Say two years ago, Superman revealed his plan to officially renounce his U.S. citizenship.1 According to Superman, he was fed up with having his actions construed as U.S. foreign policy. His plan is to officially announce his renunciation, while giving a speech before the United Nations. It is not known, however, whether he followed up on all the renunciation procedures, such as (1) signing an oath of renunciation (2) in a foreign country (3) before a U.S. consular or diplomatic officer, (4) catching up with late or missing tax returns, and finally (5) complying with Section 877A.

Knowing that Superman enjoys traveling, meeting people, and his established status as a proud public figure, he probably would not have any issues dealing with the first three or four requirements. However, dealing with the IRS is an entirely different matter. He will most likely need a good tax counsel to analyze and review his situation under Section 877A.

Section 877A was enacted as a part of the Heroes Earnings Assistance and Relief Tax Act (the “Heroes Act”). This section generally imposes a “mark to market” regime on expatriates covered under this section and it assesses taxes based on a hypothetical income that assumes that all properties owned by the expatriate were sold at market value on the date before expatriation. This law is intended to prevent tax avoidance schemes by affluent taxpayers, who have taken advantage of deferral features of current tax laws.

How many people will be affected by the “Heroes Act”? The law in Section 877A applies only to a handful of cases where (1) the net average annual income taxes owed for the five tax years preceding the expatriation date is more than $151,000 for an expatriation during the year 2012, (2) the net worth was more than two million U.S. Dollars, or (3)if the individual failed to comply with any federal tax obligations in the five tax years leading up to the expatriation date. In fact, you can find Section 877A cases more often that you thought.

Dr. Jeong H. Kim seems to be one of these cases. If you are not already familiar with recent news related to Dr. Kim, he is a Korean-American electrical engineer who came to the U.S. when he was 14 years old. He left his home at sixteen and worked menial labor jobs before eventually obtaining a Ph. D. Eventually he founded a venture, Yurie System, and he sold it to Lucent in 1998 for almost a billion dollars. He is an American success story, and a hero to many Korean immigrants in the United States. After serving many public posts, receiving various honors and making large charitable contributions, he was appointed by the South Korean government as the Minister of Future Creation and Science.

To take that offer, he announced his intention to give up his U.S. citizenship. However, he soon withdrew his plan to take the appointment, and blamed the political situation for changing his mind. However, many people cast doubts on his reasoning and sudden change. After all, he pledged, like Superman, to loftily contribute to his mother country. Some newspapers previously reported the impacts of Section 877A on this Korean -American hero’s decision. Considering that a corporate transaction typically involves stock issuance and deferral of gains, the mandatory recognition of income under Section 877A could have had certain effects on his decision. Even though no one knows for certain whether Section 877A was his Kryptonite, the case was interesting enough to attract attention to this law.

Several months ago, Superman quit his day job at the Daily Planet. I am not sure if he will eventually found a profitable company, like Dr. Kim. Nonetheless, if he is planning to renounce his U.S. citizenship as a part of his long term plan, he will be better off having his tax counsel involved at an early stage.

1 See the news at http://www.foxnews.com/entertainment/2011/04/28/superman-renounces-citizenship-00th-issue/


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Let’s say you are a good beekeeper, who happens to live next door to an exceptionally good gardener. You realize that your bee colonies take advantage of the variety of flowers in your neighbor’s garden. But sometimes you notice that some of your larger hives are split, and many of your bees end up in your neighbor’s hives. Now you want to take a share of the honey out of your neighbor’s hives. What would you do?  Would you barge in your neighbor’s yard without permission and take some honey? Or do you want talk to your neighbor first?

Most people would avoid barging in on their neighbors, for obvious consequences. Nevertheless, the United States clearly had the first option in its mind when it announced the Foreign Account Tax Compliance Act (“FATCA”) in 2010.[1] The FATCA targets non U.S. foreign financial institutions(“FFI”) that serve U.S. taxpayers such as bankers, brokers, insurance or other investment companies. It requires FFIs to have an agreement with the United States to disclose and report any U.S. taxpayers’ identity, account information, and other related financial information to the U.S. Department of Treasury regardless of their business frequency or  size with their U.S. taxpayer clients.  If the FFIs does not enter into an agreement with the United States, the plan was to assess the FFI , 30% of  the withholding tax for all of its U.S. source income.

How feasible is it to regulate someone who is not under your jurisdiction? What if it is against their domestic laws to disclose or share the client information to a third party? As the largest economy in the world, the United States may have the power to push the FATCA into effect. However, the Department of Treasury has wisely changed its direction to implement the FATCA. The United States is currently engaging with more than 50 countries to facilitate the FATCA implementation.

The agreements signed thus far are all based on intergovernmental information exchanges under the Model I document. Under Model I, FFIs are required to report the FATCA information to their home country revenue authorities, and the revenue authorities exchange the information directly with the Internal Revenue Service. If the Revenue Agency wants to have similar information from the United States, it can reciprocally request the information from the IRS. The United States has already established bilateral agreements this way with the United Kingdom, Denmark, Mexico and Spain.[2]  In addition, there is another intergovernmental agreement model that incorporates FFI’s direct reporting to the United States. The Model II reflects a framework that the United States is working with Japan and Switzerland. However, there is not a signed agreement yet under Model II.

The Department of Treasury clearly abandoned or set aside its unilateral approach to implement the FATCA by negotiating bilateral agreements with a number of countries.[3] By all means, the FATCA could have been viewed as a nonsense U.S. law encroaching on other countries sovereignty.  Through international reciprocity, however, the FATCA seems to find a legal basis. It is still interesting to see though, how the FATCA will be implemented against FFIs in countries without bilateral agreements with the United States.

[1] Hiring Incentives to Restore Employment Act signed into law on March 18, 2010

[2] The informaiton is available at http://www.treasury.gov/resource-center/tax-policy/treaties/Pages/FATCA.aspx

[3] U.S. Engaging with More than 50 Jurisdictions to Curtail Offshore Tax Evasion November 8, 2012 available at http://www.treasury.gov/press-center/press-releases/Pages/tg1759.aspx

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There are many routes that you can take to your destination. If the destination is a common one, you would expect a common road map showing the ideal route. Even though the Foreign Bank Account and Financial Accounts Reporting (“FBAR”) requirement has been around for a while, it appears that we still haven’t found a decent road map for taxpayers with offshore account issues.

This is partially because the previous Offshore Voluntary Disclosure Programs (OVDP) did not embrace the wide variety of situations. This was especially true for international taxpayers. In many cases, international taxpayers have a reporting obligation solely due to their United States green card or citizenship by birth, when they were, in fact, working, living, or paying taxes entirely in other countries.

Would these taxpayers be willing to take the OVDP and pay harsh penalties for mistakenly failing to file the FBAR, even when they had no intention of avoiding taxes and when the FBAR penalty truly targets U.S. tax dodgers?

Over the past years, the Internal Revenue Service (“IRS”) has responded to this frustration over the one-size-fits-all nature of the OVDP. Accordingly, taxpayers now have more options to achieve the FBAR compliance status. To give you an introduction to these options, let me outline a simple road map.

1. Offshore Voluntary Disclosure Program (“OVDP”). As introduced in the previous blog post, the 2012 OVDP is an open end program with a penalty rate of 27.5% of the maximum account balance. Regardless of the increased penalty rate, the OVDP may still be the best option for those who made voluntary and intentional violation of their known legal duty of FBAR compliance.[1]
   
   
2.  Opt-out to Standard Audit Process. The IRS is flexible enough to allow taxpayers in the OVDP to opt out of the program.[2] By doing so, taxpayers can ask the IRS to handle their cases under standard audit processes. When taxpayers are already in the OVDP and find that the OVDP penalty is not appropriate for their situation, opting out may be an appropriate choice.
   
   
3. Streamlined Filing Compliance Procedures. Effective as of September 1, 2012, international taxpayers with low compliance risk may file delinquent tax returns and FBARs without concern of serious penalties. The eligibility and compliance risk in the procedure has to be carefully reviewed, as they are quite narrowly defined.[3]
   
   
4. Delinquent Filing Procedures. Taxpayers who properly reported and paid taxes on all their taxable income in prior years can now file the delinquent FBAR or delinquent information returns.[4] Once taxpayers file delinquent FBAR or informational returns such as Forms 5471 or 3520, the IRS will not impose a penalty for failing to file.
   
   
5. Quiet Disclosure to the OVDP. Some taxpayers did so-called quiet disclosures by filing amended returns and paying any related tax and interest for previously unreported offshore incomes without notifying the IRS. The taxpayers who made quiet disclosures are also eligible to participate in OVDP. The IRS strongly encourages the taxpayers who made quiet disclosures to come forward under the OVDP to avoid harsher penalties and/or possible criminal conviction.[5]
   
   

If your case fits squarely into one of these five options, then take it and resolve your offshore account issues once and for all. However, if your case falls in the gray area, then it would be safer to consult with your legal counsel.

What you are dealing with here will be more than mere numbers, and you will need good legal advice to help you to assess relevant facts and circumstances to infer your intent objectively.

[1] IRM 4.26.16.4.5.3

[2] Offshore Voluntary Disclosure Program Frequently Asked Questions and Answers #51, 51.1 and 51.2 (June 26, 2012).

[3] Instruction available at http://www.irs.gov/uac/Instructions-for-New-Streamlined-Filing-Compliance-Procedures-for-Non-Resident-Non-Filer-US-Taxpayers

[4] Offshore Voluntary Disclosure Program Frequently Asked Questions and Answers #17 (June 26, 2012).

[5] Ibid  #16.


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If you are a student, teacher or researcher invited by an accredited U.S. educational institution or university to teach or engage in research, you have probably heard about the Tax Treaty provision exempting tax on your research or teaching income for typically two years. In fact, nonresident alien students, teachers, or researchers from countries that have income tax treaties with the United States have often benefited from this provision.

The most common issue that arises from this provision is the ambiguous condition of duration stipulated in the Tax Treaty. For example, Article 20 of the U.S. Korea Tax Treaty exempts the invitee’s income from teaching or research at the inviting organization from tax, under the condition that the invitee comes to the United States for the purpose of teaching or research “for a period not expected to exceed 2 years.” Many other Tax Treaties with this provision don’t clarify whether this is the invited researcher’s expectation or the inviting organization.

Due to this ambiguity, the inviting organizations often depend on administrative evidence to determine the length of the invitee's intended stay. For example, they could decline to respect the tax treaty when the Exchange Visitor Certificate (DS-2019) shows a Visa expiration date after the two or three year limit that the relevant tax treaty requires. They issue a W-2 instead of a 1042S to the invitee and withhold income taxes from their income.

Many J Visa holders express their frustration at this kind of process, as oftentimes their expected stay was truly within the required duration under the Tax Treaty. In fact, there are plenty of possibilities that they actually planned or expected to stay was within the period that the relevant treaty required, even when the DS-2019 no longer allowed an extended stay.

The Tax Court recently made it clear that the Visa expiration date alone cannot be enough evidence to prove the Visa holder’s expectation of the two or three year requirement stipulated in the Tax Treaty.[1] In Santos v. Commissioner, a J Visa invitee argued that she could not possibly expect to stay in the United States more than two years when her Visa was not permanent and was not guaranteed valid after the two years, and her employment contract was for one year. Her argument was rejected by the Court. The Court considered all of the relevant facts and circumstances to reach “objective” determination of whether the invitee came to the United States with the intent of staying for only 2 years, and concluded that the expectation was actually more than two years.

According to this case, the expectation of duration of stay does not belonging to one party. It is shared, rather, by both parties involved- the inviting organization and the invitee. Any single or particular factor cannot prove or disprove this expectation by itself.

If you want to find out whether you are eligible for the Treaty based tax exemption, it is ideal to consult a legal professional to consider all relevant facts and circumstances in the historical context of the exchange program, including similar cases with situated individuals within your current exchange program.

[1] Santos v.Commissioner of Internal Revenue Service (35 T.C. No. 22).

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The adjective “double” seems to carry a negative connotation. For example, double dipping, a double chin, and double playing can all ruin your day.

Amongst all these despicable doubles, I would say that double taxation is by far the worst. As an immigrant to the United States, you may understand the serious consequences of  double taxation.  Let’s say that you are a green card holder in the United States and have earned your income in a different country during the same tax year. You already paid taxes to the country where you earned your income. Do you have to pay taxes in both countries? In another words, are you subject to double taxation?

The general answer to this question is no. Many countries try to avoid double taxation by signing a bilateral agreement with one another. This agreement, often referred to as a tax treaty, usually allows a taxpayer to pay income tax only in the country where the income was sourced. If you are from a country that signed a tax treaty with the United States, you may be able to take advantage of the bilateral agreement for your federal income tax purposes.

Even without a tax treaty, you may still be able to claim the tax amount that you paid to a foreign country either as foreign tax credit or as an itemized deduction to reduce your taxable income. The application procedure may seem a little complicated, but they are fair in that there is  no surprise in the final tax due.

In my previous post, I briefly explained that concepts in federal taxation are not always applicable to state tax reporting. Even though states were inspired and influenced by federal tax laws, their approach is usually unique in reflecting their own situation. The issue of double taxation is no exception.

For example, several states, including Massachusetts and New York, allow individuals foreign tax credit only for the payments made to Canada. If you paid tax to any other country, you are out of luck. You will have to include your foreign earned income in your state taxable income, and it will be taxed once again. In a state like California, there is no conspicuous relief for foreign tax payment in either credit or deduction. To make matter worse, the state of California has the highest marginal income tax rate at 10.30%.

Either way, I hope it is now clear why state tax law is just as important as federal tax law to a cross border tax payer.

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Whether you arrived in the United States for a short visit or for a permanent stay, you will be faced with navigating your obligations as a U.S. taxpayer. To help you understand the somewhat daunting nature of this task, let me introduce you to some interesting statistics from the National Taxpayer Advocate’s 2010 Annual Report to the Congress.[1]

According to this report, the U.S. tax code has grown so voluminous that it has become a challenge to calculate its volume.[2]  Comprised of 3.8 million words, the printed code equates to about 11,045 single spaced pages in Microsoft Word.[3] The Treasury Department’s income tax regulations, which provide guidance on the meaning of the Internal Revenue Code, stands one foot high in printed form.[4] The U.S. tax code has gone through constant changes throughout its history.  It was amended 4,428 times during the last ten years or on average, one change each day![5]

You may now wonder why the U.S. tax system is growing in complexity. There are a myriad of answers, but I have a relatively straightforward one: “A fair tax system cannot be simple.”

For example, European history is riddled with examples of ludicrous taxes on beards, hats, gloves, and house windows. I am sure we can laugh at the naïve rationale behind these tax laws now. However, how simple and how inaccurate would it be, if we tried to assess a taxpayer’s wealth by the price of his hat, the presence of his beard, or the number of windows in his house? Clearly, in the case of a tax system, simple is not always good.

Hopefully, you feel a little better now. Yes, you have just arrived to the U.S., a country with one of the most complicated tax systems in the world, a tax system that is constantly changing.  Yet, the change is rooted in an effort to reflect principles of fairness and equality. If it still seems like a daunting task, you are not alone. More than 60% of individuals in the United States seek professional help with their taxes.

As a newcomer to the United States, your first decision would be to determine whether you would like to handle your U.S. tax issues independently or seek advice and assistance.  For newly arrived immigrants, expert assistance generally saves time, money and hassles with the U.S. tax authority, the Internal Revenue Service.

That is what we do: help people understand the U.S. tax system and reduce the stress of tax compliance.

[1] Taxpayer Advocate Service is an independent organization within the IRS. Each State has at least one local office of the Service, and National Taxpayer Advocate (“NTA”) is the head office. By law, NTA must submit two annual reports to the Congress. To criticize the complexity of the current U.S. tax Code, the report quantifies the U.S. Tax Code in an interesting way. (http://www.irs.gov/advocate).

[2] National Tax Payer Advocate’s 2010 Annual Report to Congress (http://www.irs.gov/pub/irs-utl/2010arcmsp1_taxreform.pdf).

[3] Ibid.

[4] Ibid.

[5] Ibid.

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It’s that time of the year again. If you are an individual or business who made reportable transactions during the calendar year, you must file Informational Returns to the Internal Revenue Service (“IRS”) and issue a copy of the return to recipients. The recipients use the Informational Return to prepare their tax returns, and the IRS uses it to match the information from the specified transaction to the tax payer’s return. The deadlines are varied by the type of Informational Returns, but the earliest one falls on January 31st.

If you think the Informational Return has nothing do with you, you are wrong! You probably issued or received at least one or two Informational Returns last year, and you will likely get one this year too. Still don’t think so? How about individual forms like 1042-S, W-2, 1098-T, 1099- INT, 1099-DIV, 1099-MISC, or 5498?

If you are recipient of these forms, the instructions are pretty simple. However, this is not necessarily the case if you are the issuer of these forms. Let’s review the requirements using an example.

Say Peter is opening a new retail business in Washington, DC. He hired his old friend in Michigan to do the interior designing, and paid $3,000 for her creative design service; this friend did her design work from Michigan, for the most part. For the entity set-up procedure, Peter hired an attorney in Virginia, and paid $1,200 for his legal service. Peter also contracted services for his new shop location, like pest control, cleaning, and security. All of these services were rendered by small, individual businesses in Maryland. Lastly, Peter hired a retired marketing expert in Connecticut to run a marketing campaign for his business. This campaign was run over the internet, and Peter never met his consultant face-to-face, but nevertheless paid him $1,000.

Peter’s new business may not be up and running yet, but he still has to issue a 1099-Misc form for the payments made to these independent contractors. So, he diligently followed the IRS' instruction in regards to the payee status, amount threshold, service type, etc. He even called a couple of times to verify their tax ID and address. Peter sent out all the relevant copies to these payees in a timely manner, and finally e-filed the forms with the Internal Revenue Service.

At this point, Peter is quite tired of the whole process, and believes that he’s fulfilled all of his requirements. However, this is not the case. Next week, read what other steps Peter must take to ensure that his Informational Returns are squared away.

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Last week, we used an example of Peter, a new business owner, who contracted people to work for him from a number of different locations and his efforts to complete his Informational Returns.

Because his contractors were based in different states, Peter would be required to send a copy of their Informational Returns to the payee’s state or city.  For example, he paid a designer in Michigan who performed her service remotely from her office there. Therefore, Peter is required to file the 1099-Misc with Michigan and the relevant local governments, even when there is no MI tax withholding.[1]

When Peter paid a lawyer in Virginia, he should note that the Commonwealth of Virginia does not require the 1099 payer to file the form unless there is a Virginia income tax withheld. Since there was no VA tax withheld, he could skip the 1099-Misc filing.

For the small businesses that Peter contracted in Maryland, he should note that The Comptroller of Maryland is a participant in the IRS combined Federal/State filing program.[2] Since the Internal Revenue Service will forward the electronically filed returns to the State of Maryland, he doesn’t have to file a separate copy of the 1099-Misc.

In the case of his marketing contractor in the State of Connecticut, 1099 payers are required to provide copies of 1099-Misc to Connecticut, regardless of the withholding of CT tax. However, the State of Connecticut is also a participant of the IRS combined Federal/State filing program. So, he can skip sending an extra copy to the state, because his federal 1099-Misc will be forwarded to the state automatically.

This example shows how daunting Informational Returns can be, especially when all fifty states have different Informational Return filing requirements. However, the IRS’s combined Federal/State filing program has made great strides in simplifying this process, and currently 32 states are participating in this program. Until this program covers all fifty states, though, it is always a good idea to go the extra mile to check with State or municipal filing requirements of the Informational Returns.

[1] Public Act 211 of 2003. In fact, this requirement was repealed three weeks ago. Nevertheless, there is no detailed instruction about this change in the MI State or its municipal governments’ web-sites.

[2] You can find more about the program at the IRS Pub. 1220

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Are you a U.S. taxpayer with undisclosed offshore accounts or assets?  Have those accounts or assets generated income that you did not report to the Internal Revenue Service? If so, there is currently more than one option for you to come forward.

The Internal Revenue Service announced its reopening of the Offshore Voluntary Disclosure Program (“OVDP”) on Friday, January 9th. The OVDP is an IRS initiative to bring taxpayers that have used foreign accounts or entities to avoid tax into complying with U.S. tax laws. When a taxpayer complies with all the provisions of the OVDP, the IRS accepts the penalty payment at a reduced rate and does not recommend criminal prosecution to the Department of Justice.

The penalty for the program has increased from 25% in 2011 to a current rate of 27.5%. Smaller or qualified account holders will face a reduced penalty rate of 12.5%.  If you  do not come forward and your offshore accounts are ultimately detected by an IRS audit, the penalty can be up to 75% of your income from the audited accounts and 50% of the account balance. In addition, criminal prosecution can inflict up to three to ten years of prison time.

You may think that the program penalties are set too high. Let me give you an illustrative example to compare the two different cases with and without the OVDP program.

Eight years ago, say you deposited one million in offshore income generating accounts, and earned $400,000 in interest. You neither reported the existence of the accounts nor paid tax on the income from the accounts.

If you participate in the OVDP program in 2012, you will pay about $600,000, assuming the highest income tax rate. The amount includes an income tax of $140,000 ($400,000 x 35%), accuracy related penalty costs of $28,000 ($140,000 x 20%), program penalties of $385,000 ($1,400,000 x 27.5% = $385,000), and interests on unpaid tax dues. However, if the IRS independently detects your offshore accounts and found your tax avoidance, over 4.5 million dollars of tax, penalties, and interest may be assessed.[1] That’s right: the payment may be 7.5 times more without the OVDP program.

The United States has never made an effort to regulate tax avoidance through offshore accounts. Since 2009, when the program was initially launched, the OVDP has expanded its covered periods and increased the penalties over the years. As current IRS Commissioner, Doug Shulman has stated, their effort is “gaining its momentum internationally” through bilateral tax treaties, agreements, and active lawsuits.

This is why you should consider taking advantage of the OVDP program in 2012, if you have yet undisclosed offshore accounts.

[1] See the IRS website comparing the payment dues under the two different scenarios with or without OVDP program participation at; http://www.irs.gov/businesses/international/article/0,,id=235699,00.html.

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In many countries, local taxes are assessed separately on regional, municipal, and prefectural levels. The United States is no exception. In the United States, taxpayers must file an annual federal tax return and file a separate state tax return.  In many cases, state tax laws are similar to federal tax laws. Nevertheless, as state income taxes are based on autonomous state law and administration, you will find that concepts in federal taxation are often not applicable to state tax reporting.

State tax rates vary by state. For example, the state of New York has the highest marginal income tax rate (8.97%) for individuals. On the contrary, states like Florida, Nevada, Alaska, Texas, Washington, Wyoming, or South Dakota do not tax individuals on their income at all.[1]

People often find it specifically challenging when they have to apply for two different sets of state rules for their tax reporting. In fact, it is not uncommon for a U.S. taxpayer to reside in one state and work in another.  To illustrate this tricky “multi-state tax reporting situation,” take a look at a few hypothetical cases below. These cases illustrate the complications that can occur when two separate sets of state taxes overlap.

Case 1:

Q: I am a resident of New Hampshire, but work in Massachusetts. New Hampshire does not tax individuals for their earned income, but Massachusetts assess 5.3% tax on an earned income. As a NH resident, am I still subject to MA income tax reporting requirements?

A: Yes, you are. Since the source of your income is from Massachusetts, you have to file a MA tax return as a non-resident of Massachusetts and pay applicable taxes. As for New Hampshire, you are not subject to file or pay tax on your Massachusetts earned income in the state of New Hampshire, since your home state does not assess income tax on an earned income.

Case 2:

Q: My spouse is living in Virginia and works in the District of Columbia. Does she have a different case from mine?

A:Virginia and District of Columbia are adjacent localities, and they have established a State Reciprocal Income Tax Agreement (“reciprocity”). As long as your spouse properly filed her exemption form with her employer and certified that she was not a resident of DC, she will not be subject to filing or paying tax requirements on her DC earned income to the DC government.  Instead, she will have to include all of her DC earned income into her VA tax return and pay taxes in Virginia.

Case 3:

Q: Next year, I am planning to live in New Jersey and work in New York. I understand that both states have individual income taxes. Do I need to pay taxes in both states?

A: Yes. There is no reciprocity between the two states. You will have to file a tax return in NY as a non-resident and pay applicable taxes. As a resident of NJ, you will also have to file and pay taxes in NJ. However, New Jersey will allow tax credits to offset your tax burden in New Jersey in order to minimize the effect of double taxation.

[1] Individual Income Tax Rate at the state level is available at http://www.taxadmin.org/fta/rate/ind_inc.pdf.
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If you are like any other tax payer, you probably tried, at least once, to compare two  tax systems by looking at the  income tax rate. In 2010,  the highest marginal tax rate was in the United Kingdom at 50% , while  Canada’s highest rate was 29%, and the United States was somewhere in the middle at 35%. So, you may think it would be best to live in Canada to save on your taxes.[1] In fact, this is quite misleading to compare the top marginal income tax rates of different countries.

There are several fundamentally different ways a country may structure income taxes. Some could have a flat rate;  some could have different exemption or deduction rules for the threshold amount for the marginal tax rate; some could additionally assessed tax on the same income.   As such, it is tough to meaningfully compare tax systems based on rates alone.

The Organization for Economic Co-operation and Development (OECD) provides the All-in average personal tax rate data on wages, a good resource for individuals who want to compare their taxes on their earned income.[2]  For example, the All-in tax rate for the U.S. single taxpayer’s wage was 22.9% in 2010. The rate for the sole-earner married with two children was 8.2%. The U.S. tax rate was ranked in the middle of the OECD member countries for the single tax payer’s wage. For the sole-earner family with two children category, it was the fourth lowest rate.

If you are not a wage earner, you might be interested in the GDP vs. Tax ratio. OECD compares its member countries’ tax revenue with their gross domestic product (“GDP”) every year. The ratio shows the effective tax burden or rate assessed on each country’s domestic economic activity. According to this report, the U.S. tax revenues was 24.8% of its GDP in 2010. This was the third lowest rate among 34 OECD countries.[3]

Even these statistics are not enough to paint a complete picture of what your tax situation would be in these countries. Until you collect all the relevant information and run some numbers under each country’s tax system, you would not be able to tell which country has a higher tax or tax rate for your individual case. Nevertheless, you can be assured that the U.S. tax rate is generally ranked as one of the modest tax systems compared to other industrialized countries.

[1] OECD Tax Data available at http://www.oecd.org/document/60/0,3746,en_2649_34533_1942460_1_1_1_1,00.html#pir.

[2] OECD developed a model to show effective tax rate on wage by countries including income tax and social security tax paid by employee and employer. To find more detail, please see the article available at http://www.oecd.org/dataoecd/55/11/47813509.pdf

[3] OECD Tax Data available at http://www.oecd.org/document/60/0,3746,en_2649_34533_1942460_1_1_1_1,00.html#pir.

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Technology has changed how we communicate in our business and personal lives. Even if you have not met a single friend for a month or two, you can still have thousands of FaceBook friends.

You did not meet a person during the day? Not an issue. You know what is going on with other people by following their Twitter accounts.

Overbooked professionals or businesses on a budget will routinely look for  alternatives to meetings in person in the realm of technology, such as Skype or similar teleconferencing ideas.  These new technologies seem to makes our social and business lives richer at a cheaper cost Then, why do many nonprofits still spend a significant amount of resources to periodically organize large conferences, conventions, or trade shows?

I believe it is because nonprofit people understand the importance of fun and the value of play in building a community. At least, all the people I have met in the nonprofit industries have understood the importance of the entertaining features of their services to members and supporters. As Johan Huizinga, a Dutch historian, once put it in his book Homo Ludens, the play aspect is a necessary condition to produce a culture.

Whether a nonprofit’s mission is to protect animal rights or to amplify an occupational group’s voice in society, your organization won’t be successful with dry or boring program activities. Constrained professionalism will not generate the “culture or vibe” to attract members or supporters. Our tax code reflects this same reality.

According to the IRS, convention and trade show activities, when carried on by a qualifying organization in connection with a qualified activity, will not be treated as unrelated trade or business.[1]

In order for a convention activity to be considered qualified, the  organization must sponsor the activity for the “promotion and stimulation” of interest in products and services that are either common in the industry or related to the exempt activities of the organization.[2]

[1] Treas. Reg. §1.513-3.

[2] Internal Revenue Code §513 (d)(3)(B).

Last week, I gave a theoretical account of a small business owner that was run out of business by a local non-profit.

Fortunately, this is not a real story. To alleviate this potentially unfair competition issue, the Internal Revenue Code makes an exempt organization like the EDL, subject to federal tax at a corporate level to the extent that their income is generated from a business unrelated to their mission. This is commonly called, “Unrelated Business Income.” The Unrelated Business Income has to be reported separately in the Form 990-T.

Unrelated business income is usually found when there is a trade or business activity that is carried on regularly, but is not substantially related to the exempt purpose of the organization.[1] In our theoretical EDL case, the sandwich sale was clearly a business activity, as it involves a sale of product. Furthermore, these sales were made every day. Since the mission of the EDL was to feed people in need, these sales cannot be substantially related to the EDL’s exempt purpose. Therefore, EDL will have to report their sandwich sales separately in 990-T and pay taxes on that income.

In a previous article, I briefly introduced a specific rule about how a membership organization has to calculate their income from journal sales when there are two different price tags for member sales and non-member sales. In fact, this rule was just the tip of the iceberg of a  very complicated calculation process of UBIT income and expenses for a membership organization. We will go over more specific rules for the UBIT calculation later by type of organization. However, let me now put in a very broad context, the UBIT in Form 990-T . Generally, Unrelated Business Income is taxable after deducting directly connected expenses, and the tax is called UBIT (“Unrelated Business Income Tax”).[2]

[1] See Internal Revenue Code Section 513(a) for definition of UBIT.

[2] See Treas. Reg. 1.512(a)–1(a) to find the meaning of “directly connected.”

We are living in a society that encourages free, open, and fair competition. If you find your competitor with some type of privilege, you will likely be discouraged or at least disappointed.

Let’s say, you own a sandwich shop at a busy downtown strip mall near a tourist attraction. The shop next door is owned and operated by a nonprofit entity called as EDL which stands for “Everyone Deserves Lunch.’ The shop's mission is to give out free sandwiches to low income household children and homeless people. After 2 p.m. every day, they sell their left-over sandwiches to office workers, shoppers, or tourists at a small margin, since they see it as their service to the community. Their unusually cheap price was possible  as  the EDL doesn’t pay property tax, franchise tax or income tax. They also don’t pay any salary to their workers, as they are all volunteers. People like the idea of helping out a nonprofit entity in good will. Furthermore, they like their cheap lunch.

It sounds like a great thing going on for everyone else in this town except for you, the sandwich shop owner. Since you are faithfully paying property tax, income tax, sales tax, and salary to your staff, your sandwich is about 40% more expensive than the one sold by your local nonprofit competitor. It’s just matter of time. You will lose all your business, and may have to wait in line yourself for a free sandwich at the EDL.

Is the EDL really doing a good job nurturing the community or is the EDL driving the small business out of business?

Fortunately, this is not a real story. My next article will address the ways in which the Internal Revenue Service alleviates this potentially unfair competition issue.

Last week, we spoke a little about how to factor in an income from periodicals for your nonprofit.

The first issue is to find how much you need to allocate the membership income to journal income. The sales price of the subscription without membership was $60.00. However, the discount that members received for not receiving the journal was $50.00. If you were once a math person, the answer that you came up with will be one of the following three.

(1)   $60.00 x (600 Members with subscription + 300 Subscription only) = $54,000.

(2)   ($50.00  x 600 Members with Subscription) + ($60 x 300 Subscription only) = $48,000

(3)   (40% x $100 x 600 Members with subscription) + ($60 x 300 Subscription only) = $42,000

These three answers are all correct in a sense. However, we are dealing with this issue in the context of Form 990, which is governed by specific code and rules.[1] To get a correct answer, you should be a good reader of the legal rules too.

The rule can be summarized like so:

1. When 20% or more of the total circulation consist of sales to nonmembers, the nonmember price is used to calculate the journal income.
   
   
2. If the first condition is not applicable and 20% or more members pay reduced due by electing not to receive the journals, the reduction in dues for a member is used to calculate the journal income.
   
   
3. If neither of these two conditions is applicable, the membership receipt is multiplied by the ratio of periodical cost vs. Sum of periodical cost and other exempt activities cost.
   
   

Based on this rule, our example Associations’ journal income should be (1) $54,000.

The subscription sale was only 300 out of 900, so it was more than 20% of total subscription sale. Therefore, the first condition was applied, and the subscription price is assumed to be at $60 for all 900 subscription sales.

You should be wary though, as you might get confused with the second condition. More than 40% of members of the Association here have elected not to receive the journal.  The second condition, therefore, seems to be satisfied too, right? Or since the first and second conditions are both met, should we not just use the third method or any choice among the three?

Let me get back to the correct reading of the rule. The second rule clearly says that it is applicable “only when” the first condition is not satisfied. [2] Therefore, when the first condition is met, the second and third rules are not applicable. Therefore, we don’t even have to look into the second and third condition.

If you’ve made it this far, I salute your patience. You are one of few who are not allergic to the complication of legal math. Trust me. Many people are allergic to math. If that’s not the case, they are likely allergic to the laws. If neither is the case, they certainly hate complicated issues.

[1] 26 CFR 1.512(a)-1(f)(4)(i) to (iii).

[2] See 26 CFR 1.512(a)-1(f)(4)(ii) that the rule reads quite complicated. (Subscription price to nonmembers: If paragraph (f)(4)(i) of this section does not apply and if the membership dues from 20 percent or more of the members of an exempt organization are less than those received from the other members because the former members do not receive the periodical, the amount of the reduction in membership dues for a member not receiving the periodical shall determine the price of the periodical for purposes of allocating membership receipts to the periodical).

A question for a membership organization with journals: How much is your journal subscription income when a subscription is offered as a part of the membership benefit?

When you sell a subscription of periodicals separately from  membership, the price is usually set higher than the one that includes membership. The reasoning for this is that generally we give more benefits to members or to attract more people to become members. The question is how do we calculate the journal income with these two different price tags for Form 990 and 990-T.

To give you more detailed view of this situation, let me set up an imaginary membership association,  called National Caffeinators Association.

Membership and Benefits: The membership is offered to coffee shop owners at $100.00 per year, and its membership benefits include a one-year subscription of quarterly journal, Coffees R Us.  The quarterly journal gives you the newest information about roasting, brewing, and serving coffee.

Price Structure and Sale: If a member opted not to receive journals, the member pays $50.00 instead of $100. The journal subscription for sale is separate from the membership at the organization’s website, Amazon.com, and many bookstores at $60.00. The Association had 1,000 members in 2011 and 400 of these members elected not to receive the journals. The Association sold 300 subscriptions separately from the membership in 2011.

Journal Publication Cost: The publication cost of the quarterly journal is about 40% of the association’s cost including publication cost and other exempt activities cost.


Can you calculate the 2011 income from the sale of journal subscription?