Wednesday, February 25, 2009

New Homeowners Tax Credit – Revisited

This is an update to my blog of January 13th on the 2008 New Homeowners Tax Credit.

There have been changes made in the Economic Stimulus Plan concerning the new homeowner credit. Here are the highlights of the new law:

The credit is now available if you close on your home between January 1 and November 30, 2009.

You cannot have owned a home for three years prior to closing on your new home.

The credit amount is 10% of the purchase price of the home to a maximum of $8000. So if you buy a house for $50,000, you only get a credit of $5,000. Previously, the maximum was $7,500.

You do not have to pay the credit back if you buy a house in 2009. If you qualified for the $7,500 credit by purchasing a home in 2008, you still have to pay the credit back over 15 years.
You must pay the credit back if you sell the home within 3 years.

The tax credit is refundable. This means that if your total taxes are $3000, the IRS will send you a check for $5000 ($8,000 credit less the $3,000 you owe in taxes).

The credit may not exceed a total of $8000. If two individuals buy a house together, the $8,000 is divided between them rather than each getting a credit.

You cannot buy the house from a related party, like your parents or grandparents.

You can claim the credit on your 2008 tax return even if you bought the house in 2009.

You start losing the credit when your income exceeds $75,000 if you are single or $150,000 if you are married.

How do you claim the credit? File Form 5405 with your 2008 tax return. You can still claim the credit If you are buying a home after your filed your 2008 tax return. Just file an amended return to claim the credit.

Here is where some planning comes in handy. If you owe the IRS, file an extension. After you buy the home, file the return with the credit, and avoid having to write the IRS a check. Suppose you owe the IRS $2,000 and close on your house in May of 2009. File an extension (Form 4868) for your tax return. Then, after you have closed on the house, file the return with the $8,000 credit. You get a check for $6,000, the $8,000 credit less the $2,000 you owed in taxes. This is a great deal and you should take advantage of it. Call it your own personal bailout.

The law was recently signed. The details are still being worked on and the IRS has not issued any guidance. So keep an eye on the news and this blog as things develop.

Comments anyone?

Sunday, February 22, 2009

Throwing Away the Old Financial Records

"How long do I need to keep my financial records?" is a common question. Here are some pointers:

Financial records (such as bills) that do not effect your tax return can be destroyed as they are paid. Unless you are using your phone, electric, and gas bills as tax deductions, there is no compelling reason to keep them. The major exception to this would be records of home improvements, like the new kitchen or garage.

You should keep your tax records for a minimum of 4 years and a maximum of 8 years. This would be copies of your W-2s and 1099s, real estate tax bills, business expenses etc. Anything that effects your tax return should be maintained. Why the difference in holding period? If the IRS can prove that you have substantially understated your income or taxes, they can go back 7 years from the date of the filing of your return. So a return for 2001 can be audited up to sometime in 2009. The vast majority of taxpayers have a W-2, some investment income and a house. The odds of these taxpayers understating their income are remote. So, to be on the safe side, keep your records for 8 years.

You should keep your investment records permanently. However, this does not mean that you need to keep every scrap of paper that comes from your broker, mutual fund or bank. Most mutual funds send out a statement each quarter and then an annual one summarizing all the activity for the year. Once the annual statement arrives, get rid of the quarterly ones. The same goes for brokerage accounts. Nowadays, the mutual fund companies and brokerage firms maintain a record of your investment purchases. BUT these can get lost if you switch brokerage firms and some mutual fund companies don’t have the records if you opened the account a long time ago.

Some other notes:

With all the identity theft that is going on today, it is best to shred rather than throw out any records you decide to get rid of. Definitely do not put financial records that are not shredded in the recycle bin.

Keep electronic copies of your records. This is easy if you have brokerage accounts or mutual funds. You can download PDFs of your statements and store them on your computer. You can do the same thing with your charge card statements. You can also get PDFs of your tax returns, and can scan and store the basic records. Think of all the trees you can save by not getting paper copies of everything.

To guard against a computer crash, be sure to backup your data if you keep electronic copies of your records

Tuesday, February 17, 2009

Can't Pay the IRS?

What do you do if you can’t pay the IRS the taxes you might owe in April? You have a few options:

You could borrow the money from a bank or your parents. You could put it on a charge card. Or you could borrow the money from the IRS.

Taxpayers have always had the option of paying their taxes over time by entering into an installment agreement with the IRS, a process that has recently been made easier. Historically, you had to prove you couldn’t pay the taxes in full before they would agree to a payment plan. Then the IRS realized they could save time and effort and raise more money by making the installment agreement process almost automatic.

To make such an agreement with the IRS you just need to complete Form 9465. You will have to divulge personal information such as your phone number and bank account information. You then submit a down payment and determine how much you will pay each month so you can pay off what you owe within one year. You can even pick a day when the payment is due and have the IRS automatically deduct it from your checking account each month.

Some good advice: Don’t skip a payment. The IRS gets really testy if you do. This could void your installment agreement and cause the IRS to put a lien on your bank account and other property. And expect a problem if you ask for an installment agreement every year.

Here is the catch: You are going to be charged interest and penalties on the balance due until it is paid in full. The total interest and penalties can rival charge card interest rates, so make the payments as high as you can afford, and pay extra if you can.

If you cannot pay your federal taxes, you may not be able to pay your state taxes either. The states also have installment plans in place to collect the taxes. However, if all the states are like Massachusetts, the process is difficult to go through. Usually, your state taxes are much less than your federal taxes, so my suggestion is to pay the state taxes in full if you can, and get the installment agreement with the IRS for your federal taxes.

Friday, February 13, 2009

Fast Refund?

Are you familiar with the ads on the radio and TV about getting your federal tax refund fast -- sometimes in as little at three days? Is this a good deal? Let’s examine what these "refunds" actually are:

Suppose you have Company X prepare your return. They complete your tax return and then offer to get your refund to you in three days. Your first thought might be "Wow, that’s a down payment on a car!" and agree to the deal. You return three days later and your refund check is substantially less than you expected. What happened?

These fast refunds are not coming from the IRS. The company that prepared your return is actually lending you this money. They then get your refund when it comes from the IRS. The company is charging you a fee for making the loan, a separate fee for preparing your return, and could even be charging you interest.

The best idea is to say no to the offer. Have your refund direct deposited into your checking account by the IRS and the state. You will have your money in two to three weeks. You can then make that car down payment and probably have a little money left over.

Another good idea is to go to my blog at and look in the January archives. Check out the posting called File your return Free with the IRS. If you have a fairly simple return you can file it, get direct deposit of your refund, and pay no fees for the preparation of your return.

Tuesday, February 10, 2009

Writing the IRS

About 3% of taxpayers get a notice from the IRS each year. Luckily, it’s not the same 3% every year. What should you do when you receive a letter? First of all, don’t ignore it. That would be a big mistake. The IRS will not forget and will harass you forever.
Most of the time the IRS is asking you about a mistake they think you made on your tax return. Take a deep breath and read the letter. Then read it again because you freaked out just opening the envelope. Compare what they say to what is on your tax return (you did keep a copy of your tax return didn’t you).

If they are right, sign the notice and send them a check. If they are wrong, and they are 20% of the time, you need to explain why they are wrong.

If they are wrong and you write them back, here is what you DON’T say:

* Don’t tell then how stupid they are.
* Don’t explain all the circumstances around the transaction or error. (They really don’t care that Aunt Sarah is somehow involved.)
* Don’t apologize.
* Don’t address the envelope to the Infernal Revenue Service.

And here are some DO’s.

* Do type the letter. You want them to be able to read your response.
* Do keep the letter short, one page should be enough.
* Do stick to the facts.
* Do be polite.
* Do sign the letter.
* Do respond quickly
* Do thank them for their help, no matter how much it galls you.

Tuesday, February 3, 2009

Should you EFile your tax return?

Sending your tax return to the IRS via the Internet as an electronic file is called EFiling. You need special software to do this. It is available if you use one of the popular personal tax preparation products like Tax Cut or Turbo Tax. It is also available if you file directly through the IRS Web site. For more information see my blog called File Your Return for Free with the IRS.

Here are a number of good reasons to EFile your return:

1. You will get your refund faster
2, Your return will not get lost in the mail
3. It is safer than mailing your return
4. The IRS will have an accurate return. They can make a significant number of errors that result in letters going out to the taxpayer.
5. Your refund check will not get lost in the mail if you opt to direct deposit your refund

Should you opt to direct deposit your refund? Absolutely. You do this by providing your bank routing number and checking account number to the IRS when you EFile. The number one reason given for not choosing direct deposit is the fear of providing your checking account information to the IRS. Guess what? You give them the same information when you mail them a check. The IRS has strict guidelines dictating when they can legally take money out of your account. The situation would have to be pretty extreme for them to do this without warning you. Unless you are filing a fraudulent tax return, there are safeguards that should protect you.