The Foreign Service Journal, February 2007

F E B R U A R Y 2 0 0 7 / F OR E I GN S E R V I C E J OU R N A L 57 The annual AFSATaxGuide is designed as an informational and reference tool. Although we try to be accurate, many of the newprovisions of the tax code and IRS imple- menting regulations have not been fully test- ed. Therefore, use caution and consult with a tax adviser as soon as possible if you have specific questions or an unusual or complex situation. Federal Tax Provisions TheMilitary Families TaxRelief Act of 2003continues toprovide a significant ben- efit for ForeignService families who sell their homes at a profit, but would have been unable to avail themselves of the capital gains exclusion (up to $250,000 for an individ- ual/$500,000 for a couple) fromthe sale of aprincipal res- idence because they did not meet the IRS “two-year occu- pancywithin the five years pre- ceding thedateof sale” require- ment due to postings outside the U.S. In relation to the sale of a principal residence after May 6, 1997, the 2003 law notes that the calculation of the five-year period for measuring ownership is suspendedduring any period that the eligible individual or his/her spouse is serving on qualified offi- cial extendedduty as amember of the uni- formed services or the Foreign Service. The five-year period cannot be extend- edbymore than 10 years. Inotherwords, Foreign Service employees who are over- seas onassignment canextend the five-year period to15 years, dependingon thenum- ber of years they arepostedaway fromtheir home. Note that the provision is retroac- tive, so that anyone who has already paid the taxon the saleof a residence thatwould have qualified under the new lawmay file anamended return toget the benefit of the new rule. There is, however, a three-year statute of limitations, afterwhichone can- not obtain a refund. Foreign Service employees most fre- quently askAFSAabout home ownership, tax liabilityuponsaleof a residenceandstate of domicile. We have devoted special sec- tions to these issues. For 2006, the fivebasic tax rates for indi- viduals remainat 10, 15, 25, 28 and33per- cent, with a top rate of 35percent. The 10- percent rate is for taxable income up to $15,101 for married couples, $9,551 for singles. The15-per- cent rate is for income up to $61,301 for married couples, $30,651 for singles. The 25- percent rate is for income up to $123,701 for married cou- ples, $74,201 for singles. The 28-percent rate is for income up to $188,451 for married couples and income up to $154,801 for singles. The 33- percent rate is for income up to $336,551 for married couples and singles. Long-term capital gains are taxed at a maximum rate of 15 percent and are reportedonScheduleD. This rate is effec- tive for all sales in2005, except for thosepeo- ple who fall within the 10- or 15-percent tax bracket: their rate is 5 percent. Long- termcapital gain is definedas gain fromthe saleof propertyheld for12monthsormore. Personal Exemption For each taxpayer, spouse and depen- dent the personal exemption has been increased to $3,300. There is, however, a personal exemptionphase-out of 2percent for each $2,500 of AdjustedGross Income over $150,500 (singles), $188,150 (headof household), $225,750 (joint) and$112,875 (married, filing separately). For those tax- payers in the last category, the phase-out is 2 percent for each $1,250 of Adjusted Gross Income over $109,475. Foreign Earned Income Exclusion Many Foreign Service spouses and dependentswork in theprivate sector over- seas and thus are eligible for the Foreign Earned Income Exclusion. American cit- izens andresidents livingandworkingover- seas are eligible for the income exclusion, unless they are employees of the United States government. The first $82,400 earned overseas as an employee or as self- employed may be exempt from income taxes. To receive the exemption, the taxpay- er must meet one of two tests: 1) the Physical PresenceTest requires that the tax- payer be present in a foreign country for at least 330days during any12-monthperi- od. (The periodmay be different fromthe taxyear); or2) theBonaFideResidenceTest requires that the taxpayer havebeenabona fide resident of a foreign country for an uninterrupted period which includes an entire taxyear. Most ForeignService spous- es and dependents qualify under this test, but they must wait until they have been overseas for a full calendar year before claiming it. It shouldbe kept inmind that self-employed taxpayersmust still pay self- employment (Social SecurityandMedicare) tax on their income. Only the income tax is excluded. Extension for Taxpayers Abroad Taxpayerswhose taxhome isoutside the U.S. on April 15 get an automatic exten- sionuntil June15 to file their returns. When filing the return, these taxpayers should write “Taxpayer Abroad” at the top of the first page and attach a statement of expla- A F S A N E W S JOSH AFSA 2006 TAX GUIDE Federal and State Tax Provisions for the Foreign Service