Do I have to pay income taxes on the sale of my house on my tax return?

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One of the most misunderstood concepts that I have experienced over many years as a tax return preparation specialist is what happens to proceeds from the sale of a home? Is it taxable? Do I have to claim it on my tax return?

First of all, you can sell your principal residence of which you have lived in for 2 of the past 5 years and have up to $250,000 of gain if single or $500,000 if married without having to pay any capital gains tax on it. It is important to note that I said gain, not sales price. For example if you purchased a house in 2003 for $150,000 and it was the only home that you lived in, you could sell it for $400,000 if single or $650,000 if married and not have to pay any capital gains tax.

Now, even if you do not meet the 2 out of 5 year ownership requirement you are entitled to a reduced maximum exclusion limit if the primary reason for your sale was a change in your place of employment, health reasons, or unforeseen circumstances. For example, a taxpayer who sold his home in order to acquire the space needed to care for his recently disabled wife was entitled to a partial exclusion. The IRS ruled that the sale in this case was because of a qualifying health reason of the homeowner.

Regulations contain several situations that constitute unforeseen circumstances, including divorce, casualty, or multiple births from the same pregnancy. The IRS continues to expand the definition of unforeseen circumstances. Recently the IRS has held that a move caused by crime in the neighborhood was an unforeseen circumstance, allowing the homeowner to claim a partial exclusion on his tax return.

A partial exclusion is figured by multiplying the dollar limit ($250,000 for single or $500,000 if married) by a fraction, the numerator of which is the number of days of ownership and the denominator of which is 730 days. To illustrate: You are a single person and purchased a home for $300,000 90 days ago and have now been transferred by you employer across the country. You would multiply $250,000 by (90 / 730) and see that you would be able to sell your home for a gain of up to $30,821 and not have to pay any capital gains tax on it.

If you have any questions regarding the home sale exclusion or any other tax preparation return related matters or if you would like us to help in the preparation of your income tax return this year please contact us at (651) 647-4935 or email us at info@bergersontax.com.

Should We File Jointly or Seperately?

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Couples who were married at any point during the year are viewed as married for the entire year. Filing jointly allows the couple to use the tax table or rate schedule , which operates to average the tax over both individuals and produce tax savings. Joint filing is also necessary in order to take advantage of certain tax breaks. However, there are some situations in which filing separately may make sense.

The following tax breaks only apply to married filing jointly taxpayers:

  • The $25,000 rental loss allowance
  • Credit for the elderly or permanently disabled
  • IRA deduction for a nonworking spouse
  • Education credits
  • Tuition and fees deduction
  • Student loan interest deduction
  • Dependent care credit (unless living apart for the last 6 months of the year)
  • Earned income credit (unless living apart for the last 6 months of the year)

If you receive Social Security benefits, joint filers may need to include only 50% or perhaps none of the benefits in income; separate filers automatically must include 85% of benefits in income.

Even though there are compelling reasons to file jointly, there are two key situations in which separately filing is advisable:

  • To limit tax liability for the other spouse. If a joint return is filed, both spouses usually are liable for the tax. When one spouse has concerns about the other spouse’s tax positions, separate filing will avoid liability related to the other spouse’s positions that could result.
  • To maximize deductions and lower taxes. If couples itemize and the spouse with the lower income has greater medical, casualty and theft, and/or miscellaneous itemized deductions (deductions that have adjusted gross income thresholds), separate filing can enable greater write-offs and result in lower total income tax for the couple.

Our Best Advice:

There is not a blanket answer as to which filing status is most beneficial since every situation is different.  When in doubt about which filing status to use, figure your taxes both ways—joint and separate—and compare your results.

Safe Tax Tactics

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As a self-employed person, you are three times more likely than an employee who receives a W-2 form to be audited by the Internal Revenue Service, according to 2005 data from the IRS. Combine that with the fact that the number of audits of small corporations has been on the rise in the last few years, and you have the potential for a real hassle. But don’t despair; there are several things you can do to reduce your chances of being audited and to protect yourself in the event that you are.

File OH time. Make sure you file both your income tax return and quarterly estimates before the deadlines. Nothing throws up a red flag and says “audit me” more than consistently filing your returns and quarterlies late. If you can’t file on time, be sure to file an extension. Remember, though, that extensions don’t eliminate interest charges.

Keep good records. One particularly vexing issue for salespeople who use their cars for business is substantiating business mileage with a properly documented mileage log. Few mileage logs are up to IRS standards. The IRS will accept either paper or computer-generated logs, but the IRS tends to view computer logs as less credible. (You can find my version of a paper mileage log, called The Audit Angel, for $19.99 at my Web site, www.bergersontax.com)

Double-check meal and entertainment deductions. Meal and entertainment costs are deductible up to 50 percent if they are ordinary (commonly done) and necessary to your business and are either directly related to the active conduct of your business or directly preceding or following a substantial business discussion on a subject associated with your business. Ordinary and necessary costs are those considered helpful and common practice in your industry. You can entertain business associates in nonbusiness settings such as restaurants, theaters, sporting events, and nightclubs, provided the entertainment directly precedes or follows a business discussion. Business associates would include clients, prospective clients, suppliers, employees, partners, or advisers. You should document where the meeting was held, with whom, and the purpose of the meeting. Keep this information with the receipt.

Classify your workers properly. A top audit trigger is a business-such as a real estate brokerage-that treat workers as independent contractors. Questions are more likely to arise about the employment status of office personnel or assistants working for salespeople. If the IRS rules that these workers are employees, you could owe employment taxes, penalties, and interest. While federal tax law provides a safe harbor that classifies real estate salespeople as independent contractors, unlicensed assistants do not have such protection. One important factor in determining independent contractor status is behavioral control, or to what degree workers control how, where, and when they work. If a worker receives extensive instructions on how work is to be done, it suggests employee status. If a worker receives benefits such as paid leave, health insurance, or a retirement package, this might also indicate employee status. For further details on the distinctions between independent contractors and employees, go to www.irs.gov/business and read Publication 1779.

Review IRS audit guides. Audit technique guides were developed by the IRS to assist its agents in performing examinations. These guides contain examination techniques, industryissues, business practices, industry terminology, and other information to assist examiners in performing audits for particular industries. These guides are available to the public at the IRS Web site so you can obtain them and learn in advance what issues the IRS will examine during an audit.

Get good advice. If you’re not aware of new twists in the country’s constantly changing tax laws, you might cost yourself money. If you have a question regarding possible deductions or how to report income, ask a tax professional or call the IRS directly. The money that you spend for good advice up front can pay you back many times over into the future. Follow these easy steps, and you’ll reduce your chances of an IRS audit. At the very least, you’ll have appropriate backup for your deductions to satisfy even the toughest auditor.

Should I Pay Off My Debt Or Should I Invest For My Retirement

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The answers to the questions you have always had about your personal finances.

 

We will frequently address a personal finance, tax, or investment topic that personally affects you and your overall financial well-being.  These articles will be laid out in a way that everybody can understand and apply to their own real life finances.  We at Bergerson Tax Services, Inc can help you with all of your personal finance and tax related needs. Please fell free to contact us anytime. This month’s topic is

Should I Pay off My Debt Or Should I Invest For My Retirement?

 

By Jeff Bergerson, Bergerson Tax Services, Inc

In a perfect world you would be able to pay off all of your debt and also invest for your retirement.  Unfortunately, like most of us you probably do not have enough money to pay off all of your debt and invest for your retirement at the same time.  So what is the most financially savvy strategy to help you pay off your debt and fully fund a retirement account? Should you pay off all your debt before contributing to a retirement account; or should you keep certain debt and contribute to your retirement account.  In this article I will address the different types of debt that you might have, which debt is the best and worst to keep, and walk you through an illustration.

First of all, lets address the type of debt that you might currently have: Home mortgage, student loan, car loan, and credit card debt.  As I wrote in January’s article, To Pay Off My Home or Not to Pay of My Home, That is the Question, a home mortgage can be considered reasonably good debt to maintain.  Interest rates on home mortgages are generally lower than car loans or credit cards, plus the interest you pay is tax deductible. For example, if you have a interest rate of 6% on your mortgage and are in the 35% tax bracket, the after tax cost of your loan is only 3.9%.  Student loan interest is very similar in that the interest rates are reasonably low and the interest is tax deductible.  Up to $2,500 of student loan interest is deductible as long as your modified adjusted gross income is below $70,000 for single filers and under $140,000 for married filers.

Car loans are a different story; depending on the terms of your car loan your interest rate may or may not be as low as your home mortgage or your student loan, but the interest you pay on it is not tax deductible.  Finally, the worst kind of debt that you can have is credit card debt.  The national average interest rate on credit cards is a staggering 15%, plus the interest you pay is not tax deductible.

When determining what debt to pay off first, it is clear that credit card debt and possibly car loans need to be paid off before your home mortgage and any student loans. The question of whether to even try to pay off your home mortgage or keep it is answered in January’s issue, To Pay Off My Home or Not to Pay of My Home, that is the Question.

It has been determined that credit card debt is the first debt that you should attempt to pay off, but what about investing for retirement? Should you pay off your credit card first, and then save for retirement, or should you just pay the minimum on your credit card and invest the rest into your retirement account?

Lets look at an example to help you decide.

Lets say you have a $5,000 credit card balance of which the interest rate is 14%.  At the same time your employer has a 401K plan and offers a 50% match (50 cents per every dollar you contribute) up to 6% of your salary.  At first glance it looks like a no-brainer, 50% vs.14% returns.  But consider the fact that the 50% match is a one-time gift while the 14% compounds yearly and eventually will overtake the 50%.  Now lets say you have $250 every month of which you have to pay your minimum credit card payment of $125, so you have $125 to either put toward the balance of your credit card or invest in your 401K.

Example 1.  You pay just the minimum of $125 and invest the $125 (which is actually $174 because it will be contributed pre-tax) every month.  You will need 55 months to wipe out your credit card debt.  During that time if you earn 8% in your 401K and receive a 50% match you will accumulate $17,271 in your 401K.

Example 2.  You choose to put the entire $250 toward your credit card debt and hold off entirely on contributing to your 401K.  You will pay off your credit card in 23 months.  At that point you can begin contributing all $250 to your 401K.  By the end of 55 months you would have $18,515 in your 401K plan.

By focusing on paying off your credit card completely and then funding your 401K rather than splitting your money between the two you will have $18,515 rather than $17,271 over that 55- month period. You can see that paying off your credit card completely before funding your retirement plan is a more effective strategy.

There are a couple caveats to the idea that paying off your credit card will produce more money in your pocket overall.  First, if you just have a small amount of credit card debt and would be able to pay off that debt in under a year’s time, go ahead and fund your retirement account and take advantage of that employer match.  In instances where you do not have any credit card debt I would always advise to contribute the maximum amount to your 401K up to your company match, its free money!  The other time where I would advise to contribute to your retirement account before paying off your credit card debt completely is if you do not contribute to your 401K at first it meant you never ended up doing it.  In this case I would say start contributing and get the ball rolling and then pay off your credit card.

Ideally the best financial strategy for most people who have credit card debt is to focus on paying off your entire credit card balance first before you begin investing into your retirement account. Once you pay off your credit card balance, begin investing into your retirement account.

Now that we have determined paying off your entire credit card balance is the most financially savvy strategy, I will give you a couple of strategies to help you pay off your credit card debt in the most effective way.

If you have more than one credit card and cannot pay them all off, the best bet is to try to consolidate all of your cards into the one that offers the lowest rate.  Most credit card companies make offers of lower interest rates, called balance transfer credit cards, in an attempt to attract you to consolidate your debt with their company.  Be careful, as sometimes there is small print that can boost up your rate after a certain period of time.  Read all the small print and research the credit cards thoroughly before making your decision where to transfer your debt.

If you own a home and have built up equity, it would be a good idea to take out a home equity loan to pay off your credit card debt.  You will get a much better interest rate and the interest you pay on a home equity loan is tax deductible.  Whichever route you choose the most important thing to do is pay off your credit card and the sooner you begin, the better.

Jeff Bergerson founded Bergerson Tax Services, Inc (BTS) eight years ago and pilots a rapidly growing practice in St. Paul, Minnesota. Jeff has written many articles offering tax related strategies, financial strategies, and business guidance. Bergerson Tax Services, Inc. provides individuals and small business tax preparation services, small business consulting, and tax planning.  He can be reached on the web at http://www.bergersontax.com/ or by email at info@bergersontax.com.

Why You Should Always Hire A Tax Professional.

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I have been asked many times over the years why people should hire a professional to prepare their taxes as opposed to preparing their own return.  In my opinion the decision to have a professional prepare your taxes is as big of a no-brainer as there is. This is because of my experience in the income tax industry and the horror stories of self-prepared returns that I have witnessed. However, I can see how some people might not understand why they should hire a high quality tax professional rather than attempting to prepare them on their own.  Throughout this article I will point out several of the reasons everybody should have their taxes prepared by a professional.  Keep in mind that when I say a tax professional I mean someone who is qualified, has ample experience, and is willing to speak with you personally to explore your individual tax situation to best maximize your deductions.

The first thing I like to ask people is whether they go to a medical professional to diagnose what affects their health? Or whether they would go to court without a law- professional representing them?  Personally I do not, because I believe in specialization.  I want a professional carpenter putting on the addition to my house, an electrician to do the wiring, and a mechanic to work on my car.  These people do this everyday, have had extensive training and know what they are doing. This is why I cannot imagine individuals attempting to do something they do once a year and that has such a large financial impact on their lives, like preparing their tax return.

I have witnessed so many cases in which people have either caused an audit because what they have included on their return or have cost themselves thousands of dollars by missing credits or deductions that they were eligible for.  I currently have many clients who at one-time prepared their own returns and would never do it again because they now see the benefits of having a professional tax preparer.

What is the thing that we never have enough of and that we can never get back once it is gone?  Yes, time.  Recent government estimates show it takes taxpayers 28 hours and 30 minutes to complete an average tax return with schedules A and B.  Don’t you have better things to do with your time?  My clients put all of the information they receive in a folder and bring it into me to complete their tax return.  On average my clients come in, meet with me, and have their returns filed electronically in under an hour. That is quite a savings in time.

Another reason to hire a tax professional is that you do not keep up with current tax law.  Congress is constantly passing new laws, the IRS comes out with new rulings, and judges make new decisions all the time, all which directly affect your tax situation. How many of you not only read about all these decisions in the newspaper, but research them thoroughly to see how they affect your individual tax situation?Professional tax preparers subscribe to newsletters, press releases, and alert services that keep them abreast of every changing tax law.  In addition, professional tax preparers attend tax education courses throughout the year and learn from experts, IRS agents, and state officials.

One of the best commercials I have seen is where the husband gets into a little tax trouble and asks his wife what he should do.  He obviously had used a do-it-yourself tax software, so she told him to ask the box.  This is so true.  I receive telephone calls throughout the year from clients who have received letters from the IRS and do not know what to do, have tax planning questions, or simply have to make a decision in their life and want to know how it will affect their taxes.  I just wonder where people who prepare their own taxes go for that type of information.  Like with all high quality tax preparers I am available year round to help clients out with any tax questions or concerns that they might have.  Keep in mind if you make an important decision in your life, chances are it will affect your taxes.

Finally, by using a high quality tax preparer you are actually lowering your chances of an audit. Tax professionals know the thresholds at which deductions throw up red flags. By informing you that your charitable deductions are extremely high, you might be able to eliminate an audit of your entire return.  Statistics are available that track average taxpayers deduction amounts and tax preparers know this information and can tell you when your deductions are greatly exceeding these averages.  I have made these itemized deduction averages available in The Audit Angel:  Your Essential Income Tax Organizer and Mileage Log, which you can order at http://www.bergersontax.com/.  If you prepare your own taxes you won’t know if your deductions are raising a red flag and you might either take less deductions than you could or take way too many deductions and draw attention to your return.

I urge anybody that I speak with to hire a high-quality tax professional to complete their tax returns.  I have personally been in the income tax industry for over ten years and provide my clients with personalized and expert income tax service.  I am available year round to help with any tax related matter.  You can reach me at 651-647-4935, email-info@bergersontax.com, or on my website at http://www.bergersontax.com/. If you have any questions about my services or any other tax related matter, or would like to set up an appointment for this coming tax season please call me anytime.

The Top 5 Reasons to Keep a Mileage Log

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  1. Huge Tax Savings! For 2009 the I.R.S offers a 55 cent/mile deduction for miles driven for work purposes using the standard mileage rate.  Find more information on the standard mileage rate in The Audit Angel 2009, Your Essential Income Tax Organizer & Mileage Log or at www.bergersontax.com under the Tax Answers and Article section. Using a mileage-log allows you to claim the standard mileage rate and take advantage of this generous tax deduction.
  1. The I.R.S. is Cracking Down. The days of the kinder, gentler I.RS. are over. They have realized that some taxpayers have been exploiting deductions and are not able to validate their deductions in an audit situation.  The I.R.S has hired thousands of new agents to target self-employed individuals and people who use mileage for business purposes as a deduction. Unfortunately many of these audit victims are not prepared and do not have a complete mileage-log and record keeping system to validate their mileage and business related expenses.
  1. Incredibly Easy to Use. Just keep your mileage-log in your vehicle and write down the key pieces of information required by the I.R.S for your business related mileage every time you drive.  At the end of every week or month total up the amount and carry it forward to the end of the year.  At the end of the year deduct the total amount of business miles driven and reap the huge tax deduction!
  1. New IRS Rules. Unlike in the past, the I.R.S now allows you to claim the standard mileage rate on multiple vehicles. Just carry your mileage-log with you in whichever vehicle you use to document the proper information.  To simplify even more, use different color pens for certain vehicles.  Then it will be easy to total the mileage on each vehicle at tax time.

5. Tax-Time Relief. Rather than having to scramble for receipts or to find out how many miles to claim on your taxes you will have everything already documented.  You will never have to worry about if your tax return gets audited because you will easily be able to validate all the key pieces of information that the I.R.S requires.  Simply take the running total of all the business miles driven over the course of the year and claim that amount on your income tax return to receive the generous 55 cents/mile.

Vehicle Donations Info

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Under the new law, allowable deductions for charitable contribtutions of vehicles for which the claimed value is over $500 will depend on how the vehicle is used by the recipient charity. If the chairty sells the vehicle without any significant intervening use or material improvement, the donors deduction is limited to the gross sales proceeds received by the charity. If the charity uses the asset in direct furtherance of its charitable purpose the donor may deduct the “Fair Market Value” of the vehicle. Example: If a vehicle with a “Fair Market Value” of $3,000 is donated to a charity and they sell the vehicle for $1,500, the donor can only deduct $1,500. If the charity provides the vehicle to a disadvantaged person, the donor may deduct the “Fair Market Value” of $3,000.

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