From the Archives: You Won the Dream Home, Part 4 — Changing My Mind

In early 2012, I wrote 6 parts relating to the tax consequences of winning the HGTV Dream Home. I wasn’t happy with any of the 6 parts because they were so disjointed. It was supposed to be a 2- or 3-part series, very simple. But as I was writing I kept thinking of new variables, and readers would write to me with suggestions and corrections.

By the end of the 6 parts, the series had become hard to follow. But all 6 parts remain popular more than 3 years later.

Here’s Part 4 of that series.

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Originally published January 26, 2012

I learned some new information on Thursday that has changed my mind on what I would do if I won the HGTV Dream Home. I hadoriginally said I would rent out the home as a vacation condo. But there’s a big problem with that, and it has nothing to do with taxes.

Covenants

A website visitor from Utah checked out the local covenants and reported the following to me:

I went to the River Meadows Ranch (where the HGTV dream home is for 2012) and read the covenants. You can’t rent the home out for seasonal use. It can be rented for residential use with a standard lease agreement only. You also cannot have more than 2 non related persons living in the home. Thus, even if you wanted to live in it and rent out the one end of the home with the bedroom, family room and changing room it could only be to a single couple.

Basically this means you can’t rent the home on a short-term basis. You would have to find an ongoing renter, which would be hard. Anyone who could afford the monthly rent on a home with a $2 million market value would probably just buy a home rather than rent one.

Take the Money and Run!

With this information, I am now inclined to say that if I won the Dream Home, I would take the cash option and not even mess with taking possession of the house.

Image: Stuart Miles / FreeDigitalPhotos.net

From the Archives: New Preparer Requirements on Earned Income Credit = Higher Fees for Clients

checklist-310092It’s a holiday week so I’m re-publishing popular posts from the past.

This post is editorial commentary from December 21, 2012, about new IRS requirements on preparers regarding tax returns claiming the earned income credit.

With editorials, it’s interesting to look at predictions as time passes.

What I’ve found in my practice is, the EIC documentation requirements have indeed resulted in higher fees for returns claiming the EIC, but I didn’t raise fees as much as I had thought I would.

I also have found that the paperwork burden is not nearly as bad as I had thought it would be. I don’t deal with a lot of EIC claims, but for those that I have dealt with, getting the needed paperwork and filling out the Form 8867 isn’t that onerous.

Image courtesy of user Nemo on Pixabay.com

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Originally published December 21, 2012

The IRS has placed new requirements on tax preparers who prepare tax returns that claim the Earned Income Credit. As Robert Flach (aka, “The Wandering Tax Pro”) says, the IRS is basically making tax preparers become social workers.

For example, if someone who claims the EIC has a qualifying child, we — the preparer — must ask for, and keep copies of, documentation that proves that the child lived with the taxpayer. Examples of documentation we must ask for and keep copies of include: school records, medical records, child care provider records, etc. (You can see the entire list of insanity by viewing the full Form 8867, “Paid Preparers Earned Income Credit Checklist.”)

Preparers have always been required to review data, ask questions, and verify anything that seems suspicious. But we’ve never before been asked by the IRS to play the role of auditor by forcing clients to submit documents such as school records to us to review.

Thankfully I don’t prepare too many EIC returns. But the few that I do prepare will be billed at a much higher rate than in the past.

My fee for returns claiming the EIC will increase more than $30 over what I have charged for EIC in the past. There’s simply too much work involved, and too much risk on my end of me being hammered by the IRS if I don’t check the right boxes on the Form 8867.

Glossary of Tax Terms: AMT

ID-10011791AMT stands for Alternative Minimum Tax. AMT is an alternative tax calculation that re-figures taxable income without personal exemptions and certain itemized deductions.

Those certain itemized deductions that are not allowed for AMT purposes are:

  • All state and local taxes (income tax, property tax, car registration, etc.)
  • Miscellaneous deductions subject to the 2% of AGI limitation
  • The allowable amount of medical expenses is different
  • Mortgage interest if any part of the mortgage was used for a purpose other than buying, building or improving your home (example: you take out a line of credit on your house to buy a car — the interest on that LOC is deductible for regular tax purposes but not for AMT)

There are many other adjustments that may need made, depending on the taxpayer’s situation. You can look at Form 6251 for a complete list of adjustments.

AMT Exemptions and Tax Calculation

Once you’ve calculated your income for AMT purposes, you subtract out an exemption amount. For 2013, those amounts were $51,900 for single filers and $80,800 for married filers. (If your income is above certain levels, your exemption amount is reduced; see line 29 of Form 6251). The resulting number is your taxable income for AMT purposes.

If the amount is less than $179,500, you multiply the amount by 26% and compare it to the amount of “regular” tax you owe. Whichever amount is higher is the amount of tax you owe. If your AMT taxable income is above $179,500, a 28% tax rate applies. See Line 31 of Form 6251.

Image courtesy of graur razvan ionut / freedigitalphotos.net

Why Make Estimated Tax Payments, Part 2

money-case-163495_1280This is part 2 of an explanation of estimated tax payments. In Part 1, I detailed the math behind the tax formula. In Part 2, I’ll explain why a taxpayer might want to make estimated tax payments.

Here’s the reason: if you’re fully self-employed, you don’t draw a paycheck in the traditional sense.

Since you don’t draw a paycheck, there’s no withholding on your earnings. If we reference the tax formula in Part 1, if your tax liability is larger than your withholdings, estimated tax payments and tax credits, you’ll owe tax when you file your tax return.

If you’re fully self-employed, turned a profit in your business, and paid no estimated tax payments, you’ll likely owe at tax time.

Estimated tax payments aren’t required, but they are highly recommended.

Here’s an example from a real client of mine.

The client is self-employed. He typically owes $25,000-$30,000 when he files his tax return.

He never makes estimated tax payments, and he doesn’t have $30,000 sitting around to send the IRS. So he enters into a payment plan.

Time passes quickly and now it’s tax time again. He owes another $30,000. All of the tax payments he made during the year were applied to last year’s tax debt. So now he’s got another $30,000 debt and another payment plan to work out.

If this process repeats itself too many times, a taxpayer can find themselves hopelessly in the hole.

And that’s why you make estimated tax payments. It forces you to pay your tax liability bit-by-bit during the year, so you don’t end up being saddled at tax time with a tax liability that’s too large to pay in full.

Breakeven Analysis for Small Businesses, Part 2

income-tax-491626_1280 (2)In part 2, we’ll look at variations on the breakeven formula and analysis.

For example, what if you sell multiple products? This quite likely with a typical small business.

The first thing you need to figure out is your “sales mix.”

Sales mix is the amount of sales of each product you sell.

Example

Your fixed costs are $52,000. You have 3 products with the following sales prices and variable costs:

 

Product X Product Y Product Z
Sale Price 100 50 30
Variable Costs 50 30 10
Contribution Margin 50 20 20
Percent of Sales 20% 30% 50%

From here, you need to determine your “weighted average sales price.” This is not as hard or ominous as it sounds!

  1. Product X sells for $100 and makes up 20% of your sales. $100 x 20% = $20
  2. Product Y sells for $50 and makes up 30% of your sales. $50 x 30% = $15
  3. Product Z sells for $30 and makes up 50% of your sales. $30 x 50% = $15
  4. $20 + $15 + $15 = $50

Your weighted average sales price is $50.

Then, we use the same process to calculate our weighted average variable costs.

  1. Product X: $50 x 20% = $10
  2. Product Y: $30 x 30% = $9
  3. Product Z: $10 x 50% = $5
  4. $10 + $9 + $5 = $24

Your weighted average variable cost is $24.

Now What?

Now it’s a matter of using the basic breakeven formula.

Average sales price of $50 – Average variable cost of $24 = $26 contribution margin.

Fixed costs are $52,000. $52,000 / $26 contribution margin = 2,000 units

You’ll need to sell 2,000 units at your sales mix percentage in order to break even.

  • Product X: 2,000 x 20% = 400 units
  • Product Y: 2,000 x 30% = 600 units
  • Product Z: 2,000 x 50% = 1,000 units

If we sell each product at these levels, you’ll break even.

Problems

The problem with this (and with breakeven analysis in general) is if your sales mix varies at all, it throws off the entire calculation.

Breakeven analysis is not an exact science, especially for a small business that probably doesn’t have the resources to run this calculation with high precision.

I tell people that this is still an important exercise to go through so you get a general idea of how much you need to be selling, and how much you need to charge, so you can at least break even and hopefully turn a profit.

And of course, a good accountant can help with this analysis.

Image courtesy of user stevepb on Pixabay.com