American Expats and Year-End Tax Planning

Several weeks ago, Jane Smithy asked me whether she could withdraw $100,000 from her traditional Individual Retirement Account without jeopardizing her Alternative Minimum Tax (AMT) rebate? My knee-jerk reaction was whether Jane would have attained 59.5 years of age by the time of her withdrawal since otherwise a 10% penalty applies.  A quick review of her file confirmed that she was now 60 years old.

Jane had paid AMT in prior years for exercising Incentive Stock Options. Eligibility for the credit (rebate) is determined on Form 8801. Starting in 2007 this otherwise nonrefundable credit may be refundable up to 20% annually. But the amount available depends on the difference between the regular tax and AMT. Jane, being single, was concerned that her withdrawal could trigger AMT and thereby disqualify her from the refundable credit.

It turns out that Jane qualifies for over $40,000 next year once her 2008 tax return claiming the credit is filed.  But most Americans affected by AMT little understand how this tax is triggered.

Year end tax planning can be crucial even for American expatriates whose income flows are less complicated than Jane’s.  A self-employed person might not want that large fee paid to him in 2008.  Those business supplies might need to be purchased before 31 December. Contributions to a favorite charity might make sense this year. Profitable stock sales earlier in the year may require some offsetting losses now. An employed expatriate might want that year-end bonus in January.  Estimated taxes may need to be boosted to avoid penalties.

Furthermore, what will be Obama’s approach to taxes once in office? Given recurring financial hammer blows affecting America, won’t he raise taxes? And if so, should more income be taxable in 2008 than 2009? His main proposals are . . .

Raise the top two personal income tax rates from 33% and 35% to 36% and 39.6% respectively. 
Restore the income phase-outs for personal exemptions and itemized deductions.
Raise the top capital gains tax rate from 15% to 20%.
Increase the top dividend tax rate from 15% to 20%.
Increase taxes on oil and gas as well as multinational companies.

As these taxes are aimed at wealthier Americans, the Obama administration is also likely to take back the phase out of the Estate Tax, due to be repealed in 2010. Since the enactment of the 2001 Economic Growth and Tax Relief Reconciliation Act, the Applicable Exclusion Amount (AEA) has been gradually increased.  In 2008 AEA is $2,000,000, and next year increases to $3,500,000.  If Congress does not repeal the Estate Tax, the AEA will fall back to $1,000,000 with a top estate tax bracket of 55%. Since World War II, Americans have accumulated billions of dollars in assets just waiting to be passed on to the next generation.