Categories
Taxpayer Representation

Bankruptcy vs IRS Offer in Compromise

If you have a large amount of other debt besides just tax debt, bankruptcy may be an option you end up considering. Is this the right thing to do when you have tax liabilities?

For some people, bankruptcy can be the right way to go. While bankruptcy will not erase most tax debt, the bankruptcy court determines what you pay each creditor, and may remove some of the penalties and interest, depending on the case.

The interest rate that the IRS charges, to be honest, isn’t that bad. The rate is adjusted several times per year, and it currently sits at 4%. What kills people are actually the penalties. It is not uncommon for tax debtors to max out all their penalties, which tacks on a whopping 45.5% to their principal, and THEN interest accrues on the whole thing.

To determine whether bankruptcy is the best route for you, you should consult with a bankruptcy attorney. If all you have is IRS debt, and don’t have significant other creditors and/or don’t want the bad credit associated with bankruptcy, but you cannot otherwise go on a monthly payment plan, then consider an Offer in Compromise with the IRS. It’s a good non-bankruptcy alternative for folks that might otherwise have no other choice but to file Chapter 7, but would only be filing chapter 7 because of their IRS debt.

If you do choose to file for bankruptcy, it’s important to have a contingency plan for those taxes that cannot be discharged. For example, Trust Fund Recovery Penalty assessments, property taxes, and sales taxes will not generally be flushed in a Chapter 7. So, if your tax liability consists of those tax types, you need to be looking at other options.

Personal income taxes (1040 taxes) can be discharged in bankruptcy if they meet certain criteria. In general, income taxes must be at least three years old to be discharged in bankruptcy, and the tax return on those tax debts must have been filed at least two years ago. So, if you haven’t filed the actual tax returns that will incur the tax debt you want to discharge in bankruptcy, you’re going to have to file the returns and then wait two years.

Filing bankruptcy is obviously not a decision to be taken lightly, and you must consider the tax debt implications of doing so. However, bankruptcy isn’t nearly as bad of a thing to go through as many people think it is (and I’m talking from experience, by the way). Consult with both your tax professional and your bankruptcy attorney regarding this important decision.

Categories
Tax Planning

The Tax Shelter Over Your Head Is Still a Good Idea For 2013

Home prices, which had been on a tear, have leveled out and even fallen in places. The housing “bubble” definitely appears to be over. So, the question becomes: Is real estate still a good place for your money?

Despite uncertain real estate prices, buying a house is still a smart choice for most families. Buying, rather than renting, replaces nondeductible rent with deductible mortgage interest. You can borrow tax-free against your home’s growing equity. And you can still sell your home for up to $500,000 profit, tax-free. This particular capital gains tax break isn’t likely to disappear in 2013, despite all the rhetoric about classic tax breaks disappearing.

Mortgage Interest

Tax-deductible mortgage interest is a cornerstone of tax planning for many families. You can deduct interest on up to $1 million of “acquisition indebtedness” you use to buy or substantially improve your primary residence and one additional home. You can deduct interest on up to $1 million of construction loans for 24 months from the start of construction. (Interest before and after this period is nondeductible.) Plus, points you pay to buy or improve your primary residence are generally deductible the year you buy the home if paying points is an established practice in your area. This deduction, while discussed as one that could get the axe by Congress, is too politically sensitive to actually be taken away from American voters in 2013.

Home Equity Interest

You can deduct interest you pay on up to $100,000 of home equity loans or lines of credit secured by your primary residence and one additional residence. Using home equity debt to pay off cars, colleges, and similar debts lets you convert nondeductible personal interest into deductible home equity interest.

Make sure you compare after-tax rates before you refinance consumer debt with home equity debt. If you can buy a car with a special interest rate, your nondeductible personal interest may still cost less than deductible home equity interest. If you can transfer a credit card balance to a new card with a low introductory rate, you could save money and avoid the paperwork needed to refinance your home.

If you pay points to refinance your home, you can’t deduct those points immediately. However, you can amortize them over the life of the loan. If you pay off the loan before fully deducting your points (including refinancing with a new lender), deduct the remaining balance the year you retire the loan.

You can still deduct the interest you pay on home equity balances over $100,000 if you use the proceeds for a deductible purpose. If you use home equity debt to buy stocks, for example, you can deduct it as investment interest; if you use it to finance your business, you can deduct it as a business expense.

Property Tax

You can also deduct property taxes you pay on your primary residence and vacation homes. Microsoft founder Bill Gates can deduct over $1,000,000 he pays on his Seattle-area compound. But be aware that property tax deductions may be limited by the AMT.

Tax-Free Income From Selling Your Home

The Taxpayer Relief Act of 1997 made important changes when you sell your primary residence. The old law, effective for sales before May 5, 1997, let you roll unlimited gains into a new home and offered a one-time $125,000 exclusion if you sold your home after age 55. The new law lets you exclude up to $250,000 of gain ($500,000 for joint filers) every two years, with no need to roll your gains into a new home.

You can exclude $250,000 if:

  1. You owned the home for two of the last five years,
  2. You occupied it as your primary residence for two of the last five years, and
  3. You haven’t used the exclusion within the last two years.

You and your spouse can exclude up to $500,000 if:

  1. Either of you owned it for two of the last five years
  2. Both of you used it as your primary residence for two of the last five years, and
  3. Neither of you has used the exclusion within the last two years.

You can exclude part of your gain (calculated by dividing the number of months you qualify by 24) without meeting that two-year minimum, if your move is due to:

  • Change in employment (you, your spouse, a co-owner of the house, or any other person whose principal abode is in the home accepts a job whose location is at least 50 miles farther from the home than their previous place of employment);
  • Health (a qualifying person or their relative moves to treat a disease, illness, or injury or to obtain or provide medical care for a qualified individual); or
  • “Unforeseen circumstances” (including, but not limited to, involuntary conversion, natural or man-made disaster, or a qualifying individual’s death, unemployment, change in employment or self-employment status, divorce, or multiple births from the same pregnancy).

Taking advantage of the tax shelter over your head won’t guarantee gains. You have to consider how long you will own your home, the cost of maintaining and repairing it, and the eventual cost of selling it. But the tax shelter over your head is still likely to prove a long-term winner.