Some people don’t want to deal with tax talk until right before the end of the year.
I personally believe that it is never a bad time to plan or even talk about income taxes.
Maybe it’s because I like to see what others are thinking and planning.
Perhaps it’s because I want to make sure that what’s out there is actually correct.
I don’t know.
I happened to end up on Kiplinger’s website.
An article called 10 Ways To Lower Your Taxes had me shaking my head.
First I wondered if the editors fact check this information.
Why?
The author, Kimberly Lankford does not have anything regarding an accounting or tax background on her mini-bio.
No, I am not taking a shot at her personally, just stating a fact.
Secondly, because the entire story is not told about each of the deductions mentioned.
As an accountant it really pisses me off.
To me, there isn’t a place for half-assed suggestions and half-truths in journalism or advice-giving.
Well, unless you’re not interested in your reputation or what gets published under your name.
But other than that, I find it completely irresponsible to knowingly leave out important information in articles like this, especially when it really wouldn’t take up that much more space (or take much more time to research).
All this stuff does, is cloud the minds of people who rely on them as resources.
And, in this particular article, there were so many places to expound on an idea or give warnings about not being able to qualify it’s amazing that anyone let this thing get published at all.
So what’s got me all riled up?
Well it would be the advice given to taxpayers on these subjects:
Tax Loss Harvesting
This as a blanket suggestion is a very bad idea right from the start for multiple reasons.
The first reason is that you can only offset $3,000 of income after countering capital gains with the losses.
It would make sense if the advice was to sell enough losers to first wipe out any gains you may have had, and then just enough to reach the $3,000 limit.
You get no bonus points for carrying a loss forward.
And there is no guarantee that you will even have any gains in the following years in order to use up those carry-forwards.
Simply because you want to save a little bit on your tax bill now is a terrible reason to sell stocks or funds that are down.
The second reason why it is a bad ideas is because there was a purpose behind investment purchases.
Unless that purpose has changed, there is no need to dump it for a small benefit today.
Giving To Charities
This is another one that confuses me.
To begin with, you can only take a deduction if you itemize, and that is a fact that escapes many people.
If you are looking to lower your tax bill, especially if it is due to the fact that you need the extra money in the refund, then why would you spend money to save even less on your income tax return?
It is counter-intuitive.
It’s one thing to donate because you want to and can afford to, but if you are in such dire straits that you need to scratch and claw for every penny you can get back on your return then donating to charity is not the way to go about finding those extra pennies.
Also, what many advice articles do not mention is that the IRS has established guidelines for what are reasonable amounts of donations based on income levels, and anything above those figures may flag the return for a potential audit.
All will be fine if everything you reported is on the up and up (and not just when it comes to the donations), but if not you better be able to come up with a pretty good rationale for why you did report what you did or else face not only paying the tax that would have been due had the correct numbers been used, but also penalties and interest are attached.
Worse yet, once you are audited and found to be guilty of falsifying your return or abusing certain privileges, you will then be on the IRS watch list, and no one wants to be in that position.
Prepaying Mortgages
This is a simple one to explain.
Very plainly, the IRS has established guidelines that state that a deduction can only be claimed for the portion of the expense that was allocated to the current year.
In plain English that means if you pay anything beyond your January mortgage in December, the 1098 will only contain the interest that was paid and applied up until December 31.
If you report more and try to justify that you are including it due to the fact that you made the payment in the current year, guess what: you’re wrong.
Since the interest portion of your payment was originally allocated to the next year, you are disallowed from claiming it early.
Real Estate Taxes
Another pretty simple one.
You cannot claim any deduction unless it was paid in the current year.
Everyone knows that the assessments are sent out in August or September and that the bill goes out in November, but just because you were issued a bill does not allow you the right to claim the deduction.
You must have physically paid the taxes by December 31 of the current year in order to get the deduction.
There is a bright side, however, and if for some reason you do not have the ability to pay that bill in the current year, you are permitted to claim the deduction in the following year when you do finally pay it.
Buying A Home Is A Great Tax Write-Off
I’m not sure where to even begin.
Many people, particularly the frugal will tell you that buying a home simply for the mortgage and real estate tax deduction is a horrible idea.
Aside from the fact that you will generally take on a great deal of debt, certain other factors come into play.
If you happen to buy into an area that has a homeowners association, or if you purchase a condo, you will have to pay association fees which are not deductible.
The HOA guidelines you must follow in regard to upkeep and appearance as well as home ownership costs that aren’t deductible such as:
- Lawn maintenance
- Appliance replacement
- Insurance
- Cleaning of the sidewalks and roof
- Replacing damaged portions of the visible domicile (ie: driveway pavers and roof tiles).
And, in order to even receive the deduction for the real estate taxes, you must (as was mentioned previously) actually pay them, and this is one of the top areas in which people underestimate or even exclude from their budget when considering a home purchase.
If you can afford to do so, then a home certainly does provide some tax breaks, although the breaks alone do not justify making such a large investment.
Let’s not forget that if you purchase a home at distressed prices, the mortgage interest and taxes may not be enough to itemize.
In that case, you get zero tax benefit at all.
College/Post-Secondary Expenses
This may be one of the more difficult deduction to figure out, especially since there are multiple deductions to choose from and the rules have recently changed.
But one thing is very clear: not every expense is allowed in the calculation of qualified expenses.
Tuition and associated fees are the only costs that are deductible, or to put it another way, only those costs that you pay to matriculate and sit in a class are deductible.
So what does that leave as non-deductible?
Well, pretty much everything else:
- Room and board (including meal plans even though most freshman are required to buy them)
- Costs of living (if off campus)
- Transportation fees
- Student life fees (sports and activities fees)
- Books, supplies and lab fees
- Insurance and medical expenses
**Some people will argue that books are an eligible expense, but per the IRS, they are only allowed to be included in your qualified expense calculation only if they are a requirement for enrollment or attendance.
I’ve never attended a class where the school stated that you weren’t allowed to register if you don’t plan on buying the books.**
Unfortunately, that is the way it is, and equally unfortunate is the fact that this distinction is often left out of the discussion on the topic giving taxpayers false hope for a large deduction.
Again, this is just a list of the more common deductions that are not often fully explained.
Almost every deduction has limitations of some sort, but many of the other major ones get full attention when it comes to their discussion.
The only thing you can do is to educate yourself to the best of your ability on the ones that apply to you.
You can also pay an experienced professional to prepare your taxes and know that in most instances, they have a much better understanding of the tax code.
That should get you the deductions that you truly qualify to take and save you the risk of being audited by ignoring the ones that you have no business even going near.
I did not know that about the “Pre-paying the Mortgage”. So, if you do happen to have enough money to actually make an extra payment, the interest is NOT deductible? Correct me if I am wrong.
Technically, no. The way it works is that interest from one month accrues and is due to be paid in the following month. So, if you pay your January bill before December 31st, you will get the deduction. If you pay the interest that was allocated to January’s bill early, you won’t get it. The IRS states in Publication 936 Home Mortgage Interest Deduction under the prepaid interest section:
If you pay interest in advance for a period that goes beyond the end of the tax year, you must spread this interest over the tax years to which it applies. You can deduct in each year only the interest that qualifies as home mortgage interest for that year. However, there is an exception that applies to points, discussed later.
If you prepaid interest in 2010 that accrued in full by January 15, 2011, this prepaid interest may be included in box 1 of Form 1098. However, you cannot deduct the prepaid amount for January 2011 in 2010. (See Prepaid interest, earlier.) You will have to figure the interest that accrued for 2011 and subtract it from the amount in box 1. You will include the interest for January 2011 with other interest you pay for 2011.
Of course the years are from the prior filing year due to the fact that the tax year 2011 publications and forms haven’t been issued yet, but it still is applied the same way.
I’m so glad you are busting a few of these misconceptions. A lot of good deductions like giving to charities and mortgage interest are ONLY if you itemize. A fact that a lot of people don’t realize until they sit at my desk and tell them, then we get into an argument.
Another one a lot of people misunderstand is the medical expenses. It only starts counting after 7.5% of your adjusted gross income so sometimes people don’t even reach that threshold and it doesn’t make any difference. Plus you don’t get credit in the year you are billed, they have to actually be PAID in that year.
Great job on clearing some of this confusion!
One of the biggest arguments I get is that people think because they are billed in the current year (medical expenses, real estate taxes), that they can take the deduction even though they haven’t paid them in the current year. They simply don’t know the difference between cash and accrual basis nor do they want to know.
I had one guy tell me that he wanted me to take all of the expenses he paid to board and nurse stray cats until he found a home for them, even though it was a non-issue and can’t be done. His argument was that he would deal with the IRS if they cam questioning it, regardless of how vehemently I argued that it would never fly. He was insistent that he could convince them otherwise.
Does the 1098 provided by the bank include the Jan/Dec interest situation?
I really don’t know the answer to that one, Evan. I would assume that the mortgage company reports what has been paid based on the amortization schedule for each particular loan, but there is also a chance that they just report any interest paid leaving the taxpayer responsible for calculating what is deductible. I’d check with the bank to see if they can tell you exactly how it is done.
No harm in admitting that I don’t understand many of these. I often think of leaving tax related stuff to professionals only.
That’s my point, SB. If someone doesn’t understand the rules they are supposed to follow, they need to turn to someone who does in order to get the job done the right way. Of course, when you buy your house, you will qualify for quite a few of these situations!
I love this post! You made several great points on deductions. Long time ago I made some charitable contributions but ended up not getting any tax benefits because I did not itemize.
That’s not bad, unless you only did so thinking that you would get the deduction. Sometimes the giving itself is worth more than any deduction you can claim anyway.
I totally agree. While some articles actually want to help, few only really help because they never provide the 360 degree outlook of every tip they provide especially for Charitable contributions and post-secondary or college expenses.