Owe back taxes? Visit this site before shelling out thousands for no reason.

February 22, 2013

Owe back taxes? Visit this site before shelling out thousands for no reason.

Just a quick note about a new tool at the IRS site.

If you owe lots of money in back taxes, you might have been tempted by one of those ads promising to make your IRS debt go away for “pennies on the dollar.” Before you go and pay a few thousand dollars in fees to one of these (often corrupt) companies, you might want to check out the IRS Prequalification Tool for Offers In Compromise (OIC).

Basically, an (OIC) is the only real way you might be able to settle a tax debt for significantly less than your current liability. Qualifying is primarily a pretty mechanical process of running your income, assets, and liabilities through a formula. There’s some nuance to it, but it’s mostly just plugging in numbers.

Now with the new IRS tool, you can plug in the numbers online and get an idea whether or not you might qualify. If not, then you can stop being tempted by those offers to settle your IRS debts for pennies on the dollar. And if it appears you may qualify, just contact a local Enrolled Agent or CPA with a good reputation and have them help you with the process.

But whatever you do, don’t spend thousands of dollars to have a company tell you what you can now find out by filling out some forms online.



Telecommuting has many advantages…the home office deduction often isn’t one of them

February 6, 2013

I love being a regular telecommuter. The time and cost savings of not having a standard commute are invaluable, and I love the flexibility that goes with telecommuting. And from an employer’s perspective, this allows companies to find the best talent with fewer geographical limitations, and saves costs by not requiring office space for every employee. It’s no wonder it has become so popular.

But if you’re a telecommuter and a home owner, and you’re looking forward to taking a big home office deduction, chances are you’re in for a disappointment.

The amount of home office deduction is determined by finding what portion of your home is used as your home office, and then multiplying that ratio by your home expenses. For home-owners, your two largest home expenses are probably mortgage interest and real estate taxes…which you already get to deduct as personal expenses. Having a home office allows home-owners to deduct a portion of their utilities and insurance, which they wouldn’t normally deduct at all. Home-owners can also take a deduction for a portion of the depreciation on their home. (That’s just taking a very small percentage of the purchase price and deducting it each year.)

However, in order to benefit from the home office deduction, you have to have enough work-related expenses to exceed 2% of your Adjusted Gross Income (AGI). Only expenses exceeding this amount are actually deductible. There are a few other expenses that go in this 2% category as well (investment expenses and tax preparation expenses being the most common), but usually work-related expenses are the big one in this 2% category. What this means for many people is after subtracting 2% of AGI, they actually have little or no deduction available. In fact, taking the home office deduction can cost you money in the long run, as I’ll show in this example.

Suppose you have a household Adjusted Gross Income of $90,000. You have a home office that takes up 10% of the square footage of your home. You pay $15,000 each year on mortgage interest and real estate taxes. You have $3,000 in insurance and utilities. And your home was bought for approximately $270,000 — I say approximately because we’ll assume the depreciation on the whole home would be $10,000…which means the purchase price was close to $270,000. And finally, we’ll assume you paid $500 in investment expenses and tax preparation fees.

Using 10% of your expenses gets you a home office deduction of $2,800. (10% of $15k plus 10% of $3k plus 10% of $10k) That sounds good at first. But remember we also have to subtract 2% of AGI from the home office deduction and other expenses in this category. The home office deduction ($2800) plus $500 in other expenses gets us to $3300, but we have to subtract 2% of our $90,000 AGI, or $1800. So now you’re left with a deduction of $1,500. A deduction of $1,500 sounds good…but part of your home office deduction is $1,500 for mortgage interest and real estate taxes that you could have deducted anyway!

So you kept all those records and did all that calculating…for no deduction at all! But wait, it gets worse…

Because you took the home office deduction, you were allowed to depreciate a portion of your home. That was worth $1,000 as a deduction. If you later sell your home at a gain, which we all hope to do eventually, you’ll have to “recapture” that $1,000 of depreciation that you were allowed to deduct earlier. “Recapture” just means you now treat that $1,000 as income because you were allowed to deduct it earlier…even though the deduction didn’t actually benefit you!

This may be one of the biggest traps in the tax code. People sometimes deduct depreciation because it offers a small benefit now…but when they later have to recapture the depreciation, they wind up paying tax on more money than they actually deducted earlier. In this example, the true value of the home office deduction was $0! Nevertheless, if the home is sold the next year, this taxpayer will pay tax on $1,000 of “recaptured” depreciation that didn’t actually do any good.

So that’s the home office trap. This isn’t to say it’s never a good idea to take the home office deduction. If you’re self-employed or a renter (or both!), then the home office deduction is much more likely to make sense for you. But this is a great example that just because you CAN deduct something, doesn’t mean it’s always a good idea!