3.3.1.2.1, a voluntary disclosure occurs when:
The communication (tax return and/or related letter) is truthful, timely and complete. This includes:
the taxpayer shows a willingness to cooperate (and does in fact cooperate) with the IRS in determining his or her correct tax liability; and the taxpayer makes good faith arrangements with the IRS to pay in full, the tax, interest, and any penalties determined by the IRS to be applicable.
At this point, the I.R.S.sends the tax return[s] to a special unit that deals with amended or late returns. Over two months may pass before the taxpayer receives any reply. Pay in as much of the estimated tax, interest and penalties as possible with the returns. Make sure to indicate what year each payment should be applied to. Otherwise, it will be applied to the current tax year - which is a hassle to correct.
The I.R.S. has additional triggers they consider when evaluating the situation.
How many tax years are involved?
What is the amount involved? Clearly, a $1 million unreported amount may get a different response than a $10,000 unreported amount.
What prior filing history does the taxpayer have? Is this the first issue, or part of a long history of problems?
Often, if no special issues come up, the taxpayer will receive a straightforward letter simply saying the return was received and the following tax, interest and penalties is owed. In all my experiences, if the taxpayer pays any amount due within the 30 days allowed after receiving that letter, it is very normal to never again hear from the I.R.S. with regards to that tax return for that particular year. However, nothing in this article guarantees this result.
The moral to this story is that I.R.S. policy and case law clearly MOVES TO THE SIDE OF THE TAXPAYER toward avoiding criminal prosecution the moment the taxpayer mails the unfiled or amended tax returns and pay as much of the unpaid balance due as possible.
NOTE: The Voluntary Disclosure policy does NOT apply to illegal source income. For example, unreported drug trafficking income will not qualify for the Voluntary Disclosure procedure, as that type of income is illegal under other (non-tax) laws. In contrast, there is nothing illegal about earning interest income from a Swiss bank account, so it is not illegal "source" income. However, the failure to report such income on your tax return can be a tax crime. Therefore, the Voluntary Disclosure policy can apply to the Swiss interest income.
WHEN IS THE VOLUNTARY DISCLOSURE POLICY NOT AVAILABLE?
It is important to note when a taxpayer is considered "contacted" by the I.R.S.: Again from Internal Revenue Manual Sec. 9.5.3.3.1.2.1
A disclosure is timely if it is received before:
the IRS has initiated a civil examination or criminal investigation of the taxpayer, or has notified the taxpayer that it intends to commence such an examination or investigation; the IRS has received information from a third party (e.g., informant, other governmental agency, or the media) alerting the IRS to the specific taxpayer's noncompliance; the IRS has initiated a civil examination or criminal investigation which is directly related to the specific liability of the taxpayer; or the IRS has acquired information directly related to the specific liability of the taxpayer from a criminal enforcement action (e.g., search warrant, grand jury subpoena).
If the above has occurred, please consult a tax attorney. You may actually do more harm than good by sending in a tax return (or amended return) to the IRS Service Center at this point, as the I.R.S. may consider that an attempt to work around the tax examiner who contacted you, to gain a legal advantage.
A tax evader never knows when a, b, c, or d above may occur or when an I.R.S. letter will show up in their mail box. At that moment, the opportunity to avoid criminal prosecution may be lost forever. It is an "on/off" switch for which there is precedent in I.R.S. policy and case law.
So please, if you are in this situation, get to them before they get to you, and please consider seeking competent tax advice before doing so.
The policy of most state, local and European tax authorities is similar, although you should seek advice competent in the policy of each tax authority before taking any action.
Also, assuming you have legally avoided criminal prosecution, many people try to negotiate unpaid taxes, interest and penalties. Please be very skeptical of companies that promise to negotiate your tax liability. In reality, only the bankrupt or near bankrupt qualify for these programs, and many, many people have given me feedback on how some firms take an upfront fee and then do nothing, or even make matters worse. Please be careful.
With regard to penalties to be assessed, a complete review is beyond the scope of this article except to say, they will be very significant.
Please see the attached from Doug Shulman, Commissioner of the IRS, from 3/26/09: http://www.irs.treas.gov/newsroom/article/0,,id=206014,00.html.
I am always available for questions and comments at 510 797 8661 x237.
Ron Cohen is a Partner at a top Bay Area CPA Firm, Greenstein, Rogoff, Olsen & Co. He has more than 25 years experience in public accounting and related industry work. He earned an undergraduate accounting degree from the University of Illinois, Chicago, and then a Masters in Taxation from Golden Gate University. Ron has extensive knowledge in International Tax and has traveled extensively throughout Europe and Asia handling tax issues.
Monday, November 9, 2009
Tax Tips for IT Consultants and Contractors
Author: Stephen Nelson
Source: articleage.com
I live and work, quite literally, down the road from the main Microsoft campus. No surprise, then, that I'm commonly asked by freelance consultants for the best ways that these self-employed independent contractors can minimize their income taxes.
If I can, I try to weasel my way out of the discussion, offering up such basic tidbits as, "Well, be sure to look at the home office deduction." And "make sure you're taking advantage of deductions for health insurance and pension funds."
Usually, those simplistic answers work. Everyone once in a while, though, I encounter some guy who's really motivated to save on taxes. Usually, someone now making good money consulting or contracting… When I can't deflect their questions in some other way, I tell them about the three best ways that independent contractors have to save on taxes.
Technique #1: Smooth Your Income
Whatever you think of the US Internal Revenue Code, you need to know that it's quite progressive. That progressivity means the more you make, the more you pay. The progressivity also means that if your income fluctuates, your income taxes go up even if you make the same money on average as someone else makes.
To give you an example of this, suppose that you compare two consultants, John and Jane. If John makes a steady $60,000 a year and has a mortgage, a spouse and couple of kids, he might pay about $1000 over four years (net of tax credits for these like his children.)
In comparison, suppose that Jane averages $60,000 a year, but sees her income fluctuate between $30,000 a year and $90,000 a year. If she also has a spouse, two kids and a mortgage, she'll probably pay $8,000 to $10,000 over those same four years.
Please note that over the same four years, the two consultants make the same amount of money: $240,000. But what they pay in taxes differs radically. Jane pays eight to ten times what John pays. Bummer.
What can Jane do? Well, let's bring this back to the example of working consultants. Jane can probably smooth her income. She can make sure that she's not stacking two big retainers or performance bonuses in the same year. She can spread out year-end payments over the ending and beginning year in ways that smooth her income out. She can even try to stuff more of her expenses into the good years. In the good years, for example, she can buy new computers, take those graduate classes, or top off her pension.
Technique #2: Setup an LLC and Elect S Corporation Status
I've written and talked much about how S corporations save taxpayers money and how the right way to set up an S corporation is first create a limited liability company and then ask the IRS to treat the LLC as an S corporation for tax purposes.
Let me review the basics here again, however. Suppose that you're making $90,000 a year as a consultant or contractor. If you just treat your business as a sole proprietorship, you might pay $12,000 in income taxes on the $90,000 and then another 15.3% self-employment tax, or roughly $13,500 on the $90,000.
If you set up an LLC and have the LLC treated as an S corporation, you'll still pay the same $12,000 in income taxes. But you'll only pay the 15.3% self-employment tax on that portion of the profit that you categorize as wages. If you categorize, say, $50,000 of the profits as wages, you'll pay $7,500 in self-employment taxes. (The other $40,000 in remaining profits, by the way, gets paid out as a dividend-like "distribution.")
Note, then, that the S corporation saves you roughly $6,000 every year. Sweet, right?
Two quick points about S corporations: First, S corporations require some extra tax and accounting so you don't get to spend all of your savings. Some of the savings go to the lawyer, the accountant, and the bank. Second, you absolutely must set your salary to a reasonable level.
Technique #3: Relocate Your Residency
One final, easy planning gambit if you telecommute. Remember that there are states like Alaska, Florida, Nevada, Texas and Washington that don't charge residents state income taxes. Accordingly, if you relocate to one of these states, you'll automatically drop your overall tax bill because you won't have state income taxes.
Sometimes, one of the benefits of independent contracting and freelance consulting is that is that you do get to live wherever you want. Why not choose a place that doesn't tax your income?
But a caution: Do be careful that you don't get blindsided by the other taxes a state levies. For example, Washington state where I live charges a one and half percent excise tax on service revenue. This is probably still less than the income taxes that many other states charge. But it highlights an important caveat: Before you move to some other state, you definitely want to run the numbers and compare your current state to the possible new state.
Florida LLC formation expert Stephen L. Nelson CPA has written more than 150 books. Formerly an adjunct tax professor at Golden Gate University, Nelson is also the author of Quicken for Dummies. Copyright ฉ by 2006 by Stephen L. Nelson.
Source: articleage.com
I live and work, quite literally, down the road from the main Microsoft campus. No surprise, then, that I'm commonly asked by freelance consultants for the best ways that these self-employed independent contractors can minimize their income taxes.
If I can, I try to weasel my way out of the discussion, offering up such basic tidbits as, "Well, be sure to look at the home office deduction." And "make sure you're taking advantage of deductions for health insurance and pension funds."
Usually, those simplistic answers work. Everyone once in a while, though, I encounter some guy who's really motivated to save on taxes. Usually, someone now making good money consulting or contracting… When I can't deflect their questions in some other way, I tell them about the three best ways that independent contractors have to save on taxes.
Technique #1: Smooth Your Income
Whatever you think of the US Internal Revenue Code, you need to know that it's quite progressive. That progressivity means the more you make, the more you pay. The progressivity also means that if your income fluctuates, your income taxes go up even if you make the same money on average as someone else makes.
To give you an example of this, suppose that you compare two consultants, John and Jane. If John makes a steady $60,000 a year and has a mortgage, a spouse and couple of kids, he might pay about $1000 over four years (net of tax credits for these like his children.)
In comparison, suppose that Jane averages $60,000 a year, but sees her income fluctuate between $30,000 a year and $90,000 a year. If she also has a spouse, two kids and a mortgage, she'll probably pay $8,000 to $10,000 over those same four years.
Please note that over the same four years, the two consultants make the same amount of money: $240,000. But what they pay in taxes differs radically. Jane pays eight to ten times what John pays. Bummer.
What can Jane do? Well, let's bring this back to the example of working consultants. Jane can probably smooth her income. She can make sure that she's not stacking two big retainers or performance bonuses in the same year. She can spread out year-end payments over the ending and beginning year in ways that smooth her income out. She can even try to stuff more of her expenses into the good years. In the good years, for example, she can buy new computers, take those graduate classes, or top off her pension.
Technique #2: Setup an LLC and Elect S Corporation Status
I've written and talked much about how S corporations save taxpayers money and how the right way to set up an S corporation is first create a limited liability company and then ask the IRS to treat the LLC as an S corporation for tax purposes.
Let me review the basics here again, however. Suppose that you're making $90,000 a year as a consultant or contractor. If you just treat your business as a sole proprietorship, you might pay $12,000 in income taxes on the $90,000 and then another 15.3% self-employment tax, or roughly $13,500 on the $90,000.
If you set up an LLC and have the LLC treated as an S corporation, you'll still pay the same $12,000 in income taxes. But you'll only pay the 15.3% self-employment tax on that portion of the profit that you categorize as wages. If you categorize, say, $50,000 of the profits as wages, you'll pay $7,500 in self-employment taxes. (The other $40,000 in remaining profits, by the way, gets paid out as a dividend-like "distribution.")
Note, then, that the S corporation saves you roughly $6,000 every year. Sweet, right?
Two quick points about S corporations: First, S corporations require some extra tax and accounting so you don't get to spend all of your savings. Some of the savings go to the lawyer, the accountant, and the bank. Second, you absolutely must set your salary to a reasonable level.
Technique #3: Relocate Your Residency
One final, easy planning gambit if you telecommute. Remember that there are states like Alaska, Florida, Nevada, Texas and Washington that don't charge residents state income taxes. Accordingly, if you relocate to one of these states, you'll automatically drop your overall tax bill because you won't have state income taxes.
Sometimes, one of the benefits of independent contracting and freelance consulting is that is that you do get to live wherever you want. Why not choose a place that doesn't tax your income?
But a caution: Do be careful that you don't get blindsided by the other taxes a state levies. For example, Washington state where I live charges a one and half percent excise tax on service revenue. This is probably still less than the income taxes that many other states charge. But it highlights an important caveat: Before you move to some other state, you definitely want to run the numbers and compare your current state to the possible new state.
Florida LLC formation expert Stephen L. Nelson CPA has written more than 150 books. Formerly an adjunct tax professor at Golden Gate University, Nelson is also the author of Quicken for Dummies. Copyright ฉ by 2006 by Stephen L. Nelson.
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