The Foreign Service Journal, January-February 2015

THE FOREIGN SERVICE JOURNAL | JANUARY FEBRUARY 2015 59 AFSA NEWS rented. In exchanging the properties, capital-gains tax may be deferred. Technically, a simultaneous trade of investments occurs. Actu- ally, owners first sign a con- tract with an intermediary to sell their property, hold the cash proceeds in escrow, identify in writing within 45 days the property they intend to acquire, and settle on the new property within 180 days, using the money held in escrow as part of the payment. It is impor- tant to emphasize that the exchange is from one invest- ment property to another investment property—the key factor in the IRS evalua- tion of an exchange transac- tion is the intent of the inves- tor at the time the exchange was consummated. The IRS rules for these exchanges are complex and specific, with a number of pitfalls that can nullify the transac- tion. An exchange should never be attempted without assistance from a tax lawyer specializing in this field. Calculat ing Your Adjusted Basis Many Foreign Service employees ask what items can be added to the cost basis of their homes when they are ready to sell. Money spent on fixing up the home for sale may be added to the basis. To qualify as legitimate fixing-up costs, the follow- ing conditions must be met: 1) the expenses must be for work performed during the 90-day period ending on the day on which the contract to sell the old residence was signed; 2) the expenses must be paid on or before the 30th day after sale of the house; and 3) the expenses must not be capital expenditures for permanent improvements or replacements (these can be added to the basis of the property, the original pur- chase price, thereby reducing the amount of profit). A new roof and kitchen counters are not “fix-up” items, but paint- ing the house, cleaning up the garden and making minor repairs qualify. The Affordable Care Act The A“ordable Care Act imposed two new tax increases beginning in 2013. There is a 3.8-percent net investment tax on net invest- ment income to the extent it is in excess of modified adjusted gross income of $250,000 for those married filing jointly, and $200,000 for those filing singly. Net investment income includes interest, dividends, rents, roy- alties, pensions and annui- ties, and gain from the sale of property. Secondly, the rate of the Medicare tax that is withheld from employees’ paychecks is increased by 0.9 percent on salaries or self-employment earnings over the same thresholds. STATE TAX PROVISIONS Liability: Every employer, including the State Depart- ment, is required to withhold state taxes for the location where the employee either lives or works. Employees serving overseas, however, must maintain a state of domicile in the United States where they may be liable for income tax; the consequent tax liability that the employee faces will vary greatly from state to state. In addition, the many laws on taxability of Foreign Service pensions and annuities also vary by state. This section briefly covers both those situations. Domici le and Residency There are many criteria used in determining which state is a citizen’s domicile. One of the strongest determinants is prolonged physical presence, a standard that Foreign Service personnel frequently cannot meet because of overseas service requirements. In such cases, the states will make a determination of the individu- al’s income-tax status based on other factors, including where the individual has family ties, has been filing resident tax returns, is registered to vote, has a driver’s license, owns property, or where the person has bank accounts or other financial holdings. In the case of Foreign Ser- vice employees, the domicile might be the state fromwhich the person joined the Service, where his or her home leave address is, or where he or she intends to return upon separa- tion. For purposes of this arti- cle, the term“domicile” refers to legal residence; some states also define it as permanent residence.“Residence” refers to physical presence in the state. Foreign Service person- nel must continue to pay taxes to the state of domicile (or to the District of Columbia) while residing outside of the state, including during assignments abroad, unless the state of residence does not require it. Members are encouraged to review the Overseas Brief- ing Center’s Guide to Resi- dence and Domicile, available on AFSA’s website at www. afsa.org/domicile. Domest ic Employ- ees in the D.C. Area Foreign Service employees residing in the metropolitan Washington, D.C., area are gen- erally required to pay income tax to the District of Colum- bia, Maryland or Virginia, in addition to paying tax to the state of their domicile. Virginia requires tax returns frommost temporary residents, as well. Most states allow a credit, however, so that the taxpayer pays the higher tax rate of the two states, with each state receiving a share.We recom- mend that youmaintain ties with your state of domicile— by, for instance, continuing to