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Frequently Asked Tax Questions

I live abroad and want to participate in the new Streamlined Foreign Offshore Procedures for reporting undisclosed offshore assets but I’m not sure if I qualify as a "non-resident" because I maintain ties to the United States. How can I tell?

The non-residency test – which can mean the difference between paying a five percent penalty or no penalty at all – is whether, in any one or more of the most recent three years for which the U.S. tax return due date has passed, you did not have a U.S. "abode" and you were physically outside the United States for at least 330 full days. "Abode" is a somewhat nebulous term variously defined as an individual’s home, habitation, residence, domicile, or place of dwelling. "Abode" has a domestic rather than a vocational meaning, focused on where you maintain your economic, family, and personal ties, and does not mean the same as "tax home."

Can I use a "hardship" exception to avoid tax and penalties on a withdrawal from my 401(k)?

It may depend on the wording of your 401(k) plan, which may or may not permit hardship distributions and may limit the categories of hardship that qualify. The IRS, in addition, has its own criteria for determining "hardship." For a distribution from a 401(k) plan to be "on account of hardship," there must be an immediate and heavy financial need and the amount distributed must be limited to the sum needed to satisfy the financial need. Whether a need is "immediate and heavy" depends on the facts and circumstances, including the availability of other resources, but certain categories generally qualify: (1) certain medical expenses; (2) costs relating to the purchase of a principal residence; (3) tuition and related educational fees and expenses; (4) payments necessary to prevent eviction from, or foreclosure on, a principal residence; (5) burial or funeral expenses; and (6) certain expenses for the repair of damage to the taxpayer’s principal residence. Note that the hardship distribution is still taxed as income unless the money withdrawn consisted of designated Roth contributions. All you can hope to avoid is the 10 percent penalty on early distribution.

Is there a "hardship distribution" exception I can use to avoid federal tax on an emergency distribution from my IRA to meet unexpected expenses?

The rules for IRAs are much different from those governing 401(k)s, which causes a lot of confusion. In general, there are no restrictions on IRA distributions but your IRA distribution will be treated as taxable income earned in the year of the distribution and must be reported as such. The financial institution holding the IRA will also report your distribution to the IRS. There is an additional 10 percent "early distribution tax" which may be avoided in limited circumstances, such as a first-time home buyer distrubition and a distribution for certain higher education expenses. The IRS publication 590-B Distributions from Individual Retirement Arrangements (IRAs) contains information concerning the various exceptions available.

I read somewhere that the IRS has imposed an IRA One-Rollover-Per-Year Rule – is there such a Rule and how does it affect me?

Under IRS Announcements 2014-15 and 2014-32, beginning in 2015, taxpayers can make only one rollover from an IRA to another (or the same) IRA in any 12-month period, regardless of the number of IRAs owned. The money in the taxpayer’s IRAs, including SEP and SIMPLE IRAs as well as traditional and Roth IRAs, is lumped together and treated as a single IRA for purposes of the limit. Since most people use rollovers to move their money from one financial institution to another, the better practice – and one that avoids this confusing new rule – is to arrange for a direct transfer from one financial institution to another, which may be as simple as checking the correct box on a form. This way you never take possession of the funds, as a result of which the transfer isn’t considered a rollover at all, and the rule does not apply. There is no limitation (at least as of the time this is being written) on the number of direct transfers as you can make.

When I defaulted on my loan payments, the lender issued a Form 1099-C which makes it look like I was paid income – what’s that all about?

Thanks in large part to a wrongly-decided Depression-era U.S. Supreme Court case, if you borrow money and the lender later cancels or forgives the debt, you may have to include the cancelled amount in income for tax purposes. The theory is that the portion of the loan you will no longer be required to pay back is a "windfall" reportable as income. The lender is usually required to report the amount of the canceled debt to you and the IRS on a Form 1099-C, Cancellation of Debt. There are some exceptions to treatment of the discharged indebtedness as income, which include: (1) qualified principal residence indebtedness, an exception created by the Mortgage Debt Relief Act of 2007 and applicable to most homeowners, provided Congress keeps renewing the law when it expires; (2) debts discharged through bankruptcy; and (3) you were legally "insolvent" when the debt is cancelled, that is, your total debts are more than the fair market value of your total assets. A non-recourse loan is another exception, but this is rare among consumer debts. A non-recourse loan is a loan for which the borrower assumes no personal liability and the lender’s only remedy in case of default is to seize the property being financed or used as collateral. It is important to remember that, even if the forgiven debt is excluded from income, the amount of debt forgiven must be reported on Form 982, which becomes part of your federal income tax return. The reported income is ultimately "zero’d out" during the return preparation process.

I received an inheritance from a non-resident alien relative who lived in a foreign country. Do I have to report this foreign money even though an inheritance in the United States is not considered "income"?

Only if the total amount you receive is valued at more than $100,000. If so, you must complete Form 3520Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts. This is separate from your income tax return filing requirement and generally will not result in taxable income provided the money is a legitimate gift or bequest.

I obtained copies of my Account Transcripts using the IRS "Get Transcripts" program, and I see the notations "Substitute tax return prepared by IRS" and "Tax return filed." Does that mean the IRS filed my tax return for me? Can they do that?

If you fail to file a federal income tax return and the IRS has income information from other sources, such as W-2s and 1099s, the IRS may prepare a "bare bones" tax return as a basis for making a tax assessment against you, with penalties and interest, of course. The Substitute For Return ("SFR") allows only the standard deduction, one exemption, and single or married-filing-separately filing status. The combination of no itemization of personal deductions and no deduction of business expenses results in significantly overstated income and a resulting over-assessment of tax due. You can still file your own return, which will then be deemed an "amended" return, in order to claim the exemptions, credits and deductions to which you would have been entitled.

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