Basis determines:

• Whether losses are deductible
• Whether distributions are taxable
• Whether you recognize gain when selling your interest

And the rules are dramatically different between S Corporations and Partnerships.

What Is Investor Basis?

An investor’s basis generally:

• Starts with contributions
• Increases with income
• Decreases with losses and distributions

Simple in theory — until you see how differently it works across entity types.

S Corporation Basis: Narrow and Dangerous

An S Corporation shareholder’s basis is extremely limited.

What Increases S Corp Basis?

• Capital contributions
• Taxable income allocated to the shareholder
• Tax-exempt income
• Direct loans from the shareholder to the S Corp

What does not increase basis?

• Bank loans
• Mortgages
• Any third-party debt

This is where people get burned.

Example

Sarah invests $50,000 into an S Corp.
The company allocates her an $80,000 loss.

• She can only deduct $50,000 — the rest is suspended.
• Her stock basis drops to $0.

Next year the company distributes $20,000 cash.

Because Sarah has no basis, the entire $20,000 is taxed as a capital gain — even though economically she is still underwater.

Partnership Basis: Flexible and Powerful

Partnerships work very differently — and much more favorably.

What Increases Partnership Basis?

• Capital contributions
• Taxable income
• Tax-exempt income
• The partner’s share of partnership liabilities — for real estate partnerships this includes mortgages

This means partnership investors often have far more basis than cash invested.

Example

David invests $100,000 into a real estate LLC owning 50%.

The partnership buys a building for $1,000,000 using:

• $200,000 equity
• $800,000 mortgage

David’s basis becomes:

• $100,000 cash
  • $400,000 share of mortgage
• = $500,000 total basis

Year 1: David is allocated $120,000 loss
→ Fully deductible.

Year 2: Another $20,000 loss and a $50,000 cash distribution
→ The loss is deductible and the distribution is tax-free because he still has basis.

Why This Matters So Much

S Corporations routinely create these traps:

• Losses get suspended when investors need them most
• Distributions become taxable even though no profit was made
• Highly leveraged businesses get punished

Partnerships, on the other hand:

• Allow loss deductions funded by debt
• Permit tax-free distributions funded by refinancing
• Align tax results with economic reality

The Bottom Line

The wrong entity structure doesn’t just cost you money — it changes the timing and character of your income.

By the time most business owners discover basis limitations, the damage is already done.

Choosing between an S Corp and a Partnership is not a formality — it is a long-term tax strategy decision that should be made with full awareness of how investor basis truly works.

Disclaimer:
This article is for educational purposes only and does not constitute tax or legal advice. Please consult your tax advisor before restructuring or making investment decisions.

The post Investor Basis: Why Choosing Between an S Corporation and a Partnership Can Cost You Thousands appeared first on Cole & Waxman Tax Services.

Each year, more Americans and green-card holders decide to formally end their U.S. tax relationship. The reasons are deeply personal, but the tax consequences are anything but simple.

If you are considering expatriation, this article walks you through what the IRS actually means by “expatriate,” what events trigger expatriation, and how to avoid becoming a “covered expatriate” subject to the U.S. exit tax regime.

Why People Expatriate

Most clients come to this decision after years of frustration, not on a whim. Common motivations include:

Practical pressures

• Crushing U.S. tax compliance burden while living abroad
• Endless foreign bank account reporting (FBAR, FATCA)
• Closed accounts and de-risking by foreign banks

Emotional reasons

• Desire for simplicity and lower stress
• Wanting citizenship to match identity and reality
• Feeling disconnected from the U.S. tax system

Who Is an “Expatriate” in IRS Language?

Under the tax code, an expatriate is:

• A U.S. citizen who formally relinquishes citizenship, or
• A long-term U.S. resident (green-card holder) who stops being a lawful permanent resident.

A green-card holder becomes a “long-term resident” (LTR) if they held a green card in 8 of the last 15 tax years. Partial years count.

Treaty election years during this 15-year span can interrupt the count, delaying LTR status. This detail often changes the entire planning strategy.

What Actually Triggers Expatriation?

The IRS does not treat letting a green card expire as expatriation.

The most common expatriation events are:

• Renouncing U.S. citizenship before a U.S. consular officer (Form DS-4079 + $2,350 fee)
• Filing Form I-407 to abandon green-card status
• Making a treaty election (green-card holders only, after LTR status is achieved)

Covered vs. Non-Covered Expatriates

Not all expatriates are treated equally.

When departing the U.S. tax system as a covered expatriate, the IRS enforces IRC §877A to impose an exit tax on all appreciated assets you are transferring out of the country, similar to a capital gains tax. Additionally, IRC §2801 aims to prevent expatriates from avoiding estate taxes by transferring their wealth abroad and then bequeathing it back to U.S. heirs. This provision imposes an estate tax on inheritances received by U.S. beneficiaries from covered expatriates.

The Three Tests That Decide Your Fate

You are a covered expatriate if you fail any of these three tests:

1. Net Worth Test
   Net worth of $2 million or more on the expatriation date.
2. Tax Liability Test
   Average U.S. income tax liability for the prior 5 years is $206,000 or more (2025 figure).
3. Certification Test
   You cannot certify that you complied with all U.S. tax obligations for the last 5 years.

If you “pass” all three, you are a non-covered expatriate — the gold standard result.

Two Important Exceptions

Even if you fail the net-worth or tax-liability tests, you may still escape covered status if:

• You were a dual citizen at birth and expatriate from your other country of citizenship, or
• You were under age 18½ on the expatriation date.

What the IRS Requires When You Expatriate

• Form 8854 – Initial and Annual Expatriation Statement
• Often a dual-status tax return
• Exit tax calculation (covered expatriates only – IRC §877A)
• Compliance with IRC §2801 for gifts/inheritances to U.S. heirs (covered expatriates only, future Form 708)

Form 8854 – More consequential than it looks

Omitting Form 8854 can permanently convert a non-covered expatriate into a covered expatriate.

You must disclose:

• Your personal details and the date you gave up U.S. citizenship or long-term residency
• Confirmation that you complied with U.S. tax rules for the prior five years
• Your average U.S. income tax liability for those five years
• Your total net worth at the time you expatriated

The Bottom Line

Expatriation is not a form. It is a multi-year tax strategy.

The difference between doing this correctly and making a single error can easily exceed seven figures in lifetime tax exposure, especially for clients with Israeli pensions, trusts, or U.S. real estate.

If you are even thinking about expatriating, the correct time to plan is before you trigger the event — not after the damage is done.

At Cole & Waxman Tax Services, expatriation planning is a nuanced area of our practice, where thoughtful planning can make a meaningful difference for clients.

Disclaimer

This article is provided for general educational and informational purposes only and is not intended as tax, legal, or accounting advice. The information herein is not a substitute for professional advice tailored to your individual circumstances. Expatriation and exit-tax planning involve complex legal and tax issues that depend on specific facts and current law.

Before taking any action related to U.S. citizenship, green-card status, or expatriation planning, you should consult with a qualified tax and legal professional who is familiar with your situation.

The post Expatriating from the United States: What You Must Know Before You Cut Ties appeared first on Cole & Waxman Tax Services.

Every week, I have "the PFIC talk" with several clients. The conversation always hits on the "why" question. Why does the US government want to punish me for saving money and opening a kupat gemel?

At one level, the question is irrelevant. We're tax accountants, darn it, not philosophers. But nonetheless, we as humans naturally look for order and logic amidst the chaos. The demands of US tax compliance for dual US-Israeli citizens are indeed onerous (in my opinion) and difficult to cope with.

In the best case scenario, this dual citizen must avoid many common investment and savings vehicles that their non-US citizen friends and neighbors are able to freely invest in. In the worst case scenario, they're saddled with additional taxes and compliance fees. Many of these products are marketed for their preferential tax treatment in Israel, but the impact of US compliance will often turn this tax-deferred dream into a tax and compliance nightmare.

If you're looking for the TLDR, there is no satisfying answer. There's just a series of events that led to some congressmen passing legislation that is making your life in Israel (and other countries) difficult.

Note - if you want to skip the history and jump straight to practical solutions, then jump to this article: https://colewaxman.com/pfics-a-practical-guide-to-the-perplexed/

The Origin Story: From PDICs to PFICs

Before we talk about PFICs (passive foreign investment companies), let's talk about PDICs (passive domestic investment companies). I'll confess that "PDIC" is not a term that anyone uses—I just made it up. But I want to use this term to help understand the background that led some congressional subcommittee lawyers to invent the term "PFIC." Prior to 1986, "PFIC" also was not a term that anyone used.

How "PDICs" Work

Typically, the government shares in the profits of investments on a "pay as you go" basis. That is, as you earn investment income, you include this income on your annual income tax return and thereby pay your "fair share" of the profits to your benefactor known as the US government.

This is the purpose of a 1099 or K-1 form that you receive from your bank, brokerage firm, or S-corporation partnership. These forms report your investment income in the form of interest, dividends, capital gains, rents, distributions, etc. The IRS also gathers this information and will review your tax filing to confirm compliance. If you neglect to include part or all of this income, then no worries—the IRS has your back and they'll remind you by sending a CP2000 underreporting notice and also add some penalties for good measure.

But all of the above only applies to "PDICs"—financial entities that fall under the legislative and regulatory authority of the United States.

1968-1981: The Golden Era of Offshore Investing

On January 12, 1981, IRS attorney Richard A. Gordon published "Tax Havens and Their Use by United States Taxpayers - An Overview." The report was a response to the rapid growth of offshore financial activity, with U.S. direct investment in foreign corporations nearly tripling from 1968 to 1978 (from approximately $70 billion to $200 billion) and earnings increasing fourfold.

Wealthy investors were able to save on their annual tax assessments by moving their funds offshore to foreign entities that were all too eager to accommodate the wishes of their American patrons. These savings included a mix of legal and not-at-all-legal tactics.

Legal tactics might include tax deferral. Foreign entities could (and would) defer the declaration of annual investment income by using their local bookkeeping regulations. This would effectively create something similar to a traditional IRA or 401(k) that deferred taxation indefinitely until the time of withdrawal. The added value for our wealthy tax schemers was that these vehicles would not be limited by annoying regulations such as:

• Limits on deposit amounts
• Gross annual income restrictions
• Required minimum distributions
• Age-based withdrawal rules

For those looking for even higher tax savings, wealthy investors would exploit foreign entities that would simply help their clients hide their assets and income. This is otherwise known as tax evasion and is quite illegal. Al Capone couldn't beat that rap—maybe he should have parked his extra cash in the Cayman Islands too?

The Writing on the Wall

By the early 1980s, the party was clearly coming to an end. High-profile cases were making headlines:

• Leona Helmsley became the poster child for wealthy tax avoidance with her infamous quote: "We don't pay taxes; only the little people pay taxes." Her conviction in 1989 for evading over $1 million in taxes through fraudulent schemes captured public attention.
• Corporate inversions began with McDermott International's 1983 move to Panama, saving the company about $200 million in taxes by restructuring to avoid U.S. corporate taxes on foreign profits.
• Tax haven activity exploded, with about half of all international banking assets flowing through offshore centers.

The IRS's 1981 Gordon Report laid bare the scope of the problem, documenting how wealthy Americans were systematically using foreign entities to defer or evade taxes on massive scales.

1986: The Tax Reform Act Strikes Back

In the mid-1980s, the public was concerned with rising budget deficits. In 1986, the federal budget deficit clocked in at $221 billion. In today's terms, while we are approaching a $2 trillion deficit, that seems quite tame. But at the time, it was quite alarming.

Enter the Tax Reform Act of 1986 (H.R. 3838), sponsored by Democrats Richard Gephardt in the House and Bill Bradley in the Senate, and signed by Republican President Ronald Reagan. This bipartisan legislation included the creation of PFIC rules as part of a broader effort to close tax loopholes and make the wealthy pay their "fair share."

The PFIC provisions were designed to put U.S. investors in foreign passive investment vehicles on equal footing with those who invested in similar U.S. vehicles. If you wanted the benefits of U.S. citizenship and legal protections, Congress reasoned, you should pay U.S. taxes on your investment income—even if that income was generated overseas.

The Unintended Consequences

Here's where the story gets frustrating for modern expatriates and dual citizens. The PFIC rules were crafted primarily to target wealthy Americans hiding money in Caribbean tax havens and sophisticated offshore investment schemes. But the broad language of the law swept up ordinary retirement savings, insurance policies, and investment funds that are perfectly normal and legitimate in countries around the world.

Your innocent kupat gemel in Israel? It likely meets the technical definition of a PFIC because:

• It's a foreign corporation (from the U.S. perspective)
• More than 75% of its income comes from "passive" sources like dividends and capital gains
• Or more than 50% of its assets produce passive income

The result? What should be a simple retirement account becomes subject to:

• Punitive tax rates on distributions
• Interest charges calculated back to your original investment date
• Complex annual reporting requirements on Form 8621
• Professional compliance costs that can easily exceed your annual returns

The Bottom Line

The PFIC rules represent a classic case of legislation designed to catch sophisticated tax avoiders that ended up ensnaring ordinary people living normal lives abroad. While the original intent—preventing wealthy Americans from hiding money offshore—was arguably reasonable, the execution created a compliance nightmare for dual citizens and expatriates who simply want to participate in their local country's normal savings and investment vehicles.

Understanding this history doesn't make the rules any less burdensome, but it does help explain why Congress thought it was a good idea to create these rules in the first place. The wealthy tax schemers of the 1970s and early 1980s essentially ruined it for everyone else.

So the next time you're wondering why your perfectly reasonable Israeli investment account is causing tax headaches, remember: you can thank the tax avoiders of the 1980s and the congressional response that followed. Sometimes, being in the wrong place (tax-wise) at the wrong time means dealing with rules that weren't really designed for people like you.

Practical Solutions

These complications apply to kupat gemel and many other popular investment vehicles that your typical Israeli bank or investment advisor might recommend because he is not aware of US tax traps. If you've gotten this far, then you're probably wondering how you can avoid these complications or mitigate them if you're already invested in PFIC's. Stay tuned for our next installment in the PFIC series for some practical suggestions.

This article is for informational purposes only and should not be considered specific tax advice. PFIC rules are complex and fact-specific. Always consult qualified tax professionals for guidance on your particular situation.

The post US Tax Traps and Israeli Investments (PFIC’s) appeared first on Cole & Waxman Tax Services.

By I. David Waxman, EA

When a US citizen residing in Israel passes away with assets held in the United States, their beneficiaries may face an unexpected administrative hurdle: obtaining an IRS Transfer Certificate (Form 5173). This seemingly obscure document can become a critical requirement for accessing inherited assets, potentially causing delays and additional costs during an already difficult time.

The Scenario: Cross-Border Estate Administration

Consider this common situation: An Israeli resident who maintains US citizenship dies in Israel, leaving behind various American assets. These assets might include:

Investment and Retirement Accounts:

• Taxable brokerage accounts
• Traditional or Roth IRAs
• 401(k) accounts

Other US Assets:

• Real estate properties
• Bank accounts
• Life insurance policies (if payable to the estate of a US citizen).

While the decedent's estate may seem straightforward to settle, US financial institutions sometimes require proof that all federal tax obligations have been satisfied before releasing assets to beneficiaries.

Understanding the Estate Tax Exemption Threshold

The good news for most families is that the vast majority of estates won't owe federal estate taxes due to generous exemption thresholds:

• 2025: $13.99 million per individual
• 2026: Expected to increase to $15 million under the One Big Beautiful Act (OBBA)

Portability Provisions: Married couples can effectively double their exemption through the Deceased Spousal Unused Exclusion (DSUE), allowing the surviving spouse to use any unused portion of the deceased spouse's exemption.

US Citizens vs. Non-US Citizens: A Critical Distinction

The requirements and processes differ significantly based on citizenship status:

US Citizens: Regardless of residence, US citizens are subject to the same estate tax rules as domestic residents. They benefit from the full exemption threshold and can utilize all available estate planning strategies.

Non-US Citizens: Face more restrictive rules, including a much lower exemption threshold (currently $60,000 for 2025) and limited access to certain tax benefits, making estate planning more complex.

The Transfer Certificate Challenge

Here's where many families encounter unexpected complications. Even when an estate is well below the taxable threshold, US financial institutions may still require Form 5173 (Transfer Certificate) before releasing assets. This certificate serves as the IRS's confirmation that:

• All required estate tax returns have been filed
• Any estate taxes owed have been paid or adequately secured
• The transfer of assets to beneficiaries can proceed without IRS objection

The Reality Check: Banks and brokerage firms often require this certificate as a protective measure, even for estates that clearly fall below taxable thresholds. Without it, assets may remain frozen indefinitely.

The Process: What to Expect

Obtaining a Transfer Certificate typically involves several steps and can be surprisingly complex:

Professional Engagement: Most families need to engage a qualified attorney or tax professional experienced in cross-border estate administration. This specialized expertise comes at a cost, often ranging from several thousand to tens of thousands of dollars, depending on the estate's complexity.

Documentation Requirements: The process typically requires extensive documentation, including:

• Complete asset inventory and valuations
• Death certificates (often requiring apostille for international recognition)
• Probate or succession documents from Israeli courts
• Tax identification numbers and filing histories
• Beneficiary identification and documentation

Timeline Considerations: The process can take several months to over a year, particularly when dealing with international elements and coordination between Israeli and US authorities.

Form Filing: Even estates below the taxable threshold may need to obtain the transfer certificate in order to allow the brokerage or bank account to release the funds. Sometimes this requires form 706 (United States Estate Tax Return) to obtain the Transfer Certificate For estates below the threshold, filing a notarized affidavit could be sufficient. In either case, , this adds another layer of complexity and cost.

Nonresidents that are not US citizens have the lower threshold of $60,000. US assets in excess of this lower threshold would trigger the requirement to file form 706A rather than 706. This is a common scenario for Israeli investors in US real estate.

Planning Ahead: Preventive Measures

While the Transfer Certificate process cannot always be avoided entirely, proper estate planning can minimize complications:

Consider Asset Relocation: One of the most effective strategies is to liquidate US-based assets during your lifetime and transfer the proceeds to Israel or your current country of residence. This eliminates the need for Transfer Certificates entirely and simplifies the estate administration process for your beneficiaries. While this approach requires careful tax planning to manage potential capital gains implications, it can save significant time, complexity, and professional fees later.

Documentation: Maintain organized records of all US assets, including account numbers, beneficiary designations, and contact information for financial institutions.

Professional Relationships: Establish relationships with qualified cross-border tax professionals before they're needed.

Life Insurance for Non-Citizens: For non-US citizens who own US real estate and face the lower $60,000 exemption threshold, consider purchasing term life insurance to provide liquidity for potential estate taxes. This strategy can help beneficiaries pay inheritance taxes without being forced to sell property in a potentially unfavorable market.

Beneficiary Designations: Properly structured beneficiary designations on retirement accounts and life insurance can sometimes bypass probate requirements, though Transfer Certificates may still be required.

Communication: Ensure family members understand the potential requirements and have access to necessary documentation.

The Bottom Line

For US citizens living in Israel, the IRS Transfer Certificate represents an often-overlooked aspect of estate planning that can create significant administrative burdens for grieving families. While most estates won't owe federal taxes due to generous exemption thresholds, the certificate requirement persists as a procedural necessity.

The key to minimizing complications lies in advance planning and professional guidance. By understanding these requirements and preparing accordingly, families can ensure a smoother transition of assets during an already challenging time.

Important Note: This article provides general information and should not be considered specific legal or tax advice. Cross-border estate planning involves complex regulations that change frequently. Always consult with qualified professionals experienced in both US and Israeli tax and estate law for guidance specific to your situation. For personal guidance, schedule a consultation with your tax expert at Cole & Waxman Tax Services.

The post From Dust to Dust: When Estate Planning Meets Earthly Bureaucracy appeared first on Cole & Waxman Tax Services.

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How to calculate?

When is tax due?

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Don’t forget your silent partner, otherwise known as the federal government. In this brief blog post, we’ll leave aside Uncle Sam’s little brother – state tax. If you permanently live outside of the U.S. (as is the case of most of our clients), then you may not have to file state taxes.

Here’s what Uncle Sam (via our friends at the IRS) expect from you – diligently keep track of your income and expenses. That’s pretty much it. You might need an accountant to determine exactly what a business expense is and how to do tricky stuff like depreciation. The accountant might also give you helpful tips about tracking business mileage on your truck etc. Don’t accidentally forget to include some of your income that got paid in cash and immediately was spent as if it never happened. The sleuths at the IRS have their ways of finding hidden income. You will also likely need to make quarterly estimated payments.

Now we’ll talk about self employment tax. This is an issue that salaried employees need not be concerned with. Your employer will conveniently deduct your social security and medicaid taxes directly from your pay slip without any effort on your part. Self employed individuals also play the role of employer, so they have some extra work to do. This is done on the schedule C, which is attached to your annual form 1040 tax filing. The long form is a bit involved and is liable to cause severe headaches and/or accounting fees. If you have a simple cash business, then the EZ schedule might very well suffice. Schedule C will generate “self-employment tax” (or SE tax for short), which consists of social security and medicaid. These taxes are separate and in addition to your income tax assessment.

For many self-employed Americans living abroad, you may avoid SE tax by invoking a totalization agreement. The idea of a totalization agreement is simple enough. That is, it is sufficient to pay into the national insurance of one country and thereby avoid double taxation just as you expect to avoid double taxation on income tax. Unfortunately for Americans living in Israel, Israel and the United States have failed to execute this agreement. Therefore, you will indeed pay both social security/medicaid and Israeli national insurance if you are American and self employed in Israel.

Here are the nitty-gritty numbers. They are taken from the 2016 schedule SE.

• SE tax is 15.3% of 92.35%, or 14.13% of your SE profit (income less expenses).
• SE tax has two components:
  • 12.4% for social security
  •   2.9% for medicaid
• 12.4% Social security tax is applied to a maximum of $118,500 grossed up at 92.35% to $128,316. This means that the social security tax is capped at $14,694, or 12.4% of $118,500. There is no social security tax on SE income in excess of $128,316.
• 2.9% medicaid has no maximum.

Example 1 (standard)

Your SE business turns a profit of $50,000.  Your SE tax is (12.4% + 2.9% = 15.3% of 92.35% of $50,000 = $7,065.

Example 2 (high income)

Your SE business turns a profit of $500,000.  You have exceeded the maximum base for social security, so we’ll need to calculate social security and medicaid taxes separately.

• Social security tax is the maximum amount of $14,694.
• Medicaid tax is 2.9% of 92.35% of $500,000 = $13,391
• SE tax total is $28,085=$14,694+$13,391

For information about the personal benefits of social security, see our blog “Social Security for XPAT’s“.

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