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2010 Tax year

Mortgage Debt Forgiveness and Taxes

Mar 12th, 2012
by jblankenship.
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When you have a debt canceled, the IRS considers the canceled debt to be be income for you, taxable just like a paycheck.  There are cases where you don’t have to include all of it though, and mortgage debt forgiven between 2007 and 2012 may be partly excepted from being included as income.

The IRS recently issued their Tax Tip 2012-39, which lists 10 Key Points regarding mortgage debt forgiveness.  Below is the actual text of the Tip.

Mortgage Debt Forgiveness: 10 Key Points

Canceled debt is normally taxable to you, but there are exceptions.  One of those exceptions is available to homeowners whose mortgage debt is partly or entirely forgiven during tax years 2007 through 2012.

The IRS would like you to know these 10 facts about Mortgage Debt Forgiveness:

1. Normally, debt forgiveness results in taxable income.  However, under the Mortgage Forgiveness Debt Relief Act of 2007, you may be able to exclude up to $2 million of debt forgiven on your principal residence.

2. The limit is $1 million for a married person filing a separate return.

3. You may exclude debt reduced through mortgage restructuring, as well as mortgage debt forgiven in a foreclosure.

4. To qualify, the debt must have been used to buy, build or substantially improve your principal residence and be secured by that residence.

5. Refinanced debt proceeds used for the purpose of substantially improving your principal residence also qualify for the exclusion.

6. Proceeds of refinanced debt used for other purposes – for example, to pay off credit card debt – do not qualify for the exclusion.

7. If you qualify, claim the special exclusion by filling out Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and attach it to your federal income tax return for the tax year in which the qualified debt was forgiven.

8. Debt forgiven on second homes, rental property, business property, credit cards or car loans does not qualify for the tax relief provision.  In some cases, however, other tax relief provisions – such as insolvency – may be applicable.  IRS Form 982 provides more details about these provisions.

9. If your debt is reduced or eliminated you normally will receive a year-end statement, Form 1099-C, Cancellation of Debt, from your lender.  By law, this form must show the amount of debt forgiven and the fair market value of any property foreclosed.

10. Examine the Form 1099-C carefully.  Notify the lender immediately if any of the information shown is incorrect.  You should pay particular attention to the amount of debt forgiven in Box 2 as well as the value listed for your home in Box 7.

For more information about the Mortgage Forgiveness Debt Relief Act of 2007, visit www.irs.gov. IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions and Abandonments, is also an excellent resource.

You can also use the Interactive Tax Assistant (ITA) available on the IRS website to determine if your canceled debt is taxable.  The ITA tax you through a series of questions and provides you with responses to tax law questions.

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If You Converted to Roth in 2010 – You Have About 50 Days Left to Recharacterize

Aug 24th, 2011
by jblankenship.
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For those of you who took advantage of the one-time opportunity in 2010 to convert IRA funds to Roth IRA accounts, spreading the tax over the following two years (2011 and 2012), you are faced with a decision-point:  if you have reason to recharacterize the conversion, you have to do this by October 18, 2011.

Why might you want to recharacterize?

Here’s a ferinstance: If you converted $10,000 from your IRA account on December 31, 2010 into your Roth IRA and invested it in the S&P 500, that $10,000 converted is now worth approximately $8,997 (using a recent price).

If you are in the 25% bracket, you will owe $2,500 on the conversion, which equates to 27.79% in taxes on the conversion.  If your chosen investments did worse than the S&P 500 (and you know some of them probably did), your effective tax will be even higher.

Now, chances are that your investment may increase in value before you actually pay the tax on your 2011 and 2012 returns, but then again maybe it won’t.  Why pay the extra tax (or rather, the tax on the extra amount) if you don’t have to?

You can recharacterize the amount in your Roth IRA that corresponds to this conversion back into your traditional IRA – but you must do it before October 18.  At that time, you’ll also want to file an amended tax return showing that the conversion “did not happen” for tax year 2010.

On the other hand

If you bought the S&P 500 about a year ago with that same $10,000, it’s likely worth about $10,335 today, so you might want to leave the conversion alone.  Now your effective tax rate on the conversion (if you’re in the 25% bracket) is only about 24.19%.  Granted, it’s not a dramatic increase, but still it probably is better than you originally thought when you started this process.  And you’ve got two more years to pay all of the tax.

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Tax Bill Higher Than You Expected?

Apr 18th, 2011
by jblankenship.
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Now that you’ve (hopefully) filed your return for 2010, you may have noticed that the bill was higher than you expected.  This may be due to some subtle changes to the tax law that affected your return for this year.  Listed below are some of the changes that you may have been impacted by:

Social Security taxation: Especially if you had unusual income taxed in 2010, such as a Roth Conversion, you could be subject to as much as 85% taxation of your Social Security benefit.

Alternative Minimum Tax: If you’ve been impacted by this, not only are your ordinary income tax items taxed at a higher rate, but your capital gains and dividends could be taxed at a rate higher than 15% as well.  This happens for folks with incomes between $150,000 and $439,800 (or $112,500 and $302,300 for singles) as the AMT exemption phaseout occurs.

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Child Tax Credit: If your income is over $110,000 ($75,000 if filing Single), the Child Tax Credit reduces by $50 for each $1,000 over that limit.  This has the effect of increasing the marginal tax rate by 5% for each child, as your income increases.

Passive Loss phaseout for rental realty: If your AGI is greater than $100,000, the deduction of up to $25,000 of losses from rental real estate is phased out up to an AGI of $150,000 when the deduction is eliminated altogether.  This can increase the marginal tax rate by 50% ($25,000 credit eliminated as your income increases by $50,000).

There may be other reasons that impact your tax bill, but these are some that have recently come to light as typically occurring.

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The Making Work Pay Credit

Feb 2nd, 2011
by jblankenship.
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red and green holiday chocolate candies by Rainbow PhotosMany (or most) working taxpayers will be eligible to receive a special credit on their 2010 tax return, called the Making Work Pay Credit.  The IRS has recently produced their Tax Tip 2011-15 which explains five important provisions about the Making Work Pay Credit:

  1. The Making Work Pay Credit provides a refundable tax credit of up to $400 for individuals and up to $800 for married taxpayers filing joint returns.
  2. Most workers received the benefit of the Making Work Pay Credit through larger paychecks, reflecting reduced federal income tax withholding during 2010.
  3. Taxpayers who file Form 1040 or 1040A will use Schedule M to figure the Making Work Pay Tax Credit.  Completing Schedule M will help taxpayers determine whether they have already received the full credit in their paycheck or are due more money as a result of the credit.
  4. Taxpayers who file Form 1040-EZ should use the worksheet for Line 8 on the back of the 1040-EZ to figure their Making Work Pay Credit.
  5. You cannot take the credit if your modified adjusted gross income is $95,000 for individuals or $190,000 if married filing jointly or more, you can be claimed as a dependent on someone else’s return, you do not have a valid Social Security number or if you are a nonresident alien.

Be on the lookout for this important provision as you prepare your return for 2010.

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Date Set for Processing Delayed Returns

Jan 21st, 2011
by jblankenship.
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go wild by hillary h The IRS announced on January 20, 2011, that the delayed returns – those that have itemized deductions on Schedule A, include higher education tuition and fees deductions on Form 8917, and/or that include the educator expenses deduction, can begin processing on February 14.

Many processors (commercial software) will accept these returns now and send them to the IRS beginning on February 14, so there is no reason to delay.  And if your processor (or tax guy or gal) doesn’t allow for the early acceptance, you can still get your information in to them and they’ll submit it when the time is right.

This delay was explained in the article that I wrote earlier about how some returns would be delayed this year due to the late passage of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.

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A Good Reason to Not Convert to Roth

Dec 29th, 2010
by jblankenship.
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Claudius 41-54 AD by woody1778aWhile there are many reasons that it may be in your best interest to pay tax and convert funds from a traditional IRA to a Roth IRA, there are a few situations that you might want to keep in mind as you consider converting.

I covered Three Reasons You May Not Want to Convert to a Roth IRA in an earlier article, and here we’ll be talking about another – the probability of paying medical expenses from your traditional IRA.

Under current tax law, you are allowed to deduct medical expenses to the extent that the expenses exceed 7.5% of your Adjusted Gross Income (AGI).  In effect, if you utilized IRA distributions to pay for these medical expenses, everything above 7.5% of your AGI can be tax free after deduction.  This is much better than paying up to 35% on a Roth conversion and then using those funds later at no tax.

Since many of us can expect to pay a considerable amount for future medical expenses – whether for doctors and hospitals, or for nursing home costs, or even for in-home nursing care – it might make good sense to maintain a balance in a traditional IRA rather than converting all of it to a Roth IRA.

Either way, since the removal of the income limitation on Roth conversions is not restricted to 2010, you can do a conversion in 2011 or later years with no restrictions (at least under current law).

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