If you are a single taxpayer with income of $200,000 or more or married filing jointly with income of $250,000 or more, President Obama has painted a big target on your wallet. Taxpayers with this demographic will be expected to bear the brunt of tax increases which are now scheduled to take place in 2011.

2011 Projected Tax Increases

Tax increases will come in the form of a three-pronged attack on your wallet. The 33 percent tax bracket will be increased to 36 percent and the 35 percent tax bracket will be increased to 39.6 percent. The 2011 tax law will also bring back the disallowance of itemised deductions and personal exemptions when your income reaches a certain threshold. And a new twist is to further regulate the amount of itemised deductions by limiting the tax benefit to 28 percent.

As an example, suppose you have a base salary of $400,000 and receive an unexpected bonus of $100,000. You then decide to donate the entire $100,000 bonus to a charity. Under current law this would be a wash transaction as the increase in income and deductions would negate each other. Under the proposed legislation the $100,000 bonus would be taxed at 39.6 percent or $39,600. However the itemised deduction of $100,000 would likely be reduced by $3,000 leaving an actual deduction of $97,000. The tax benefit of the $97,000 deduction would be limited to 28 percent or $27,160. Thus under the proposed legislation you would be left with a tax due of $12,440.

2008/2009 Tax Law Changes

The foreign earned income exclusion for 2008 is $87,600 and for 2009 will be $91,400. If you are married and both spouses work each is entitled to a separate exclusion. Exclusions cannot be combined. If one spouse earns $120,000 and the other $50,000, the maximum exclusion is $87,600 and $50,000.

The maximum foreign housing expenses that can be deducted is $90,000 for 2008 and 2009. The actual foreign housing costs are reduced by a base amount:

20082009

90,000 90,000

-14,016-14,624

75,984 75,376

Qualifying for the foreign earned income and housing exclusions: You need to meet one of two tests.

Bona fide resident of Bermuda for a full calendar year, January 1 to December 31, 2009. Once you meet the test, you qualify retroactive to the day your residency started.

Example: Arrival on July 3, 2008. Residency test met January 1, 2010. You qualify for the exclusion retroactive to July 3, 2008. 183/366 x $87,600 = $43,800 exclusion.

The second test is the physical presence test. This is used mostly by individuals who will not be in Bermuda for a full calendar year.

Example: You arrive in Bermuda on April 1, 2008 and will leave on September 30, 2009. Under this test you need to be physically present outside the United States for 330 full days out of 365 days.

So for 2008 you would look at April 1, 2008 to March 31, 2009. If you qualify you would receive 75 percent of the $87,600 exclusion or $65,700.

For 2009 you would look at October 1, 2008 to September 30, 2009. If you qualify you would receive 75 percent of the $91,400 exclusion or $68,550.

Who Must File a US Tax Return?

For 2008, a Single taxpayer with income of at least $8,950 and taxpayers Married Filing Joint with income of at least $17,900.

Myths

A long standing myth in Bermuda is that if you earn less than $80,000 you do not need to file a tax return. As noted above the threshold for filing is significantly lower.

And, the foreign earned income and housing exclusions are elective. They are elected by filing Form 2555 with your Form 1040. If you do not elect the exclusions within one year of the original due date of the return of qualifying for them, the IRS will assume that you have waived your election. And if you are examined you will not be able to claim the exclusions.

Bermuda Pension Plan

If you are vested in the Bermuda Pension Plan the employer contribution to the plan and the earnings in the plan are considered taxable income. When you eventually receive a pension, the income will be virtually tax free.

Deferred Compensation - Code Section 457A

The Troubled Asset Relief Programme (TARP) added the above code section that requires that non-qualified deferred compensation provided by plans of companies in tax haven jurisdictions (that includes Bermuda) be included in an employee's compensation in the year the compensation is earned.

This results in a loss of tax deferral and a loss of the opportunity to have deferred funds grow on a tax-deferred basis.

If compensation is not determinable in the year it is earned, in the year in which such compensation is determinable and included in income, it will be subject to an additional 20 percent tax plus interest retroactive to the year in which the compensation was earned.

And income previously deferred must be distributed and taxed by the end of 2017.

Do You Own A Bermuda Corporation?

You need to File Form 5471 to report your interest in a foreign corporation. The penalty for failure to file Form 5471 is $10,000 plus an additional $10,000 a month to a maximum of $50,000.

Have You Formed A Bermuda Trust?

You need to file Form 3520-A to report your involvement in the trust. The penalty for failure to File Form 3520-A is five percent of the trust assets plus $10,000 a month not to exceed 100 percent of the assets of the Trust.

Have You Received A Distribution From A Bermuda Trust?

You need to file Form 3520 to report your distribution from the Trust. The penalty for failure to File Form 3520 is 35 percent of the distribution plus $10,000 a month not to exceed 100 percent of the amount distributed Pursuant to the requirements relating to practice before the Internal Revenue Service, any tax advice in this communication is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties imposed under the United States Internal Revenue Code, or (ii) promoting, marketing or recommending to another person any tax related manner.

The tax advice given by this column is, by necessity, general in nature. You should, of course, check with your own US tax consultant as to how specific transactions affect you since tax advice varies with individual circumstances.

James Paul Sabo, CPA, is the President of ETS Ltd., PO Box HM 1574, Hamilton HM GX, Bermuda. Questions should be sent to: jsabo@expatriatetaxservices.com