Preparing Individual Tax Returns: Top Five Errors

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Before filing your tax return, you should review it to make sure it is correct and complete. Here are the five most common errors on an individual tax return:

1. Incorrect or missing Social Security numbers.
2. Incorrect tax entered based on taxable income and filing status.
3. Withholding and/or estimated tax payments entered on the wrong line.
4. Math errors in addition and subtraction.
5. Computation errors in figuring out the taxable income, tax credits, standard deduction for age sixty-five or over or blind.

These are just few of the most common errors on a tax return – there are many more possible. The strong possibility of committing these errors make is imperative to review the entire tax return prior to filing it with the IRS. Remember, any errors on a tax return may result in processing delays and hold up any refund you may be entitled to.

Tax Treaties

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Tax treaties are bilateral agreements between two countries that generally provide relief from taxation for individuals who are covered. The U.S. has tax treaties with more than 50 different countries. The U.S. has a formulated a Model Income Tax Treaty to assist in negotiations of future tax treaties. In general, treaties will grant one country primary taxing rights to items of income, and the other country will be required to give a credit for taxes paid.

Primary taxing rights typically depend on either the residency of taxpayers, or the presence of a permanent establishment in a treaty country. A permanent establishment generally is defined to be a branch, factory, office, workshop, mining site, warehouse, or other fixed places of business.

Under most tax treaties, residents (and sometimes, citizens or nationals) of foreign countries will be exempt from U.S. taxes on certain items of income, and taxed at a reduced rate on other specified items. For example, many U.S. tax treaties reduce the withholding tax rate on interest and dividends, and other certain kinds of investment income. The rates and items of taxation vary according to the terms of each treaty. If there is no tax treaty between the U.S. and another country, or a treaty does not cover a certain type of income, a resident (national or citizen, if applicable) of a country will be subject to U.S. taxes.

Under these same tax treaties, though U.S. residents or citizens are subject to U.S. income tax on their worldwide income, they will be exempt from tax, or taxed at a lower rate, in general on certain items of income sourced from another country subject to the tax treaty. Many treaties utilize savings clauses to prevent U.S. residents or citizens from using provisions of a treaty to avoid paying taxes on U.S. source income.

Do you have questions concerning international tax issues? Contact Sherayzen Law Office at (952) 500-8159 to discuss your tax situation with an experienced tax attorney.

Sourcing of Income

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The sourcing of income has very important tax consequences for U.S. and foreign taxpayers.  The IRS taxes U.S. taxpayers on all income, from any source derived; however, U.S. taxpayers will be relieved of double taxation and may utilize the foreign tax credit in many circumstances involving non-purely domestic taxation. Foreign taxpayers, on the other hand, will usually only pay U.S. taxes on income sourced in the U.S. Thus, the source of income rules are critical to determining where a taxpayer will pay applicable taxes. This article will examine both income sourced inside the U.S. and foreign-source income.

Income Source Determination

In order to determine the sourcing of income, income realized is first placed into certain categories (such as interest, dividends, rent, sale of property, etc.). At times, an item of income may overlap into more than one possible category, in which case, specific IRS rules will likely clarify the proper classification. Once income is categorized, income source rules will then be applied in order to ascertain whether the income is U.S. or foreign-source. As a rule of thumb, income will be either U.S. or foreign-source depending upon where property is located, or where the income was realized, however there are many exceptions to this principle.

Income Source Examples

In this section, common income categories such as dividends, interest, personal services income, rents and royalties, and sales or exchanges of property, and their income sourcing rules will be briefly explained (other common income source rules not detailed here apply to software income, and transportation and communications income).

Dividends

Generally speaking, dividends received from U.S. (domestic) corporations are considered to be U.S.-source income. The fact that a domestic corporation may be distributing dividends derived from overseas operations usually will not matter for these purposes.

Conversely, dividends paid by a foreign corporation will generally be deemed foreign-source income. An important exception to this rule occurs in situations where a foreign corporation earns 25% or more of its gross income from income effectively connected with a U.S. trade or business for the three years immediately preceding the year of the dividend payment. In this case, that percentage of the dividend will be treated as U.S.-source income.

Interest

Interest income received from domestic corporations, the U.S. government and state governments, and non-corporate U.S. residents (among others) are deemed U.S.-source income.
There are some exceptions to this rule. For example, income will is deemed to be foreign-source if interest is received from a U.S. corporation which, over the prior three-year period, earned 80% or more of its active business income from foreign sources.

Personal services income

Personal services income includes such items as salaries, wages, fees, commissions. The location of where the services are performed will usually determine whether the personal services income is U.S. or foreign-source.

There are some exceptions to this general rule, including a limited commercial traveler exception for short business trips and de minimus amounts.

Rents and Royalties

For income received from the use of tangible property, the location of the property will determine its income sourcing. Other factors, such as where the property was manufactured, are not considered.

For income received for the use of intangible property (e.g. patents, copyrights, goodwill, etc.), in general, the location of where the property was used will determine its income sourcing.

Sale or Exchange of property

In general, the source of income relating to disposition of real property will depend upon the location of the property.

Broadly speaking, the sale of personal property (i.e, stocks, securities, equipment, inventory, intangible assets) will depend upon the residence of the seller. However, there are various exceptions to this rule. For example, if a item of purchased inventory is sold, the location of the sale will determine its income source.

Tax Treaty versus Regular Sourcing of Income Rules

Under certain circumstances, the sourcing source of an item of income or deduction could be changed by the provisions of a treaty. However, taxpayers claiming this benefit will need to file their tax return along with Form 8833.

Contact Sherayzen Law Office

This is a general overview of the taxation rules relating to sourcing of income. There are many other complex issues that may apply, depending upon the circumstances. Do you have questions concerning taxes relating to your international transactions or income? Sherayzen Law Office can assist you with these matters. Call (952) 500-8159 to set up a consultation today.

Mortgage Debt Forgiveness Tax Relief: Basic Facts

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Normally, debt forgiveness results in taxable income. However, under the Mortgage Forgiveness Debt Relief Act of 2007, you may be able to exclude up to $2 million of debt forgiven on your principal residence during tax years 2007 through 2012. The limit is $1 million for a married person filing a separate return. You may exclude debt reduced through mortgage restructuring, as well as mortgage debt forgiven in a foreclosure.

In order to qualify for the tax relief, the debt must have been used to buy, build or substantially improve your principal residence and be secured by that residence. Refinanced debt proceeds used for the purpose of substantially improving your principal residence also qualify for the exclusion.

However, proceeds of refinanced debt used for other purposes – for example, to pay off credit card debt – do not qualify for the exclusion. Debt forgiven on second homes, rental property, business property, credit cards or car loans also does not qualify for the tax relief provision.

If your debt is reduced or eliminated you normally will receive a year-end statement, Form 1099-C, Cancellation of Debt, from your lender. By law, this form must show the amount of debt forgiven and the fair market value of any property foreclosed. You should examine the Form 1099-C carefully and notify the lender immediately if any of the information shown is incorrect. You should pay particular attention to the amount of debt forgiven in Box 2 as well as the value listed for your home in Box 7.

If you qualify for tax relief, claim the special exclusion by filling out Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and attach it to your federal income tax return for the tax year in which the qualified debt was forgiven.

Note that other tax relief provisions – such as insolvency – may be applicable.

Alternative Minimum Tax: Basic Facts for Tax Year 2010

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Tax laws provide tax benefits for certain kinds of income and allow special deductions and credits for certain expenses. These benefits can drastically reduce some taxpayers’ tax obligations. Congress created the Alternative Minimum Tax AMT in 1969, targeting higher-income taxpayers who could claim so many deductions they owed little or no income tax. The AMT provides an alternative set of rules for calculating a taxpayer’s income tax. In general, these rules should determine the minimum amount of tax that someone with a certain amount of income should be required to pay. If a taxpayer’s regular tax falls below this minimum, he has to make up the difference by paying alternative minimum tax.

A taxpayer may have to pay the AMT if his taxable income for regular tax purposes (plus any adjustments and preference items that apply to him) are more than the AMT exemption amount.  The AMT exemption amounts are set by law for each filing status. For tax year 2010, Congress raised the AMT exemption amounts to the following levels:

$72,450 for a married couple filing a joint return and qualifying widows and  widowers;
$47,450 for singles and heads of household;
$36,225 for a married person filing separately.

The minimum AMT exemption amount for a child whose unearned income is taxed at the parents’  tax rate has increased to $6,700 for 2010.