Author: Leon Clinton

When you leave the U.S. to live in another country, you essentially have two choices from a tax perspective, both of which can cost you a pretty penny.

First, you can simply leave the country and take up residence elsewhere. But if you choose this option, beware: the U.S. continues to tax you on your worldwide income, no matter where you earn it or derive it from.

Second, you can formally renounce your American citizenship or long-term residency and expatriate. This option is also not without its potential financial pitfalls, because the U.S. may impose an “exit tax” on you before you leave.

The rules behind this exit tax are complex, but whether you will be required to pay it depends largely on whether you are classified for tax purposes as a “covered expatriate.”

Are You a Covered Expatriate?

American citizens and long-term residents can, of course, voluntarily give up their status as citizens or residents and expatriate.

Once you give up your status, the IRS will consider you either an “expatriate” or a “covered expatriate.” If you’re simply an expatriate, the exit tax will not apply, and you’re good to go. There’s really nothing more to it. You still have U.S. assets, and you have to pay U.S. taxes on those assets.

But if the tax law deems you a covered expatriate, you have to pay the exit tax.

In most cases, a covered expatriate is a person who meets one of the following three tests:

1. Income tax test. You’ll be deemed a covered expatriate if you paid an average of $190,000 in income tax in the five years before you expatriate.
2. Net worth test. You’re also a covered expatriate if your net worth is $2,000,000 or more on the date you give up your U.S. citizenship or long-term residency.
3. Compliance test. Finally, if you fail to certify, under penalty of perjury, that you met all your tax obligations for the five years preceding your expatriation, you’re a covered expatriate.

What Is the Exit Tax?

Under the exit tax regime, the government requires you to pay income taxes on the unrealized gain in all your property, subject to a few minor exceptions, as if you sold that property the day before your departure.

In other words, the law deems that you sold all your property at fair market value on the date of your departure, even though you did not. You then pay taxes on this imaginary gain.

Mercifully, under today’s law, you can exit in 2023 and exclude up to $821,000 of gain (adjusted annually for inflation).

You Can Pay Later, But…

In the mark-to-market deemed sale of your assets, you didn’t collect any cash, so you might be short of the cash needed to pay your taxes. The U.S. government might help you by allowing you to pay later if you can post “adequate” security as collateral for the debt, such as a bond. The following rules also apply to this payment deferral election:

• Once you make the election, it’s irrevocable.
• You can elect to defer tax on some pieces of property but not others.
• You must waive any right under any U.S. treaty that would otherwise prevent collection of the taxes.
• You pay interest on any taxes you defer.
• You or your estate must pay the expatriate taxes due when you dispose of the property or die.

Easing the Pain

To ease the pain slightly, eligible deferred compensation items, such as IRAs, pensions, and stock option plans, are not part of the deemed sale, and thus are not taxed at the time of expatriation.

Rather, the government makes the payor withhold 30 percent on any taxable payment made to a covered expatriate.

Note that to qualify for this temporary relief, the deferred compensation must be “eligible.” That means

• the payor of the deferred compensation must be a U.S. entity or a foreign entity that has agreed to submit to U.S. withholding and other requirements;
• you tell the payor that you are no longer an American citizen; and
• you permanently waive any claims you might otherwise have had to the reduction or elimination of the tax under a tax treaty.

I’m a Covered Expatriate—What Can I Do?

Though the situation is certainly a sticky wicket, all hope may not be lost.

According to the net worth test, you are a covered expatriate only if your net worth is $2,000,000 or more. With some thoughtful planning, you might structure your assets to avoid this classification.

Depending on the circumstances, direct gifting before expatriation might be one solution. Another solution might be through the creation of trusts before the big day.

You need to exercise extreme care in any such effort. It’s best to use a tax professional who understands expatriation. If you want my help, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• November 18, 2023

If you enjoy gambling, whether occasionally or frequently, it is crucial to understand how your winnings and losses can affect your tax liability.

Basic Rules

Winnings: You report your gambling winnings from casinos, lotteries, raffles, and other gambling activities as “above-the-line” taxable income.

Losses: You deduct gambling losses “below-the-line” as itemized deductions on Schedule A, but only to the extent of your winnings.

Reporting: Casinos and other gambling institutions report your winnings to the IRS on Form W-2G if they meet certain thresholds. You will also receive a copy of this form.

A Real-Life Example: The Bright Case

Jacob Bright, a casual gambler, found himself in a complicated tax situation due to extensive gambling activities. The casinos reported his large winnings on Form W-2G, totaling $110,553.

Due to poor recordkeeping and misclassification as a professional gambler, Bright incurred a tax bill of $13,898 despite his gambling losses exceeding his winnings.

Tips and Best Practices for Recreational Gamblers

Keep a gambling log: Maintain a detailed log of your gambling activities, including dates, locations, types of wagers, and amounts won or lost. This record can serve as valuable documentation in an IRS audit.

Use a player’s card: Whenever you gamble at a casino, use a player’s card to track your activities electronically.

Understand the importance of session tracking: Track your wins and losses by gambling session. The session approach allows you to offset wins and losses within the same session, potentially reducing your taxable income.

Be aware of itemizing requirements: Remember that you can only deduct gambling losses if you itemize your deductions. If you take the standard deduction, you don’t reduce your tax liability with your gambling losses.

Takeaway

Gambling has tax implications and can, for the uninformed, lead to unexpected tax bills and complications.

Keep this in mind. You could win a big jackpot on the last day of the year. Would you have the records to keep your tax bill to a minimum?

If you want to discuss the tax implications of your gambling activities, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• November 16, 2023

The Affordable Care Act (ACA) changed the landscape for small businesses that offered health benefits for their employees.

Before the ACA, many small businesses reimbursed some or all of their employees’ individually purchased health insurance.

The ACA makes that illegal and imposes a $100-a-day, per-employee penalty for such reimbursements without using one of the newer health reimbursement accounts—namely the ICHRA or the QSEHRA.

That brings us to two other choices:

1. As a small employer with fewer than 50 employees, you can offer no health benefits and face no federal law penalties.
2. You can use the health savings account (HSA) to help employees with their health benefits without facing the hurdles of the ACA.

But here’s the kicker: The one thing you need to consider when you make the HSA contributions is the discrimination rules (which are called “comparability” rules in the HSA world). If you violate these rules, the IRS forces you to pay a draconian tax of 35 percent of your total HSA contributions.

Fortunately, it’s easy to avoid discrimination—even when you favor one group of employees over another—when you follow three simple rules.

What Employers Must Know

Before we get to the three simple rules, the general rule to know as an employer is that you have to make “comparable” contributions to all employees who have a high-deductible health plan (HDHP). (Employees are not eligible for HSA contributions unless they have an HDHP.)

What if some employees have an HDHP and some don’t? You don’t have to give any benefit to the non-HDHP employees. For purposes of HSA tax law, you can simply give them nothing and ignore them.

But for your HDHP employees, you have to make comparable contributions. You do that by following the three rules below.

Rule 1—Determine the Categories of Your HDHP Employees

You have to make comparable contributions only to employees who are in the same “category.”

For two or more employees to fall into the same category, they must have identical answers to both of the following questions:

• Is the employee a full-time, part-time, or former employee?
• How many dependents are covered under the employee’s HDHP?

Full time versus part time. Part-time employees are those working fewer than 30 hours per week, and full-time employees are those working 30 hours or more per week.

Number of dependents covered. The HSA rules provide four options:

1. Self-only HDHP
2. Family HDHP covering the employee plus one dependent (“self plus one”)
3. Family HDHP covering the employee plus two dependents (“self plus two”)
4. Family HDHP covering the employee plus three or more dependents (“self plus three or more”)

Examples

Example 1. You have three full-time employees:

• Sam has a self-only plan.
• Joe has a family plan covering himself and his son.
• Kim has a family plan covering herself and her husband.

Only Joe and Kim are in the same category, because they both have self-plus-one HDHP coverage. Sam is in a different category, because he has coverage for himself only.

Example 2. In addition to the three employees above, you have a part-time employee named Barbara who has a family plan covering herself and her husband. Barbara is in a category separate from Joe and Kim. Even though she has self-plus-one coverage, she is part time, whereas Joe and Kim are full time.

Rule 2—Calculate a Comparable Amount

Contributions are comparable if you give each employee in the same category either

• the same amount of money, or
• the same percentage of the plan’s deductible.

You make this determination each month.

Example. At the beginning of the year you have two employees, and you hire a new employee who begins work on May 1. All three employees have the same HDHP.

You decide to contribute $100 per month to each employee’s HSA. For the two employees who are with you for the full year, you contribute $1,200 total to each of their HSAs. For the new employee, you contribute a total of $800, since that employee worked only eight months of the year.

Rule 3—Treat Yourself Differently

Unless you operate your business as a C corporation, tax law does not treat you as a normal employee with regard to the contributions your business makes to your personal HSA.

If you’re a sole proprietor, you simply take the deduction on your Form 1040.

If you operate as an S corporation, you treat the S corporation contribution as compensation, and then you take the deduction on your Form 1040.

Limits

For 2023, you can contribute a maximum of $3,850 to a self-only plan, $7,750 to a family plan, and an additional $1,000 for individuals over age 55.

If you want to discuss the HSA plan for you and your employees, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• November 14, 2023