December 2007

If you’re a homeowner, Uncle Sam has thrown you a tax shelter that’s beyond compare. You may deduct the mortgage interest paid on your annual tax return and deduct the property taxes on your Schedule A. If you don’t currently own a home, this tax benefit is significant enough to make you look seriously at home ownership.

“Points”
The concept is simple, but it starts to get a little more complicated when you add in “points.” Points are one type of fee paid at closing to your lender. If you pay points when you buy your new home, these may be deducted in full in the year of purchase. However, if you refinance your loan, the points must then be deducted over the life of the new loan. In the event you are deducting points annually and then decide to refinance again, you will be able to deduct the balance of the points when you pay off the old mortgage. Of course, all these deductions are based on being able to itemize your deductions on Schedule A.

There are some limitations.

• Points must not be more than amounts generally charged in your area.
• Funds provided at closing must be at least equal to the points.
• Loan must be used to buy or build taxpayer’s main home.
• Points are stated as a percentage of the principal amount of loan.
• Points are clearly stated on the settlement statement as charged for the mortgage.

Predictably, there are limits on mortgage interest deduction. Only the interest on the first $1 million of home acquisition debt is deductible. (Acquisition debt is defined as debt to purchase, build or substantially improve the residence.) Home equity debt limits are the lesser of the fair market value of the home reduced by the acquisition debt or $100,000 ($50,000 if married filing separately).

Probably the greatest advantage of home ownership occurs when you decide to sell your home. If you have owned and lived in your personal residence for two out of five years, you can sell the home and not be taxed on a profit up to $250,000 for singles and $500,000 for couples. The way home values have increased in recent years, this can be a tremendous investment opportunity. This rule seems very straight forward and simple, but beware! There are a number of exceptions.

Job related move – if you have to move out of your area (a 50-mile radius), and are unable to meet the two year time period, you can prorate the time based on a formula utilizing a ratio consisting of the number of days that you owned and lived in the home to the total number of days in the relevant 24-month period (approximately 730), multiplied by the exclusion amount.

Health problems requiring a sale – if health problems force you to move from your principal residence, you can prorate the time and exclusion based on the formula above.

Ideally, a couple that kept good records of time of ownership could buy and live in a home for two years, sell for a profit and then repeat this process. Still, there are a number of pitfalls that cause tax problems, such as the special rules surrounding home offices and move out/rent/return situations that effect the two in five requirement (this involves adjusting for depreciation recapture).

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Face it, you’ve been putting it off all year. Maybe you have to turn sideways to get in the storage room or have given up on parking your car in the garage. Well, it’s the end of the year and now you have a big incentive to clean out all that stuff! You could get a tax deduction for it.

If you itemize your deductions (use Schedule A), Uncle Sam will give you a bonus – a deduction on your tax return for donating all that stuff to a charity. This could result in a larger refund for you, but there are a few simple rules you must follow to benefit from this tax break.

First, the charity must be recognized as an exempt charitable entity. Qualifying are churches, schools, Red Cross, Amvets, Scouts, Salvation Army, Disabled American Vets, public libraries, etc. If in doubt, ask the organization or check the IRS website at IRS.gov.

Second, make sure you get a receipt from the charity for the donation. You’ll need it as proof of your donation. If your total non-cash donations are less than $500, you can list the amount on Schedule A. If more than $500, you are required to attach Form 8283 with the following information:

Make a list of the items you are donating to attach to your receipt. (Keep this receipt with your records – do not send in). Form 8283 asks for date of purchase (can be various) and the date of the gift, the name of the charity and a list of the items donated. Additionally, you must indicate how you determined fair market value. Cost is what you paid and value is what you could have sold it for at a thrift shop or garage sale.

Think of all those kitchen appliances no longer used; old toys the kids have outgrown; clothes that don’t fit or are out of date; books, tools, games, furniture and anything else you no longer want. It is fairly easy to rack up $1000 in fair market value resulting in an additional refund of $250 if you are in the 25% tax bracket. A new wrinkle beginning for tax year 2006 deductions is that clothing must be in above average condition – no more old socks, underwear and soiled clothes you used for painting! So, get busy – get rid of the extra stuff, simplify your life and enjoy that larger refund!

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A good education is the best thing you can give yourself and your children. Uncle Sam recognizes the value of education and has given us credits and deductions to help.

Hope Scholarship Credit – this credit is allowed for tuition and related expenses for the first two years of post secondary education. Students must be attending classes at least half time pursuing a degree or recognized credential at an eligible educational institution. The credit may be claimed for more than one family member. A maximum credit of $1650 is allowed for tax year 2006.

Lifetime Learning Credit – this credit is allowed for up to 20 percent of the amount of the qualified tuition and related expenses, not to exceed $10,000. The maximum credit is $2000 and is allowed for undergraduate and graduate level courses as well as any course of instruction at an eligible institution to acquire or improve job skills. There is no requirement to be a half-time student, but the credit is calculated on a per family basis rather than per student.

Credits may be taken for the taxpayer, spouse, or a dependent. Dependents are not allowed to take the credit. The credits are not available for married filing separate returns or for nonresident aliens. Both credits have an income phase-out which is $45,000 to $55,000 for single and $90,000 to $110,000 for married joint returns.

Eligible expenses for both credits are tuition and fees, including tuition paid by loans in the year the tuition is paid, not when the loan is repaid. There is a prepayment rule that allows a credit for expenses paid in one tax year for an academic period that begins in the first 3 months of the following year.

For a deeper understanding of education tax credits, you may wish to contact a licensed tax practitioner, such as an enrolled agent.

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Nothing strikes terror in the heart of the American taxpayer quite like finding a letter in the mailbox from the IRS! In an effort to help you avoid that unpleasant scenario, provided below are examples of some common pitfalls to avoid if you don’t want the IRS lining up to be your new pen pal.

It’s surprising how many people mail their returns to the IRS without a signature. Before mailing, be sure to recheck everything and don’t forget to sign your return. An even better solution is to file electronically. Returns filed electronically have safeguards and controls to eliminate common errors. Additionally, the return goes directly to the processing center and the information does not have to be keyed into a computer by an IRS employee, which could result in additional errors.

Did you remember to include all income on the return? If you received a Form 1099 from anyone, be sure this income is on the return in the right place or you will receive a notice. Even if you did not receive a 1099 for work done independently, you are required to report the income. IRS receives copies of 1099s from banks, stock brokerage firms, rental agencies, and subcontractors and these are checked against income reported.

If you made estimated payments or paid your taxes quarterly, check the amounts and the dates the taxes were paid. Forgetting to include a payment is a frequent error that makes your tax burden look heavier. Many people forget to include the January payment, so keep in mind that the first payment of the year is sent in April, followed by June and September payments and concluding with the January payment for the fourth quarter of the preceding year.

If you file or pay late, you will receive a notice of delinquency and be charged interest and penalties, so try hard to avoid that. If you can’t pay taxes that are due by April 15, be sure to file the return on time with a note requesting an installment agreement to pay the remainder of taxes due.

Incorrect social security numbers will generate a notice or a disallowance of your dependents. Don’t mail the return without verifying that all social security numbers have been entered correctly. Transposing those numbers is more common than you’d think.

A few minutes of extra time reviewing your return will pay off in peace of mind and help you stay off the IRS radar screen.

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Has it been awhile since you filed a tax return? Feeling guilty? Scared? Don’t know what to do? Do you even need to file?

Many people become non-filers each year for a number of reasons. They lose the paperwork, they couldn’t pay, or they forgot about it. Sometimes illness, family crisis or depression plays a role. The list goes on and on.

If you are a non-filer, don’t procrastinate any longer. You may be hoping the IRS has forgotten about you, but that rarely happens. In truth, the more you wait, the more costly it will be if you owe money. And if you are due a refund, the statute of limitations on that refund expires three years from the date the return should have been filed. Don’t risk losing your money.

It’s not uncommon to feel overwhelmed when you haven’t filed for a while, but don’t despair. Lost paperwork can be reconstructed. If you owe, it’s better to file and negotiate an installment agreement because this will stop the late filing penalties although interest will continue until the tax bill is paid. Sometimes, penalties can be abated if the circumstances are serious, such as family crisis, illness or other catastrophic situations.

Contact a tax professional to help you get the monkey off your back. An Enrolled Agent (EA) is licensed by the Treasury Department to represent clients who have problems with tax filing and with the IRS. EAs must pass a rigorous exam to act on a client’s behalf and can help to get taxes filed, negotiate an installment agreement for those who can’t pay in full or, possibly, negotiate an offer in compromise to reduce taxes, penalties and interest. Don’t wait for the IRS to come looking for you; it’s far better to voluntarily come forward.

Every U.S. citizen and resident is required to pay his or her fair share of tax. No more, no less. The IRS has a matching program whereby all 1099s, W-2s, etc., are entered in their computers. They match this information with the tax returns that have been filed to insure that all income has been reported and that everyone who is legally required to do so has filed a return. So, if you haven’t filed for whatever reason, get moving before the IRS comes looking for you!

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You’ve just picked up your mail and … uh oh, there among the ads, bills and too numerous offerings for credit cards is that official looking letter from the Internal Revenue Service. A feeling of dread comes over you…but don’t panic or toss it, and please DO open it. It might even be good news.

Usually, mail from the IRS is a notification that they need verification of documents or substantiation of an amount you have claimed on your tax return. Read the letter thoroughly. Determine what they are looking for, and then provide the information. Some of the most commonly missed items on a return are simple things: You forgot to sign the 1040; You didn’t attach W-2’s and required statements; If you’re paying quarterly, maybe you claimed the wrong amount as estimated tax; Or, perhaps the income you listed doesn’t match the figure that was reported to the IRS on a Form 1099 by someone who paid you during the tax year.

If you have the correct information, it’s a simple matter to fix. Make copies of your documents verifying the information on your return and send the copies back to the IRS along with a copy of the letter they sent to you. If, in fact, you didn’t include an amount on your return that should have been there, sign the form agreeing to the change and send them a check for the amount of tax due by the deadline date given for compliance. Usually, penalties and interest will be added – so, the sooner you comply, the less it will cost.

If your IRS letter advises you that your return has been selected for audit, you would be wise to seek professional advice. If the tax professionals at Accounting & Tax Solutions, Inc. prepared your return, contact us immediately. If you prepared your own return, contact us. An Enrolled Agent (EA) or CPA can help with the audit. Enrolled Agents are authorized by the U.S. Treasury Department to represent taxpayers before all administrative levels of the IRS for audits, collections, and appeals.

Now you’re thinking, what about that possible good news mentioned earlier? An unexpected refund, of course. Now, open that letter!

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You’ve probably heard about the 529 College Savings Plan. But what is it exactly? The 529 College Savings Plan is one of the best savings incentives for college and something you don’t want to miss out on if you have children or grandchildren. This plan is named for Section 529 of the Internal Revenue Code, which was passed into law by Congress in 1997. This plan includes credits, deductions, and savings incentives for education.

The 529 incentive is designed to help families save for the cost associated with future qualified higher education. Contributions to this savings plan are not tax-deductible. However, provisions in the code allow for the earnings to grow tax-deferred until the funds are withdrawn to pay for higher education expenses. The plan allows flexibility in choosing the portfolio that best fits your needs, while simultaneously allowing you to control withdrawals from the account for as long as it is maintained.

As of January 1, 2002, withdrawals from plans used for qualified college expenses are free of federal tax. Family members or friends can make contributions to 529 plans as well as parents. There is a much higher contribution limit for the 529 plan than for other education savings plans. An added bonus is the less binding income restrictions. Most states offering the plan are partnered with mutual fund companies that actually manage the funds.

In addition to the 529 plan, there are other methods to help defray the high cost of college, such as Coverdell Education Savings accounts, education savings bonds, Hope Scholarship Credit, Lifetime Learning Credit, and the education loan interest deduction.

If college plans are in your future, be sure to check out all the different ways your Uncle Sam has established to help you with ever-increasing college expenses.

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You’ve decided to start a small business working out of your home. Life is great and you can’t beat the commute. Now, how will this affect your income taxes? Can you deduct expenses for use of your home? The answer is that it depends…on a lot of things.

First of all, the business must be for profit or an expectation of profit. Next, you must set aside an area that is used exclusively for this business. Perhaps you’ve set up a room with a desk, computer, file cabinets, and storage for your product. Use the room entirely and exclusively for business purposes and it will be deductible. Beware, however, that as soon as you add a sofa bed in the corner for your in-laws to use when they come to visit, the space is no longer exclusive and you lose the deduction.

What is eligible for a deduction? This is where the math comes in. You must determine the total square footage of your home and the total square footage of the office. Example: Total house is 2000 square feet and the office area is 200 square feet. This will give you a 10% office usage equation. You will then be allowed to deduct 10% of your costs for the upkeep and maintenance of your home which includes insurance, taxes, mortgage interest (or rent if you do not own), electricity, gas, and repairs for the entire house. Additionally, you can take specific fix-up and maintenance costs in full if they are solely for the business space.

Also available is a deduction for depreciation on the home. To determine this figure, use the cost of the house, less the value of the land, and depreciate this value over 39.5 years (commercial use value). When you sell the home, you must make an adjustment for the amount of the depreciation taken. This depreciation adjustment is recaptured on your tax return at the 25% tax rate.

Be sure you fully understand the home office deduction and subsequent depreciation recapture before using it. Rules for the home office deduction can be tricky; therefore it is wise to get professional tax help from an Enrolled Agent or other licensed tax practitioner.

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