The Foreign Service Journal, February 2010

60 F O R E I G N S E R V I C E J O U R N A L / F E B R U A R Y 2 0 1 0 come from investments. Interest on loans intended to finance a business is 100-per- cent deductible. Passive-investment in- terest on investments in which the taxpayer is an inactive participant (i.e., a limited partnership) can be deducted only from the income produced by other“pas- sive income.” Interest on loans that do not fall into the above categories, such as money borrowed to buy tax-exempt se- curities, is not deductible. Home Leave Expenses Employee business expenses, such as home leave and representation, may be listed as miscellaneous itemized deduc- tions and claimed on Form 2106. In ad- dition to the 2-percent floor, only 50 percent for meals and entertainment may be claimed (100 percent for unre- imbursed travel and lodging). Only the employee’s (not family members’) home leave expenses are deductible. AFSA rec- ommends maintaining a travel log and retaining a copy of home leave orders, which will help if the IRS ever questions claimed expenses. It is important to save receipts: with- out receipts for food, a taxpayer may deduct only $45 to $58 a day (depending upon the federal meals-and-incidentals per diem rate at the home leave address), nomatter how large the grocery or restau- rant bill. Lodging is deductible, as long as it is not with friends or relatives, or in one’s own home. The IRS will disallow use of per diem rates and any expenses claimed for familymembers. If a hotel bill indicates double rates, the single-room rate should be claimed; and, if possible, the hotel’s rate sheet should be saved for IRS scrutiny. Car rental, mileage and other unreim- bursed travel expenses, including parking fees and tolls, may be deducted. The rate for business miles driven is 55 cents per mile for 2009. Those who use this op- tional mileage method need not keep de- tailed records of actual vehicle expenses. However, theymust keep a detailed odometer log to justify the business use of the vehicle and track the percentage of business use. This optional mileage method applies to leased vehicles, as well. Official Residence Expenses Since Oct. 1, 1990, em- ployees who receive official residence expenses have not been allowed to reduce their reportable income by 3.5 percent. The IRS rul- ing regarding ORE states that “usual expenses,” defined as 3.5 per- cent of salary, are not deductible. There- fore the only expenses that are deductible are those above the 3.5 percent paid out of pocket. Employees should save receipts for any out-of-pocket expenses associated with their representational duties. These expenses can be deducted as miscella- neous business expenses. Home Ownership Individuals may deduct interest on up to $1 million of acquisition debt for loans secured by a first and/or second home. This also includes loans taken out for major home improvements. On home equity loans, interest is deductible on up to $100,000, no matter how much the home cost, unless the loan is used for home improve- ments. The $100,000 ceiling applies to the total of all home equity loans you may have. The same generally applies to refinancing a mortgage. Points paid to obtain a refinanced loan cannot be fully deducted the same year, but must be deducted over the life of the loan. It is advisable to save the settlement sheet (HUD-1 Form) for documentation in the event your tax re- turn is selected by the IRS for audit. Qualified residences are defined as the taxpayer’s principal residence and one other residence. The second home can be a house, condo, co-op, mobile home or boat, as long as the structure includes basic living accommodations, including sleeping, bathroomand cooking facilities. If the second home is a vacation property that you rent out for fewer than 15 days during the year, the income need not be reported. Rental expenses cannot be claimed either, but all property taxes and mortgage interest may be deducted. Rental of Home Taxpayers who are overseas and rented their homes in 2009 can continue to deduct mortgage interest as a rental ex- pense. Also deductible are propertyman- agement fees, condo fees, depreciation costs, taxes and all other rental expenses. A F S A N E W S JOSH T he Foreign Earned Income Exclu- sion allows U.S. citizens who are not government employees and are liv- ing outside the U.S. to exclude up to $91,400 of their 2009 foreign-source in- come if they meet certain requirements. Beginning in 2006, the IRS changed the requirement for how the excluded amount needs to be calculated. This af- fects the tax liability for couples with one member employed on the local econ- omy overseas. Previously, you took your total income and then subtracted your excluded income and paid tax on the re- mainder. The change now requires that you take your total income and figure what your tax would be, then deduct the tax that you would have paid on the ex- cludable income. For example: A Foreign Service employee earns $80,000. Teacher spouse earns $30,000. Before 2006: Tax on $110,000 minus $30,000 = tax on $80,000 = tax bill of $13,121. Now (2006 and later): Tax on $110,000 = $20,615; tax on $30,000 = $3,749; total tax = $20,615minus $3,749 = tax bill of $16,866. Foreign Earned Income – Important Note