Last week’s article, Tax Time, 2014 Style, was written in a Question & Answer format to provide answers to often asked tax-related questions. Unfortunately, there was only enough column space for just a couple of Q&As, selected from a virtual storehouse of such information. I feel it important to get some of this information “out there,” before the income tax filing and payment deadlines arrive.
Q. Did he just say “deadlines” with an “S”?
A. Yes, I did. For U.S. taxpayers residing in the USA, both of this year’s return filing and tax payment deadlines fall on the same day: April 15, 2014. For U.S. taxpayers residing outside of the USA, the tax payment deadline remains April 15, 2014 but the return filing deadline is extended to June 16, 2014 via an automatic 2-month extension.
Additionally, while the tax payment deadline remains the same, no penalties will be charged to U.S. taxpayers residing outside of the USA who pay their taxes prior to June 16, 2014. Those U.S. taxpayers will be charged interest on the tax due, however, during the period of April 15 to the date of payment. If those U.S. taxpayers make payment after June 16, 2014, they will incur a penalty for doing so.
See what I mean? There’s a whole lot of information that needs to be known by U.S. taxpayers living abroad (and even those living in the U.S. itself) that isn’t easily available to them.
SO, OFF WE GO . . .
Today’s first question is based on a classic “Yes It Is / No It Isn’t” argument, and is all too often quite an emotional battle. To those who may identify with this skirmish, I ask you to simply trust my answer. If followed, it will keep you from receiving additional correspondence from the Internal Revenue Service (IRS).
Q. While discussing a tax exclusion program with a friend, he informed me that my pension is “unearned” income. Now, I earned every penny of that retirement money. All those days of slaving away on my way to retirement; and now someone says I didn’t earn it? What’s all this mumbo-jumbo of “earned” and “unearned” income about, anyway?
A. First, let me state that you very much earned your pension. But for income tax purposes, we’re not talking about your efforts. We’re talking about categorizing income by its character. For income tax purposes, all income, regardless of its source, can be separated into three categories: 1) earned income; 2) unearned income; and 3) variable income. To be placed into one of these categories, the income must meet the IRS’s definitions. The IRS explains them this way:
- Earned income is “pay for personal services performed, such as wages, salaries, or professional fees.” Examples of earned income include: salaries and wages; commissions; bonuses; professional fees; and tips.
- Unearned income is “generally all income other than salaries, wages, and other amounts received as pay for work actually done.” Examples of unearned income include: dividends; interest; capital gains; gambling winnings; alimony; social security benefits; pensions; and annuities.
- Variable income is “income that may fall into either the earned income category, the unearned income category, or partly into both.” Examples of variable income include: business profits; royalties; rents; and scholarships and fellowships.
So, there you have it – expressed in the IRS’s own vague simplicity! These are the definitions of income that count when dealing with income taxes.
Q. I’m an ex-pat. While talking with other ex-pats the other day, one of them told us that, in addition to federal income tax, we had to pay state income taxes, too. He also said that the only way out of it was to become a resident of one of the states that do not have an individual income tax. Does this mean I have to move to South Dakota or something?
A. No, you won’t have to move to South Dakota or any other state. Currently, all but seven states have an individual income tax (two of those seven only tax dividend and interest income). Generally, filing state individual income tax returns and paying any associated taxes is based on the taxpayer’s residency. Most states hold that you are either 1) a resident; 2) a part-year resident; or 3) a nonresident. Again, with the definitions. This time, we’re talking about definitions that vary from state to state. For simplicity, we’ll use the definitions provided by the State of California:
- Resident: “Everyone who is in this state for other than a temporary or transitory purpose; and every individual who is domiciled in this state who is outside of the state for a temporary or transitory purpose.”
- Part-year resident: “A taxpayer who meets both of the following conditions during the same taxable year: 1) is a resident of California during a portion of the taxable year; and 2) is a nonresident of California during a portion of the taxable year.”
- Nonresident: “Every individual other than a resident.”
Of course, these definitions spur on the need for a few more, like “temporary or transitory purpose” and “domicile.”
- Temporary or transitory purpose: “Whether or not an individual is in this state for temporary or transitory purposes depends to a large extent upon the facts and circumstances of each particular case.” Examples include: simply passing through the state; being in the state for a brief rest; being in the state for a vacation; and being in the state for a short period to complete a particular transaction, perform a particular contract, or perform a particular engagement.
- Domicile: “The place where an individual has his or her true, fixed, permanent home and principal establishment. It is the one location with which, for legal purposes, a person is considered to have the most settled and permanent connection.”
Now, hidden among those definitions is a simple fact of life: state residency does not depend on simply owning property in that state, or simply living there, alone. It’s your connection with the state that counts. If you leave the state, never to return again except as a tourist, and cut off all professional, social and government ties to persons, businesses and agencies in the state, you would be deemed to be a nonresident. Have the intent of someday “returning home” to that state and you are a resident. Spend more than a specified amount of time in that state during a taxable year (for California, it’s an aggregate of more than nine months) and you are presumed a resident.
As to being required to file and pay state income tax, it again depends on your residency status. Always remember, different states = different requirements. For the most part, however, it’s pretty much broken down like this:
- Residents: Taxed on all income, as adjusted.
- Part-year residents: Taxed on all income, as adjusted, during the period of residency, and taxed on specific items of income that are sourced to the state (i.e., coming from sources within the state) during the period of being a nonresident.
- Nonresident: Only taxed on specific items of income that are sourced to the state.
Did I say simple? Nothing is simple when it comes to income taxes.
THIS WEEK’S SUMMARY
Here’s your take-away for this week:
- Know the deadlines for filing and paying your individual income tax – both federal and, if required, state.
- Know whether or not you are required to file an individual income tax return and pay the associated taxes to a state or several states.
In future articles, I’ll try to explain methods of making sure that you are not presumed to be a resident of a particular state, and answer more questions.
Yes, I know that this tax stuff can get boring and confusing – not necessarily in that order – but you really should stick it out and keep up with it; at least at this time of year.