The Tax Dude® Speaks

Business Incentives Under the HIRE Act

2010-05-28T10:54:00.000-07:00

On March 18, 2010, President Obama signed the Hiring Incentives to Restore Employment (HIRE) Act. One of the important changes affecting businesses is the payroll tax holiday and up-to- $1,000 credit for employers who hire unemployed workers.

To help stimulate the hiring of workers by the private sector, the new law exempts any private sector employer that hires a worker who had been unemployed for at least 60 days from having to pay the employer’s 6.2% share of Social Security tax on that employee for the remainder of the 2010 tax year. This could result in a maximum tax savings of $6,621 for any previously unemployed worker who is paid at least $106,800 by the end of the year.

As an additional incentive, for any qualifying worker hired under this Act and the employer keeps on the payroll for 52 consecutive weeks, the employer is eligible for an additional non-refundable tax credit up to $1,000. This credit becomes available after the 52-week threshold has been reached. The credit will be taken on the employer’s 2011 tax return. To be eligible for the credit, the employee’s pay in the second 26 week period must be at least 80% of the pay in the first 26 week period.

Workers hired after the introduction date of this legislation (February 3, 2010) are eligible for the payroll tax forgiveness and the retention tax credit. It should be noted, the only the wages paid after the date of the new law’s enactment receive the exemption for payroll taxes.

Here are some additional features of the new hiring incentive:

• The tax benefit of the new incentive is immediate. It puts money into a business’ cash flow immediately, since the tax is simply not collected in the first place.

• The tax benefit generally applies to private sector employment, including nonprofit organizations. Public sector jobs are generally not eligible for either benefit, except for employment by a public higher education institution.

• There is no minimum weekly number of hours that the new employee must work to be eligible.

• There is no maximum on the dollar amount of payroll taxes per employer that may be forgiven.

• For workers that would otherwise be eligible for the Work Opportunity Tax Credit, the employer must select one benefit or the other for 2010. Employers cannot double dip on the tax credits.

• An employer can’t claim the new tax breaks for hiring family members.

• A worker who replaces another employee who performed the same job for the employer is not eligible for the benefit, unless the prior employee left the job voluntarily or for cause.

• For the hiring to qualify, the new hire must sign an affidavit (under penalties of perjury), stating he or she has not been employed for more than 40 hours during the 60-day period ending on the date the employment began.

• The incentive is not biased towards low-wage or high wage workers. Under this measure, the business saves the 6.2% on both a $15,000 worker and a $100,000 worker.

• The payroll tax holiday does not apply with respect to wages paid during the first calendar quarter of 2010, but the amount by which the Social Security tax would have been reduced under the payroll tax holiday provision during the first calendar quarter is applied against the tax imposed on the employer in the second calendar quarter of 2010.

• The Act creates a similar new set of rules permitting a payroll tax holiday for railroad retirement tax purposes.

• The credit for retaining qualified new hires is the less of $1,000 or 6.2% of the wages paid by the employer to the retained worker during the 52 consecutive week period. Thus, the credit for a retained worker will be $1,000 if the retained worker’s wages during the 52 consecutive week period exceeds $16,129. This credit is not available for pay not treated as wages under the Internal Revenue Code (for example, remuneration paid to domestic workers).

• Employers can avoid the 6.2% share of Social Security tax on wages paid to students who certify they worked fewer than 40 hours in the previous 60 days. Students who did not work because they were taking classes are not disqualified.

• Employers can rehire a laid off worker and avoid the 6.2% share of Social Security tax as long as the rehired worker worked fewer than 40 hours in the previous 60 days.

• Temporary employment agencies can claim the exemption on the wages of employees sent to clients as long as the employee worked fewer than 40 hours in the previous 60 days.

If you have any questions regarding this Act or any other tax provision, please feel free to contact me at thetaxdude@gmail.com.

To Convert or Not? That is the Roth IRA question in 2010

2010-04-19T12:13:00.000-07:00

For tax year 2010, the IRS income ceiling for Roth IRA conversions disappears. The Roth IRA may be one of the most powerful retirement and estate planning tools which hasn’t been available to investors until now. This has presented an interesting quandary for many investors.

There has been plenty of information about this unique opportunity provided by financial advisors, tax professionals and others. Even with this wealth of information, the decision to convert your retirement assets to a Roth IRA is not an easy one. There are several factors to consider in determining whether or not a Roth conversion makes senses. Anyone suggesting everyone should do a Roth conversion is just plain wrong!

For some people, a Roth conversion makes sense. The best candidates for conversions are those who have a favorable tax attributes that can offset a majority of Roth conversion income. Business owners and others with net operating losses (NOLs) or those with charitable deduction carryforwards will find the conversion appealing. These losses and deductions may be used to lower or eliminate the tax liability created by the conversion.

Other good candidates for a Roth conversion are those who can pay the tax on the conversion from non-retirement funds and fit one of the following criteria:

• Those who don’t expect a significant decline in their tax rates at retirement;
• Those who have made a significant amount of non-deductible traditional IRA contributions over the years;
• Those who are making the conversion at a younger age;
• Those who don’t expect to spend down their IRA funds to meet living expenses at retirement;
• Those who intend to transfer all or a significant portion of their IRA at death to their beneficiaries.

While the criterion above suggests who may be good candidates for a Roth conversion, it still does not make the decision to convert an automatic one. There needs to be thoughtful analysis before making this decision. One of the major flaws with analysis provided by many advisors is the failure to consider the difference in tax rates before and after retirement.

Many analysis suggest a retirees tax rates will be equal to or greater than their tax rates prior to retirement. It is very interesting as the conventional wisdom prior to the Roth conversion opportunity was people would be at a lower tax rate during retirement. Even if tax rates do rise, most investment allocations for retirees tend to more tax advantaged vehicles.

Tax planning is a critical element of decision making process for implementing a Roth conversion. There are two options for paying the tax. The first is including all of the Roth conversion income on your 2010 tax return and paying all of the tax at 2010 tax rates. The second option is to defer the tax until your 2011 and 2012 tax returns paying tax on 50% of the conversion income in each year. The risk in deferring the tax is the likely increase in tax rates after 2010.

With the two choices to pay the tax on the conversion, a three year tax planning analysis is an absolute must. Retirees have to pay particular attention to how the conversion may impact the taxability of their Social Security benefits. They also need to be aware of how the conversion may affect their Medicare Part B premiums.

One nice feature allowed of a 2010 Roth conversion is the “money-back guarantee”. If a taxpayer is unhappy with the conversion for any reason he or she may re-characterize the Roth back into a traditional IRA by October 15, 2011. They will also have the option to re-convert it back into a Roth in the following tax year. This feature may come in handy if the value of the IRA drops significantly and the re-conversion can be done at a lower tax cost. Re-converting the IRA is not required. The only downsides are the need to amend prior tax returns to get a refund of the tax paid from 2010 conversion and the lost investment opportunity from not having use of those funds.

While the above provides a basic framework for deciding to convert a traditional IRA to a Roth IRA, it is highly recommended that you meet with your tax advisor to discuss a customized analysis based on your unique issues. No matter what advice you getting, the decision for implementing a Roth conversion is not a one size fits all.

REIT Investors Beware…tax traps you DO NOT know about!

2010-01-14T13:15:00.000-08:00

Investors seek out Real Estate Investment Trusts (REITs) for stable, predictable cash flows. Many REITs have strong dividend yields which make them attractive. Dividend payments made by a REIT are taxed to the investor as ordinary income, unless they are considered to be “qualified dividends”. Qualified dividends are taxed at the more favorable capital gains tax rates versus nonqualified dividends which are taxed at the investor’s top marginal tax rate.

A portion of dividends paid by REITs may be classified a nontaxable return of capital. This is usually determined at the end of the year when the REIT is closing their books. These payments reduce an investor’s cost basis in the REIT investment. This creates a potential tax trap for unwary investors and unknowledgeable tax preparers.

Reporting the sale of a REIT investment is similar to reporting the sale of a common stock, but there is one key difference. When selling a common stock, you take the gross proceeds of the sale and subtract the cost basis to determine the capital gain or loss. Cost basis is what the investor paid for the security, plus related costs and commissions. This information is easily found on the investor’s trade confirmation or brokerage statements.

Determining the cost basis on a REIT has subtle difference. Remember those nontaxable returns of capital mentioned earlier. A nontaxable return of capital is return of the initial investment and these reduce the cost basis in the REIT. To determine the actual cost basis in the REIT one would need to look back at all of the 1099s received from REIT to determine how much return of capital was actually received.

Don’t count on your broker to do this and I certainly would not rely on the gain/loss statements issued by the brokerage. I can almost guarantee they are not tracking this on your behalf. A clever tax professional might be tracking your REITs cost basis, but it is likely most tax preparers are not. I wonder how many REIT investors have understated their capital gains to the IRS.

Another tax trap of REITs is one that I promise you most tax professionals are not even aware of. This tax trap affects every REIT investor who is participating in the REIT’s dividend reinvestment plan (DRIP). Most all REIT DRIPs allow shareholders to reinvest their dividends and purchase additional shares in the REIT at a discount.

The discounts can range between 0 and 5 percent of the market price of the shares. The tax trap is the discount represents a taxable dividend to the REIT owner and it is not reported on 1099 issued by REIT. Herein lays the tax trap. How many REIT investors have underreported their dividend income because of the discounts they received from the DRIP? I suspect almost all of them. How many tax professionals are aware of this? I suspect almost none of them.

REITs are not required to report these discounts on 1099s because only amounts paid to investors or reinvested into the DRIP are required to be reported per IRS guidelines. This is why you will see on REIT DRIP statements “SAVE THIS STATEMENT FOR TAX PURPOSES”. I wonder how many investors look at the year-end statement, compare the gross amount reinvested to their 1099 and then toss the statement after they can reconcile to the gross amounts reported on the 1099. This is a big mistake. Every REIT investor participating in a DRIP should be retaining their December 31st statements which show all of the year’s transactions. These statements reflect the shares purchased and the fair market value of the shares. The difference is the discount and it’s TAXABLE.

Most REITs don’t give investors any guidance related to the taxability of the discounts on the DRIP statements other than the standard “Consult Your Tax Adviser”. If a tax professional isn’t aware of this tax trap, what good would he or she be in consulting on an investor on this topic? It’s not that a REIT is trying to deceive their investors, but they are not allowed to provide tax advice. I will tell you this issue on the taxability of the discounts is covered clearly in REIT literature…if anyone has taken the time to read it.

Other than the current taxability of the REIT discounts, there is another tax issue. The discounts (since they are considered taxable income) are also added to the cost basis of the shares held in DRIP. I’m equally positive that anyone who has failed to report the discount as taxable income is more likely than not to be oblivious to the impact on cost basis. I wonder how many investors overstated their capital gains when reporting the sales of the REIT DRIP shares. My guess…almost all of them!

Commentary on the IRS Announced Plans to Regulate ALL Tax Return Preparers

2010-01-14T11:21:00.000-08:00

On January 4th, 2010, IRS Commissioner Doug Shulman announced the IRS would start regulating all tax preparers beginning with the 2011 filing season. The new regulations will mandate all paid tax return preparers register with the IRS, require continuing education and pass an entry competency test. While these requirements seem more than reasonable, there are some provisions which exempt CPAs and attorneys from these requirements. The reasons for the exemption are CPAs and attorneys have already passed a licensing examination and are already subject to continuing education requirements.

As a practicing CPA, I have a real big issue with exempting CPAs and attorneys from ALL of the requirements placed on “unenrolled preparers”. An unenrolled preparer is a tax preparer who assists with tax preparation and filing but who is not authorized to represent a business or individual before the IRS. Being a licensed CPA or attorney is no guarantee of tax expertise. The licensing examinations do not emphasize tax law. Plus, neither is required to take any tax related continuing education to maintain their licenses. Truth is many CPAs and attorneys have little tax experience. I should know. I prepare tax returns for them. Frankly, any CPA or attorney in tax practice and not willing to take the IRS competency test should be ashamed of themselves.

Before this announcement, I was fortunate to attend a public forum held in Chicago on September 30, 2009. The purpose of this forum was to gather input on tax return preparer standards. The forum featured two panels of representatives. The panels represented the tax software and unenrolled preparer industries. After the public forums was to provide Commissioner Shulman with a comprehensive set of recommendations to boost taxpayer compliance and to strengthen the standards for the tax preparation industry.

At this forum, I really thought the unenrolled preparers represented themselves well. The one thing they all had in common was their support for additional regulation for their industry. I suspect this panel probably had some quality tax preparers (at least the ones who didn’t represent the major chains) on it. From my own experience, there are some really good unenrolled preparers out there.

Unfortunately, many unenrolled preparers aren’t very good and guess where they work? The major chains like H&R Block, Jackson Hewitt and Liberty. The problem is most of these preparers are only doing this as seasonal and part-time work. Of course, their fees do reflect this lack of experience. There is a place for these operations in this world of tax preparation, but I wouldn’t recommend them for anything other than a single W-2 worker who files a 1040-EZ. If someone is willing to prepare your tax returns for something ridiculous like $40…then buyer beware!

It was curious why the IRS would even want input from software vendors who provide tax preparation software. While the software representatives also supported additional regulation for preparers. I would question why they would even care. After hearing their statements, it became obvious their only vested interest was to become the providers of continuing educations and to administer any competency test the IRS develops. It sounds like a money grab to me…a nice big, fat government contract!

It’s safe to assume the motivation for establishing these regulations was from a Treasury Inspector General for Tax Administration (TIGTA) report prepared in 2008. According to this report, unenrolled, unlicensed preparers had only a 35% accuracy rate in preparing income tax returns and more than one-third of the erroneous returns contained misstatements or omissions that TIGTA considered willful or reckless. While this isn’t a shock to me, I feel like this report was flawed on two levels.

First, the TIGTA report only sampled 28 unenrolled preparers. That’s a very small sample size. It’s certainly not a large enough sample to produce accurate results. Second, the testing excluded enrolled preparers such as CPAs, attorneys, enrolled agents and enrolled actuaries. I suspect if they were included, they would have found the same problems. Of course, none of this is news to me. Virtually every new client I get is an amended tax return waiting to happen. Guess who prepared the returns I’m amending…mostly CPAs! My brotherhood…go figure!

Reducing the Federal Deficit…A Different Look

2009-02-24T19:11:00.000-08:00

The American Recovery and Reinvestment Act of 2009 signed into law by President Obama will cost American taxpayers $1.16 trillion dollars according to some estimates. Before this piece of legislation, the United States of America already had a mind-boggling $1.5 trillion deficit. Who is going to pay down this deficit? The easy answer is the American taxpayer.

However, the answer isn’t quite that easy. There will be a significant number of taxpayers who will unknowingly and unwillingly pay more tax than necessary. Most of this group will come from the 43% of filers who prepare their own tax returns. Face it, the Internal Revenue Code contains over 3.4 million words and had nearly 500 changes during 2008. If you are not a tax professional, the odds are against you!

Our elected officials in Washington D.C. are well aware of this, but do not speak publically about this windfall. All the public ever hears about is the “Tax Gap”. The IRS defines it as “the difference between the amount of tax that taxpayers should pay and the amount that is paid voluntarily and on time”. Estimates of this “Tax Gap” vary from $40 to $123 billion annually depending whose number you want to accept. I suspect if we could determine the amount which is overpaid annually, we are probably looking at a wash with the “Tax Gap”.

Here’s my question. Why would 43% of tax filers WANT to prepare their own tax returns? I can appreciate paying qualified tax professional can be expensive, but isn’t the alternative more expensive? The one thing that troubles me is the number of people who rely on software such as Turbo Tax and Tax Act to prepare an accurate tax return. Here’s the thing, tax software is a tool. If you don’t know how to use the tool, you will NEVER get the right result. Tax software can guarantee accuracy in terms of mathematics. It cannot guarantee the Internal Revenue Code will be correctly interpreted. No software can make that guarantee.

At his confirmation hearings, Timothy Geithner admitted to more than $40,000 worth of mistakes on his tax returns from 2001 to 2004 while he worked for the International Monetary Fund. Geithner says it was an innocent mistake. When Senator Chuck Grassley asked him what program he used to prepare his taxes, he answered, “I’ll answer that question, but I will say these are my responsibilities, not the tax software’s responsibilities, but I used TurboTax to prepare my returns.” In case you didn’t know as Treasury Secretary, Geithner is responsible for the Internal Revenue Service. Talk about someone who doesn’t know how to use a tool properly.

Once you can fully appreciate why tax software can never guarantee that you receive every legal tax benefit, let’s address what is your time worth to you? The IRS estimates a self prepared tax return with the use of software will take you approximately 24.2 hours to complete. This doesn’t include the time spent preparing your state tax returns. Can you imagine the time estimate to prepare tax returns by hand?

The IRS encourages the use of tax software, but this is only for their benefit. Most tax software will allow taxpayers to file their tax returns electronically to the IRS. This means the IRS doesn’t require as much manpower to manually process tax returns. The IRS touts this as a benefit to the taxpayer because there will be fewer data processing errors. There is some truth to that because I have seen a number of illegible hand prepared tax returns. The real truth is the IRS wants taxpayers to rely on tax software and potentially overpay their tax.

The IRS has gone as far as strong-arming tax software companies to create the “Free File Alliance”. This program is touted as a “partnership” between the Internal Revenue Service (IRS) and private sector tax software companies. The “partnership” provides free federal income tax preparation and electronic filing for eligible taxpayers. Eligible taxpayers are those whose adjusted gross income for 2008 is less than $56,000.

Why do you think the program is limited to taxpayers with adjusted gross income less than $56,000? It’s pretty simple. The IRS understands most tax filers who will qualify for this program will prepare their own tax returns. We know why the IRS wants you to prepare your own tax return. They want you to overpay tax!

How does a taxpayer pay less tax legally? They need to work with an experienced and qualified tax professional. Who is qualified? I would suggest staying away from those retail tax preparation chains and those clowns who prepare tax returns “on the side”.

Here is why? In September 2008, the Inspector General for Tax Administration issued a report on commercial tax preparation chains and independently owned seasonal tax preparation offices. The report suggested 65% of the returns prepared by these establishments were incorrect and understated tax. The erroneous tax returns contained “mistakes and omissions considered to have been caused by human error and/or misinterpretation of the tax law”. It sounds like returns prepared by these establishments are audits waiting to happen. Another interesting aspect of this report was the average tax preparation fee for these erroneous tax returns was $175. I guess you get what you pay for!

Qualified tax professionals will charge rates commensurate with their level of experience and their investment in technology, tax research services and continuing education. A good tax professional is ethically bound to make certain you will legally pay the least amount of tax. This is the “peace of mind” every taxpayer should expect when working with the right tax professional.

Anyone can fill out a tax form, but only a qualified tax professional can do it right.

Remember in this economy, now is not the time to be penny-wise and dollar-foolish!

For more information about The Tax Dude® and how he provides value to his clients, please visit http://www.thetaxdude.com/.

Tax Help for Real Estate Professionals and Investors

2009-02-07T15:56:00.000-08:00

In today’s turbulent economy, the real estate market has taken a beating. With the downturn in the real estate market a lot of people have questions. Many of these questions are related to the tax implications of buying, selling or otherwise disposing of real estate.

Who do you turn to with your tax questions? You could turn to the Internet. While there is an abundant amount of information available, can you figure out how tax law applies to your specific situation? An alternative would be calling the IRS for assistance. Do you really want to wait on hold and hope you are getting the right answer?

Did you know…?

Landlords can greatly increase the depreciation deductions they receive the first few years they own rental property by using segmented depreciation.
Careful planning can permit you to deduct, in a single year, the cost of improvements to rental property that you would otherwise have to deduct over 27.5 years.
You can rent out a vacation home tax-free, in some cases.
Most small landlords can deduct up to $25,000 in rental property losses each year.
A special tax rule permits some landlords to deduct 100% of their rental property losses every year, no matter how much.
People who rent property to their family or friends can lose virtually all of their tax deductions.

The Tax Dude® helps real estate professionals and investors navigate the Internal Revenue Code. The Internal Revenue Code has more than one million words, is several pages long and in 2008, there were over 500 changes made to the code. That’s more than one per day! More than ever, you need the counsel of a qualified tax professional to decipher the Internal Revenue Code and apply it your unique financial situation.

The Tax Dude® has helped real estate professionals and investors with:

Maximizing deductible rental losses for Qualified Real Estate Professionals.
Questions related to the passive activity rules.
Tax implications of selling a residence which have been previously rented.
Tax implications of selling rental properties and depreciation recapture.
1031 Like-kind exchanges.
Tax implications of short sales and foreclosures of residences.
Tax implications of short sales and foreclosures of investment properties.
Application of the first-time home buyer federal tax credit.
Cost segregation studies for rental properties.
Involuntary conversions and casualty losses.
Historic rehabilitative and low income housing tax credits.
Deductions for environmental clean-up costs and energy efficiency.
Qualified conservation easements.

If you have a real estate related tax question, please visit our new website www.askthetaxdude.com. If you are interested in become a full service client, please visit our regular website www.thetaxdude.com for more information about The Tax Dude®.

Thoughts on the Real Estate Market Crisis

2009-01-17T22:56:00.000-08:00

It’s in the news every day. The U.S. housing market is in trouble, but how did we get here? There are many theories being bantered about. The group most commonly blamed for the crisis is the financial institutions who made these so-called “sub-prime” loans. Are they responsible for this mess? Forgive me for quoting Sarah Palin, “You betcha!” While it’s easy and convenient to point the finger at the financial institutions there are other parties at least equally culpable, if not more to blame.

The beginning of our housing crisis started many years ago. It started during the Clinton Administration. Yes, the same Clinton Administration which many believe guided us to economic stability. Let’s get real for a moment. “Slick Willy” Clinton benefited by the economic policies created by the previous administrations. Frankly, the smartest economic move Clinton ever made was the one he didn’t make. He retained Alan Greenspan as Chairman of the Federal Reserve. Greenspan subsequently repays Clinton in his memoirs titled The Age of Turbulence. In his memoirs, Greenspan sites Clinton as one of the smartest President’s he’s ever worked with (Nixon being the other). Thank goodness Greenspan’s economic aptitude was far better than his abilities to judge the intellect of others.

It’s easy to point the finger at our outgoing President for our economic mess, but he only deserves only part of the blame. President Bush also inherited many problems left behind by his predecessor.

Back in September 1999, The New York Times reported that the Fannie Mae Corporation was easing the credit requirements on loans that it would purchase from banks and other lenders. Fannie Mae was under enormous pressure from the Clinton Administration to do this. This action which began as a pilot program, encouraged lenders to give mortgages to people whose credit was generally not good enough for a conventional loan (aka “sub-prime” borrowers).

Fannie Mae took on significantly more risk by taking this action. In order to provide loans to less than qualified buyers, financial institutions created a whole slew of new mortgage products. These products became known as “sub-prime” loans. To summarize, new loan products were developed to give less than qualified buyers an opportunity to achieve the American dream. Gone was paying your bills on time to have a good credit score. Gone was saving enough money for a down payment, not to mention an emergency reserve. Heck, who needed income?

Many experts predicted that Fannie Mae would run into trouble during an economic downturn and would need a government rescue package similar to the one given to the savings and loan industry during the 1980’s. Now that day has come. Are people quick to point the figure at Fannie Mae? You betcha!

One more legislative failure of the Clinton Administration, a tax break proposed by Clinton during his 1996 Presidential campaign and eventually passed by Congress (known as the Taxpayer Relief Act of 1997). This tax break gave special treatment for capital gains on the sale of primary residences. It basically exempted most home sales from capital gains tax.

Quoting an article from The New York Times on December 19, 2008…

…many economists say that the law had a noticeable impact, allowing home sales to become tax-free windfalls. A recent study of the provision by an economist at the Federal Reserve suggests that the number of homes sold was almost 17 percent higher over the last decade that it would be without the law.

Vernon L. Smith, a Nobel laureate and economics professor at George Mason University, has said the tax law change was responsible for “fueling the mother of all housing bubbles.”

By favoring real estate, the tax code pushed many Americans to begin thinking of their houses more as an investment than a place to live. It helped change the national conversation about housing. Not only did real estate look like a can’t-miss investment for much of the last decade, it was also a tax-free one.

Don’t let my Clinton bashing lead you to believe I am anti-Democrat. I just have distain for “Slick Willy”. In good conscious I can’t heap all of the legislative blame on the Clinton Administration. Fairly recent legislation under the Bush Administration also exasperated the housing crisis.

On December 20, 2007, The White House sent a press release announcing President Bush had signed legislation called, The Mortgage Forgiveness Debt Relief Act of 2007. In his press release, President Bush remarks…I'm pleased to sign a bill that will help homeowners who are struggling with rising mortgage payments. The Mortgage Forgiveness Debt Relief Act of 2007 will protect families from higher taxes when they refinance their homes. It will help hardworking Americans take steps to avoid foreclosure during a period of uncertainty in the housing market.

On the surface, this piece of legislation sounds great. I could easily argue it was redundant and pointless. How so? The Internal Revenue Code already had a similar provision. Under Internal Revenue Code Section 108, a taxpayer who is insolvent can exclude from income any debts which have been forgiven or cancelled. The key is the taxpayer being insolvent. What is insolvency? It’s when your total debts exceed your total assets. It would stand to reason that anyone in danger of losing their home in foreclosure is likely to be insolvent.

The effect of the new legislation has actually benefitted people who aren’t insolvent. It has helped numerous people get out of mortgages completely unscathed (tax-wise). It helped people who aren’t in any financial difficulty. These people can make their payments, but choose not to because the amount they owe is greater than the market value of their home. I will address the market value issue later on. Isn’t the real problem the people who made a bad decision by substantially overpaying for their homes? Now they can walk away with only a ding on their credit report. If you think this isn’t happening, I have received dozens of e-mails from people all over the country doing this very thing.

What about these mortgage workouts we’ve been hearing about in the news? Here’s what’s really happening. Lenders are not adjusting interest rates (thereby lowering the payments) or reducing principal balances. They are simply back loading mortgages with a balloon payment for the missed payments. What is the result of these so-called workouts? A redefault rate in excess of 50%. When are we going to learn that sub-prime borrowers who couldn’t afford the payments before the workout would fare any better with these new arrangements? They are sub-prime borrowers for a reason.

Now that we have covered the major legislative aspects of our housing crisis, it’s time to move on to other contributing factors. The one I consider most important and truly the inspiration of this piece. Face it, a lot of the blame has been directed to mortgage brokers, appraisers and real estate developers. Did they play a significant role in this crisis? You betcha!

However, one group has flown under the radar of culpability. They are the realtors! Believe it or not, they played and continue to play a significant role in this mess. I’m not suggesting every realtor is to blame. There are a number of highly skilled, professional realtors out there. I am well acquainted with several of them.

Here’s the problem. Buying and selling a piece of property without a realtor is difficult. It’s almost as much of good old boy network as our judicial system. Try going to court without an attorney and representing yourself pro se. You know what happens? The judge sends you away telling you to show up with a lawyer next time. Judges were lawyers once upon a time and they take care of their own. The same thing happens with real estate transactions. How many realtors are going to show you a property on the market as “for sale by owner”? The answer is…none! Realtors are only going to show you properties in which they can receive a commission.

How did realtors contribute to our housing crisis? It goes back to the commission thing. The only person represented by a realtor is the realtor. The best explanation I’ve come across was contained in a book titled, Freakonomics written by Steven D. Levitt and Stephen J, Dubner. Here are some excerpts from that text…

…a transaction that wouldn’t seem, on the surface, to create much fear: selling your house. What’s so scary about that? Aside from the fact that selling a house is typically the largest financial transaction in your life, and that you probably have scant experience in real estate, and that you may have an enormous emotional attachment to your house, there are at least two pressing fears: that you will sell the house for far less than it is worth and that you will not be able to sell it at all.

In the first case, you fear setting the price too low; in the second you fear setting it too high. It is the job of your real-estate agent, of course, to find the golden mean. She is the one with all the information: the inventory of similar houses, the recent sales trends, the tremors of the mortgage market, perhaps even a lead on an interested buyer. You feel fortunate to have such a knowledgeable expert as an ally in the most confounding enterprise.

Too bad she sees things differently. A real-estate agent may see you not so much as an ally but as a mark. The book continues with a study cited in an earlier chapter which measured the difference between the sales price of homes owned by realtors and homes sold for their clients. The study found that an agent keeps her own house on the market an average of ten extra days, waiting for a better offer, and sells it for over 3 percent more than your house-or $10,000 on the sale of a $300,000 house. That’s $10,000 going into her pocket that does not go into yours, a nifty profit produced by the abuse of information and a keen understanding of incentives. The problem is that the agent only stands to gain an additional $150 by selling your house for $10,000 more, which isn’t much reward for a lot of extra work. So her job is to convince you that a $300,000 offer is in fact a very good offer, even a generous one, and that only a fool would refuse it. These are very powerful words given today’s marketplace when the realtors are going around asking sellers to lower their asking prices because it’s a “buyer’s market” and there is “a lot of inventory”.

The agent does not want to come right out and call you a fool. So she merely implies it-perhaps by telling you about the much bigger, nicer, newer house down the block that has sat unsold for six months. Here is the agent’s main weapon: the conversion of information into fear. Consider this true story, related by John Donohue, a law professor who in 2001 was teaching at Stanford University: “I was just about to buy a house on the Stanford campus,” he recalls, “and the seller’s agent kept telling me what a good deal I was getting because the market was about to zoom. As soon as I signed the purchase contract, he asked me if I would need an agent to sell my previous Stanford house. I told him I would probably try to sell without an agent, and he replied, ‘John, that might work under normal conditions, but with the market tanking now, you really need the help of a broker.’”

Within five minutes, a zooming market had tanked. Such are the marvels that can be conjured by an agent in search of the next deal. The fact is realtors have significant influence on the market as they are mostly responsible for setting the price for which a property is sold. When the real estate market was “hot”, who raised the bar on asking prices? The realtors. What was their rational? If a buyer can only afford a certain monthly payment for a piece of property, the amount of house they can afford increases as interest rates declines. Who cares if the property was overpriced? Not the realtors. They are well versed in telling buyers to focus on the monthly carrying costs and ignoring the actual price of the property. No doubt you can tell who the winners and losers are.

Consider now another true story of a real-estate agent’s information abuse. The tale involves K., a close friend of one of the book’s authors. K. wanted to buy a house that was listed at $469,000. He was prepared to offer $450,000 but he first called the seller’s agent and asked her to name the lowest price she thought the homeowner might accept. The agent promptly scolded K. “You ought to be ashamed of yourself, “she said. “That is clearly a violation of real-estate ethics.”

K. apologized. The conversation turned to other, more mundane issues. After ten minutes, as the conversation was ending, the agent told K., “Let me say one last thing. My client is willing to sell this house for a lot less than you might think.”

Based on this conversation, K. then offered $425,000 for the house instead of the $450,000 he had planned to offer. In the end, the seller accepted $430,000. Thanks to his own agent’s intervention, the seller lost at least $20,000. The agent, meanwhile only lost $300-a small price to pay to ensure that she would quickly and easily lock up the sale, which netted her a commission of $6,450.

So a big part of a real-estate agent’s job, it would seem, is to persuade the homeowner to sell for less than he would like while at the same time letting potential buyers know that a house can be bought for less than its listing price. These are very poignant words when we are seeing realtors who sold properties during the “seller’s market” and had the audacity to tell buyers they are getting such a great deal. Today, these same realtors are now telling these people they overpaid for their properties and are worth significantly less in today’s “buyer’s market”. You could say realtors want it both ways, but in reality they want it one way. A quick sale! If you have your property on the market and your realtor insists you lower your asking price, here’s a bit of advice. Tell your realtor to kiss your a**, stop whining and do their job. Suggest they cut their commission. They got you into this and they need to get you out of it. If they can’t do their job, list your property with a realtor who can!

Not only can we question a realtor’s ethics, but we should also question what qualifies an individual to become a realtor. To be blunt, it doesn’t take much at all. Prospective realtors must be high school graduates, be at least 18 years old, and pass a written test. Most states require candidates for a sales license to complete between 30 and 90 hours of classroom instruction. Geez, anyone can become a realtor!

Now that I’ve cast my wrath on the realtors, I want to conclude with some final thoughts. It’s time to stop treating our home as some kind of short term investment. A home is place to live. The real estate market is going through a much needed correction. We won’t be seeing people making a killing by flipping real estate. Real estate will return back to the good old days of small but steady returns. Back to the days when you couldn’t sell your home for a profit within 2-3 years after its purchase because the closing costs and commissions ate any small profit you might have.

The real estate market will rebound. When? Who knows? I suspect when our elected officials stop tinkering with the tax code, when lenders completely revert back to how we qualified for mortgages prior to 1999 and when realtors start letting buyers and sellers dictate the market.

"I've Got People" - With people like this, who needs enemies?

2009-01-07T10:15:00.000-08:00

H&R Block has been marketing "I've got people" for the last two tax seasons. With people like this, who needs enemies? If H&R Block is your people, please read the following...

Sacramento, Calif. (Jan. 7, 2009) By WebCPA staff

H&R Block has agreed to a $4.85 million settlement with California Attorney General Jerry Brown, and to stop marketing refund anticipation loans as early tax refunds.

"This settlement prevents H&R Block from marketing high-cost loans as early tax refunds," said Brown in a statement. "This is especially important because often these loans go to those who can least afford them."

Brown filed suit against Block in early 2006 regarding its marketing and sale of income tax refund anticipation loans and a related product called refund anticipation checks.

H&R Block continues to deny any wrongdoing. During the course of the investigation, Block has worked with the Attorney General's office to improve its practices. The complaint alleged a variety of deceptive practices by H&R Block, including:

• Deceptive advertising designed to disguise refund anticipation loans, which carry fees and other costs, as tax refunds, which the IRS provides without charge; and,

• Unfair debt collection practices by which customers' refund proceeds were garnished to pay off debts they supposedly owed.

The settlement provides for up to $2.45 million in restitution for consumers who purchased a "refund anticipation loan" or a "refund anticipation check" through Block between Jan. 1, 2001, and Dec. 31, 2008. H&R Block will also pay $500,000 in penalties and $1.9 million in fees and costs.

In addition. H&R Block will be prohibited from marketing RALs and related products in a deceptive or misleading manner and will be required to make clear and conspicuous disclosures to consumers prior to their purchase of these products. Terms of the settlement are limited to three years.

Brown has previously settled claims against Jackson Hewitt and recently concluded a trial against Liberty Tax Service. All three lawsuits involved refund anticipation loans and related products.

This isn't the first time H&R Block has settled a lawsuit for improperly marketing refund anticipation loans as "Rapid Refunds" and alike. Refund anticipation loans are another form of predatory lending. When a taxpayer electronically files a tax return and elects direct deposit of their refund, they will usually receive it within two weeks. Two weeks isn't too long to wait for a tax refund.

How Long Should You Keep Your Tax Records?

2008-12-12T13:49:00.000-08:00

The length of time you keep various records depends on the action, expense, or event that they record. Typically, you must keep your documentation that supports an income or deduction item on a tax return until the period of limitations for that return runs out - that is the period of time in which you can amend your return to claim a credit or refund, or that the IRS can assess additional tax.

According to the IRS, the "typical" tax return should be kept for 3 years, along with supporting documentation. However, I recommend retaining all of your tax returns. The tax returns don't take up much storage and many future problems can be resolved by looking back at old tax returns. Remember, if a tax return is filed where income was underreported or the return is fraudulent, the IRS can still come after you long past the 3 year statute of limitations. In order to start the statute of limitations, a tax return needs to be filed. This means everyone should file a tax return even if you are not required to do so. If there is a claim for losses from securities or a deduction for bad debts, then the records should be kept for 7 years. All employment records should be kept for 4 years.

Records relating to real estate should be retained until the period of limitations expires for the year in which the property was disposed of. These records support the calculation of depreciation, amortization, or depletion, and help to figure the gain or loss when the property is sold or disposed of. If there is an exchange of property, then records must be retained on both the new and the old property to support the value and treatment of the exchange.

Records that are not tax-related may still need to be retained by businesses. Insurance companies may require certain types of documents be retained, and some creditors or authorizing agencies may also have document retention requirements.

Choosing a Tax Professional

2008-11-03T13:02:00.000-08:00

Taxpayers are ultimately responsible for every entry on their tax returns. Having a paid professional prepare your tax return does not change that. That is why it's important to find a qualified professional to handle your federal and state tax matters. Unless you spend everyday handling tax matters, comprehending and interpreting the Internal Revenue Code and related regulations is too cumbersome for even the brightest taxpayers. The odds are stacked against most taxpayers.

Preparing a tax return is not a DIY project. Reliance on tax preparation software such as TurboTax does not guarantee a taxpayer will get their tax return right. Just because a tool (tax software) is available, it doesn't mean you know how to use it. I could use TurboTax and get the correct result, but doesn't mean everyone else can. Tax preparation software is only as good as the information entered into it. Think garbage in, garbage out.

How should you seek out a qualified tax professional? That's a great question. There are so many choices. Some good, some bad. For some people, going to retail tax preparation chain makes sense. If you have a very simple tax return, going to an H&R Block, Jackson Hewitt or Liberty Tax Service could make sense. Just remember, these stores are staffed with people who have minimal tax experience. H&R Block offers "tax schools" every year. They offer jobs to their best students. In many cases, the person preparing your tax return is a recent graduate from their tax school. If this person comes back for a second year, chances are they are the store manager. Other than staff inexperience, most of these stores are only open during tax filing season. If you need a professional who is available year round, these chains are not a good option.

What about CPAs? Passing the CPA exam is not a guarantee of tax competence. Not every CPA specializes in tax matters. Among those who do "specialize" in tax matters, some are good and some are not.

How about tax attorneys? Most tax attorneys do not handle compliance work (prepare tax returns). They are best at handling complex tax matters such as taking your case before the US Tax Court. Most tax issues are addressed without going to Tax Court.

One of the best ways to find a qualified tax professional is to ask someone who has a similar tax situation to yours. Getting a referral from a friend or family member work very well. You could also ask for a referral from your attorney, banker or financial advisor.

Here are some questions to ask any tax professional you are considering to work with:

Ask if your tax preparer is affiliated with a professional organization. Most organizations require its members to obtain continuing education and require them to adhere to a code of ethics.

Ask how the tax preparer how long he/she has been in the business of preparing tax returns.

Ask the tax preparer what tax issues he/she specializes in and if they have experience and knowledge to handle your tax situation.

Ask if the tax preparer is available to answer tax questions or address IRS and state correspondence year round.

Ask if the tax preparer outsources any of the work outside of their organization.

Ask if the tax preparer will perform the work personally or delegate it to someone else within their organization. If the work is delegated, ask about the review process.

Ask about your tax preparers privacy policy. Will your tax preparer share your tax information with any third parties?

Here are some warning signs of preparers you should avoid:

Avoid tax preparers who guarantee that they can obtain a larger refund than other preparers.

Avoid tax preparers who offer Refund Anticipation Loans (RALs) without full disclosure of the fees you will be charges on these loans.

Avoid tax preparers who refuses to complete the required preparer information or sign the tax return.

Avoid tax preparers who do not provide you with a copy of the completed tax return.

Avoid tax preparers who ask you to sign blank tax forms or forms prepared in pencil.

What about fees? Asking about fees is an appropriate question to ask, but don't make it your first question. Asking about fees before learning more about the preparer is not a smart move. Make this your first question and the preparer will think you are just shopping fees and less likely to answer any further questions. Remember low fees speak directly to the competence of a tax professional. Fees are directly related to your tax professionals experience and their investment in continuing education, technology and research services.

If you have any other questions about choosing an appropriate tax professional, please feel free to e-mail me at taxdude@covad.net.