A lot of people want to know exactly what we mean by the phrase “tax relief”. Depending on the taxpayer’s situation, tax relief can mean a variety of different things.
If you owe the IRS back taxes, and they are actively coming after you to collect the money, then you are in a collections situation. Therefore, tax relief for you probably means getting the IRS off your back. What I mean by this is that you need to stop the collections process, particularly to get the IRS to not come after your bank accounts and your wages.
If you’re already on an Installment Agreement, then tax relief for you might be obtaining a reduction in the penalties. This process, called a “penalty abatement”, requires you to meet certain criteria and demonstrate that, despite your best efforts, you were unable to pay your taxes on time because of reasonable cause. Reasonable cause itself has a variety of criteria, which I actually outline in an article on my firm’s web site about penalty abatement reasonable cause criteria.
Another scenario with a slightly different definition of “tax relief” could be if you have years and years of unfiled tax returns, and the IRS files returns for you based on the information they have on file. Since employers, brokerage firms, and other companies are required by law to send copies of your W-2′s, 1099′s, and other documents to the IRS, they have all that data regarding your wages and transactions. If you don’t file a return, they will file what is called a “Substitute For Return”, or SFR for short. This return is literally a worst case scenario — they give you no deductions, nothing but the standard deduction and usually only one exemption unless you have a prior history of filing married, and they assess you the highest possible tax under this scenario. The solution to this little nightmare is to file actual returns and replace the ones the IRS prepared for you.
In most cases where I have filed real returns to replace Substitute For Returns filed by the IRS, the tax liability, as well as the penalties and interest, end up getting slashed by 50% to 70%. Therefore, it’s worth spending the money to have real returns prepared on your behalf if this happens to be your situation.
For other folks, “tax relief” may be having your property tax valuation more accurately reflect the value of your home. This has become a common scenario as market prices have dropped, but property tax valuations have not. Most counties have a process by which you can contest the property valuation — most people these days either don’t realize that or simply fail to do it. Having your assessed value of your home accurately reflect it’s value can save you thousands of dollars in property taxes over the years, and if this is the type of tax relief you are looking for, then I would highly encourage you to look into it.
It seems as though this is an issue that I need to address at least every few months. The IRS or the FTC will crack down on a company advertising this, and the airwaves will be silent for a few months, and then the radio ads will start again with a new company doing the same thing.
The phrase “pennies on the dollar” was actually determined several years ago by the IRS to be a form of deceptive advertising, and they explicitly instruct licensed practitioners that the the use of this phrase is a violation of Circular 230, which is the practitioner behavior handbook for working with the IRS. However, since the IRS doesn’t have jurisdiction over firms that just market these services, it comes into the FTC’s purview to look out for these deceptive marketing practices.
What exactly does “pennies on the dollar” refer to? It is a reference to the IRS Offer in Compromise program, which allows eligible tax debtors to pay the IRS an amount of money that is less than what they owe in order to wipe out their entire tax liability.
In advertising, you’ll hear companies talk about settling for 20%, 10%, or even less. These ads, and the sales people you talk to on the phone, are trying to sell you an Offer in Compromise service package. Many of their web sites even have little interactive calculators where you type in how much you owe the IRS, and it’ll spit out a, “You may only have to pay $xxx” message.
These ads, web sites, and slick salesmen are trying to convince you that what you settle for is some fixed percentage of your tax debt. However, this simply isn’t true! These ads and sales people are LYING TO YOU!
I’ll repeat that, in case in didn’t sink: These people are LYING to you!
The amount of your Offer in Compromise settlement is calculated using a very, very strict formula…And the formula is NOT secret — it’s available on a worksheet in IRS publication 656B. Or, head over to the Wikipedia article on the Offer in Compromise that discusses the “Doubt As To Collectibility” calculation — I wrote that section.
Here’s the bottom line on the pennies on the dollar sales and advertising con: If you have equity in assets that exceeds your tax debt, you simply don’t qualify. Period. End of story. No matter what a sales guy on the says. For most individuals, the common thing is going to be equity in your house or rental properties, or perhaps equity in a collection of classic cars, stamps, coins, guns, art, etc. If the value of ANY of that stuff is greater than your tax debt, you do not qualify for the Offer program. A sales guy telling you otherwise is either a liar, an idiot, or both.
In the same vein, if you are a high income earner, it’s also highly unlikely you will qualify for the Offer program in general. The reason for this is that the IRS only allows certain amounts of money every month as “eligible expenses” for housing, cars, food, etc. If your lifestyle exceeds these amounts, the IRS doesn’t care — they will only allow you to claim the National Standard expenses. Any monthly income over those amounts gets multiplied by either 48 or 60, and THAT number goes into your offer amount.
I hope this helps prevent somebody from getting screwed. If you want a second opinion from a licensed enrolled agent, rather than a sales guy with almost zero tax training, then request a free Case Review today.
Having had previous careers in the mortgage and real estate brokerage industries, it never ceased to amaze me how many people truly believe that paying mortgage interest is a wonderful thing, because they can deduct it on Schedule A of their tax return. I’d often get into conversations with both homeowners and other real estate professionals about this, and very few of them would ever understand that paying mortgage interest, in reality, sucks.
This issue most often comes up when discussing with people the idea of rapidly accelerating the payoff of their mortgage, versus putting that money investments. Mathematically, paying off your house as fast as you possibly can is one of the single best investments most individuals could ever make.
For the sake of discussion, let’s look at a mortgage of $100,000 at 4.5% fixed rate for 30 years. Over the course of this loan, if you make just your regular monthly payments, you will pay $82,408 in interest, on top of the $100k in principal. Yes, that $82,408 in interest is tax deductible, which means that, if you are in the 25% tax bracket, you will save 25 cents in tax for every dollar you had to spend on interest. So, over the course of 30 years, you’d save $20,602 in taxes.
BUT…you have to spend the $82,408 in order to save the $20,602! To save 25 cents in tax, you had to spend a dollar, which means you’re actually 75 cents POORER. If you instead took that 75 cents and invested it wisely, it’d be worth $5 or more over the course of the three decades we’re talking about it.
I really hope this makes sense: Spending a dollar to save 25 cents makes you poorer, not richer.
There is another way to look at this: In order to pay that $82k in interest, you had to actually earn that money. If you can pay off the mortgage sooner, it’s going to cost less in interest, meaning you don’t have to make as much money over the course of the 30 years, which means you either retire earlier or retire richer.
If you add just $200 per month to this mortgage payment, you’d pay the house off in 17 years, and save $41,000 in interest. If you doubled up the mortgage payment every month, you’d own the home free and clear in just over a decade.
This is also the exact same logic for buying a modest home that meets your needs, rather than a larger house than you really need that is a stretch for you to afford. Buying a modest home that you can pay off quicker allows you to retire much, much younger, or have a significantly larger retirement nest egg if you keep working.
Bottom line is this: Yes the interest is deductible, but you still have to spend the money to get the deduction. If you don’t have to spend it, then you can invest or not even bother having to work to earn it.
One of the mistakes that people often make is to think of their home as an asset to put on their balance sheet. The problem with thinking like this is that without that asset, you have no place to live. Therefore, I always advise clients and associates that are investment-minded not to think of their home as an investment.
However, if you’re a homeowner, you can look at your home in another way: As a tax shelter. 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.
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). Given the many regulations and nuances of the tax laws, many people opt to hire a licensed tax practitioner, such as an enrolled agent.
So there you go…The roof over your head can be a substantial tax shelter, regardless of how much equity you do or don’t have. If you would like to learn more about your home as a tax deduction, or if you are a real estate investor looking to incorporate tax planning into your acquisition and disposition planning, please get in touch with me.
The vast majority of small businesses could use the services of an accountant. The number of ways in which it is possible to introduce errors into your business through accounting practices is staggering. Your accounting includes issues related to payroll, monitoring profitability, inventory control, avoiding penalties and interest on taxes, and much, much more. It is wise to select a competent professional in this field to help you navigate the minefield of accounting pitfalls. Selecting such a professional can be difficult, especially since not all accountants are created equal. Here are some questions to ask to help ensure that you are selecting the best accountant you can for your business.
Continue reading 10 Questions to Ask When Choosing an Accountant.