Tuesday, June 25, 2013

Tax Breaks for Americans in Naughty Countries Like North Korea

One lesser-known aspect of the Internal Revenue Code is its use in furthering America's foreign policy by denying certain tax benefits to US persons operating in the Axis of Evil and other bad countries.  For vague reasons, the Internal Revenue Code has two separate lists of disapproved countries, and some countries are allowed certain tax benefits but not other benefits. 

For example, the first list penalizes US companies who do business in North Korea by denying them foreign tax credits, but the second list fortunately allows American citizens living and working in North Korea to exclude up to ~$100,000 of their North Korean wages from being taxed by the United States. 

List #1
Albania was on the first list until 1991.
US taxpayers are normally allowed to claim foreign tax credits for paying taxes to foreign countries, except for any countries on a list prescribed by Internal Revenue Code section 901(j).  As a result, American individuals and businesses cannot offset their US tax liability dollar-for-dollar by taxes paid to these countries, though they can still deduct the taxes as a business expense. 

The naughty countries are:
North Korea

Iraq and Libya were most recently removed from the list in 2004.  The list also once included Afghanistan, Albania, Angola, Cambodia, South Africa, Vietnam, and the former South Yemen.

(Though the list began in 1987, poor Albania was the only Warsaw Pact country to ever be on the list.)

The US tax on income earned in the first list's countries cannot be offset by foreign taxes paid to that country, nor by other foreign taxes paid to other countries not on the list.  Furthermore, US persons are subject to US tax on their income from corporate subsidiaries operating in those countries, even though the income might be deferred under normal tax rules.  The result is that the income from those countries is generally subject to US tax no matter what.  Apple's tax-sheltering Irish subsidiary would not have worked as a North Korean subsidiary. 

List #2
An entirely separate list of naughty countries is prescribed by Internal Revenue Code section 911(d)(8).  US citizens and resident aliens who work in foreign countries are normally allowed to receive tax-free up to ~$100,000 of foreign wages and other earned income.  But this "foreign earned income exclusion" is denied if the US person works in a country on the second list.

The second list of naughty countries is:

That is all.

Libya and Iraq were the only other countries on the second list, and they were removed from the second list in 2004.

Friday, June 21, 2013

Tax Break for Working Abroad on a Yacht Full-Time

US citizens and resident aliens (such as green card holders) living abroad are subject to US tax on all of their worldwide income.  One relatively well-known exception is the foreign earned income exclusion, which allows a qualifying taxpayer to exclude up to $97,600 (in 2013) of earned income from taxable income.

The requirements for earning the $97,600 (adjusted annually for inflation) tax-free are:
1. The income must be earned income, such as wages or commissions, not a pension or other deferred compensation, and not received as an employee of the US government,
2. The person's principal place of business (his "tax home") is in a foreign country, and
3. during any period of 12 consecutive months, the person is present in a foreign country or countries during at least 330 full days in such period (or alternatively is a "bona fide resident" of a foreign country or countries, which is a complicated topic not discussed in this post).
4. The person does not live in a naughty country, which current includes only Cuba (the list was last updated in 2004 to remove Libya and Iraq). 

If a couple is working abroad, both spouses may exclude up to $97,600 of their separate salaries. 

In the landmark 2007 case of Struck v. Commissioner, the Tax Court concluded that yacht employees could claim the foreign earned income exclusion for their yacht-related salaries when the yachts were operating outside the United States.  

Mr. Myron Struck was employed full-time from 1975 to 2002 as a yacht captain for owners of private yachts.  His wife Thelma was employed on the yachts as a chef and stewardess.  They lived on the yachts, which operated primarily in foreign territorial waters, except when they took around two weeks of vacation in the United States each year.

The Tax Court concluded that the Strucks' tax home / principal place of business was on the yacht, since they did not have a regular office or other business location.  Therefore, they satisfied the requirement that their principal place of business be in a foreign country. 

The Tax Court also concluded that the Strucks spent over 330 days each year in foreign countries.  Notably, the Strucks did not have to spend all of the time in one country; they qualified by spending the 330 days in the territorial waters of multiple countries.  While time spent in international waters generally does not count as time spent in a foreign country, a day of travel in international waters from one foreign country to another foreign country is treated as a day in a foreign country.

Tuesday, June 18, 2013

Mining Bitcoins: A Taxable Event?

Bitcoins is an open source virtual currency that was developed in 2009 by an anonymous programmer.  Unlike dollars and other fiat currencies, bitcoins are not issued by any central government, but are instead "mined" by its users. 

Generally speaking, bitcoin miners download free software to solve complex equations that verify bitcoin transactions. When a miner’s computer solves an equation, the bitcoin network accepts the transactions as valid and creates 25 new bitcoins and awards them to the successful miner.  Around 11 million bitcoins have been mined, and there will be a maximum of 21 million bitcoins in circulation ever. In addition to mining new bitcoins, one can acquire existing bitcoins by purchasing them on third-party exchanges or accepting them as gifts or payments for goods or services.

It is fairly clear that when bitcoins are exchanged into dollars, the user has a taxable event to the extent that he (bitcoin users are 96% male) has gain from the transaction.  Likewise, someone who sells goods or services in exchange for bitcoins are subject to tax, in a manner no different than if he were paid in euros or chickens

A more difficult question is whether the bitcoin miner has taxable income at the moment when he receives the 25 newly mined bitcoins for solving the equations.  The United States Government Accountability Office (GAO), in a May 2013 report entitled Virtual Economics and Currencies [pdf], made the following statement:
 Bill is a bitcoin miner. He successfully mines 25 bitcoins. Bill may have earned taxable income from his mining activities.

The GAO provided no legal rationale for its statement, but it is probably based on the idea that Bill is being compensated for providing a service and that income is generally taxable unless a specific exception applies.  There is also some tax law stating that found treasure is taxable when it is discovered, even if the discoverer never sells the treasure for cash.  Treasury Regulation 1.61-14(a) provides that "Treasure trove, to the extent of its value in United States currency, constitutes gross income for the taxable year in which it is reduced to undisputed possession."

Even if bitcoin mining is a taxable event, the bitcoin miner can deduct an allocable share of his expenses from mining the bitcoins, such as the cost of the mining equipment and the electricity costs.

In comparison, small business miners of minerals generally do not have taxable income until they sell the mined products.  But the IRS will probably not be persuaded that bitcoin mining should be treated like gold mining.

A related issue is the Report of Foreign Bank and Financial Accounts (FBAR), which must be filed by all US persons with over $10,000 at any time during the year in foreign financial accounts, which includes securities accounts and commodities accounts.  If the US person transferred over $10,000 worth of bitcoins to a foreign bitcoin exchange, such as the Magic the Gathering Online Exchange based in Japan (and not an American branch of Mt. Gox), even for a brief moment, the person might have to fill out the FBAR and send it to the Department of the Treasury.  The penalties for not filing the FBAR can be especially severe. 

Thursday, June 13, 2013

Tax Credit for Energy-Efficient Mobile Homes

The Internal Revenue Code provides a tax credit to developers and construction contractors who build energy-efficient residential houses.  A tax credit is also provided to the manufacturers of energy-efficient mobile homes (manufactured homes), which happens to be more generous than the credit for non-mobile homes.

Internal Revenue Code section 45L generally  provides a tax credit of $2,000 for a home with annual heating and cooling costs that is 50% less than a comparable dwelling.*

If a mobile home achieves only a 30% energy savings, the credit is reduced to $1,000. But no credit is allowed for a non-mobile home with 30% energy savings.

The credit is claimed by the seller (the developer or contractor), not the buyer.  The home can be a newly built home, or a substantially reconstructed or renovated home, as long as the home is sold to someone as a residence.  The buyer can use the home as a secondary or vacation residence. 

The credit was originally enacted in 2005 to apply only to homes sold in 2006 and 2007, but it has been extended several times since then, most recently to apply to homes sold through the end of 2013 as part of the urgently needed sequester tax legislation.  It is unclear whether a $2,000 tax credit was necessary to stimulate the sale of new homes (median sales price ~$250,000) during the housing boom.  Congress in 2005 noted that there was no tax credit for the construction of energy-efficient homes, and naturally therefore one should be created.

* Technically, the comparable dwelling has to be constructed in accordance with the standards of chapter 4 of the 2006 International Energy Conservation Code, as such Code (including supplements) is in effect on January 1, 2006, and for which the heating and cooling equipment efficiencies correspond to the minimum allowed under the regulations established by the Department of Energy pursuant to the National Appliance Energy Conservation Act of 1987 and in effect at the time of completion of construction.

Friday, June 7, 2013

Capital Gains Rates in Various European Countries

The chart below, from the Internet, shows the capital gains rates for various European countries in stark contrast.  It ranges from no tax ("pas d'impot") in the Netherlands, to a two tier 22%/26% rate in Germany, to a highly complicated looping flowchart that calculates the rate for France. 

The capital gains rates in the United States are similarly complicated:
1. 15% for long-term capital gains, but 20% for high-income households
2. up to 40% for short-term capital gains
3. 28% for gains on collectibles
4. 25% for certain gains on real estate
5. 0% for certain exempt gains, such as gains from the sale of a principal residence and capital gains for low-income households (but not their collectible gains)
6. 0% or 7% or 14% for gains from the sale of small business stock, depending on when the small business was formed

Tuesday, June 4, 2013

Tax Break for Foreign Art Collectors

Nonresident aliens are subject to the US estate tax on the value of their assets located in the United States when they die.  For example, a nonresident alien decedent who put some cash in an American safety deposit box would be taxed on the value of the funds (Rev. Rul. 55-143).

But fortunately for foreigners who are art collectors, Internal Revenue Code section 2105(c) provides that works of art are not considered be in the United States if such works of art are—  
(1) imported into the United States solely for exhibition purposes,
(2) loaned for such purposes, to a non-profit public gallery or museum, and
(3) on exhibition, or en route to or from exhibition, in such a public gallery or museum, at the time of the death of the owner.

Before 1950, all art located in the United States were subject to the federal estate tax, with a top tax rate of 77%.  Multimillionaire Armenian oil mogul and art collector Calouste Gulbenkian had a number of old master paintings on temporary loan to the National Gallery of Art.  Gulbenkian became increasingly concerned about dying and paying the US estate tax on the loaned works, despite the fact that he was a spry 80-years-young at the time.  He made some phone calls, and the trustee of the National Gallery of Art personally asked Congress to change the estate tax law.

Congress sprang into action and on September 1, 1950, it passed Public Law 81-749, which specifically exempted art works loaned by foreigners to the National Gallery of Art from federal and DC estate taxes.

A few months later, Congress realized that the rule did not have to be so specific to one institution.  In the Revenue Act of 1951, the exemption was expanded to apply to all art loaned by foreigners to any non-profit public gallery or museum.

Gulbenkian died in 1955 with a fortune of between $200 million and $800 million.