The Foreign Service Journal, February 2009

F E B R U A R Y 2 0 0 9 / F O R E I G N S E R V I C E J O U R N A L 43 The annual AFSA Tax Guide is designed as an informational and reference tool. Although we try to be accurate, many of the new provisions of the tax code and the implementations of Internal Revenue Service regulations have not been fully tested. Therefore, use caution and consult with a tax adviser as soon as possible if you have specific questions or an un- usual or complex situation. James Yorke ( yorkej@state.gov) , who compiles the tax guide, would like to thankM. Bruce Hirshorn, Foreign Service tax counsel, for his help in its preparation. Federal Tax Provisions The Military Families Tax Relief Act of 2003 continues to provide a significant benefit for Foreign Service families who sell their homes at a profit, but would have been unable to avail themselves of the cap- ital gains exclusion (up to $250,000 for an individual/$500,000 for a couple) from the sale of a principal residence because they did not meet the Internal Revenue Ser- vice’s “two-year occupancy within the five years preceding the date of 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 suspended during any period that the eligible individual or his or her spouse is serving away from the area on qualified official extended duty as amember of the uniformed services or the Foreign Service. The five-year period cannot be ex- tended by more than 10 years. In other words, Foreign Service employees who are overseas on assignment can extend the five-year period up to 15 years, depending on the number of years they are posted away from their home. Note that the pro- vision is retroactive, so that anyone who has already paid the tax on the sale of a residence that would have qualified under the new law may file an amended return to get the benefit of the new rule. There is, however, a three-year statute of limita- tions on this provision, after which one cannot ob- tain a refund. Foreign Service employees most fre- quently ask AFSA about home ownership, tax liability upon sale of a residence and state of domicile. We have devoted special sections to these issues. For 2008, the six tax rates for individu- als remain at 10, 15, 25, 28, 33 and 35 per- cent. The 10-percent rate is for taxable income up to $16,051 for married couples, $8,026 for singles. The 15-percent rate is for income up to $65,101 for married cou- ples, $32,551 for singles. The 25-percent rate is for income up to $131,451 for mar- ried couples, $78,851 for singles. The 28- percent rate is for income up to $200,301 for married couples and income up to $164,551 for singles. The 33-percent rate is for income up to $357,701 for married couples and singles. Annual income above $357,701 is taxed at 35 percent. Long-term capital gains are taxed at a maximum rate of 15 percent and are reported on Schedule D. This rate is effective for all sales in 2008, except for those people who fall within the 10- or 15-percent tax bracket: their rate is either 0 or 5 percent. Long-term capital gain is defined as gain from the sale of property held for 12 months or more. Personal Exemption For each taxpayer, spouse and depend- ent the personal exemption has been in- creased to $3,500. There is, however, a personal exemption phase-out of 2 percent for each $2,500 of Adjusted Gross Income over $239,950 (married, filing jointly) or $159,950 (single). For those taxpayers who file under the category“married filing sep- arately,” the phase-out is 2 percent for each $1,250 of Adjusted Gross Income over $119,975. Foreign Earned Income Exclusion Many Foreign Service spouses and de- pendents work in the private sector over- seas and thus are eligible for the Foreign Earned Income Exclusion. American citi- zens and residents living and working overseas are eligible for the income exclu- sion, unless they are employees of the United States government. The first $87,600 earned overseas as an employee or as self-employed may be exempt from in- come taxes. Note: The method for calculating the tax on non-excluded income in tax returns that include both excluded and non-ex- cluded income was changed, beginning in 2006, so as to result in higher tax on the non-excluded portion. (See the box on page 46 for a full explanation.) To receive the exemption, the taxpayer must meet one of two tests: 1) the Physical Presence Test, which requires that the tax- payer be present in a foreign country for at least 330 days during any 12-month period (the period may be different from the tax year); or 2) the Bona Fide Residence Test, which requires that the taxpayer has been a bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year. Most Foreign Service spouses and dependents qualify under this test, but they must wait until they have been overseas for a full calendar year be- fore claiming it. Keep in mind that self- employed taxpayers must still pay self-employment (Social Security and Medicare) tax on their income. Only the income tax is excluded. A F S A N E W S 2008 TAX GUIDE Federal and State Tax Provisions for the Foreign Service