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Mortgage interest deduction on jointly-owned homes (Part 1)

Jointly owning a home encumbered by a mortgage with a non-spouse family member presents income tax reporting challenges and the potential for a deduction to be disallowed or challenged.  A taxpayer’s home mortgage interest is generally deductible (within limits) if the taxpayer is the legal or equitable owner of the property.  There is, however, no requirement that the taxpayer be liable on the loan (Reg. Sec. 1.163-1(b)).

In Qui Van Phan , TC Summary Opinion 2015-1 (Tax Ct.), the taxpayer’s mortgage interest deduction was allowed, despite the fact that he did not own the property and was not liable on the mortgage.  The taxpayer successfully convinced the Tax Court to allow the deduction based on the following:

1. Taxpayer was under an oral agreement to purchase the property from his family members.

2. Taxpayer paid the mortgage, taxes, insurance, and other bills associated with the property.

3. Taxpayer maintained the property.

4. Taxpayer made improvements to the property.

5.Taxpayer provided clear and convincing evidence of the above facts.

The last point is key – no matter the ownership and bill paying arrangement, it is crucial that it be provable by clear and convincing evidence.  Most challenges to the mortgage interest deduction take the form of a correspondence audit – basically, a letter from the IRS notifying you that your account has been changed and that you have a period of time to challenge the modification.  When you receive these letters, you should contact a qualified tax professional immediately to write a letter back to the IRS documenting your ownership structure and bill paying arrangements.  Although the tax savings generated from the mortgage interest deduction for that particular year being challenged may or may not be worth the cost of hiring a professional (depending upon the size of the deduction), the cost of forgoing the mortgage interest deduction for the life of the mortgage will almost always outweigh the cost.




California Tax Planning Part 2 – Estimated Tax Payments for High Income Taxpayers

High income taxpayers have two sets of estimated tax payment rules that apply to them – federal rules and California rules.  Under the federal rules, high-income taxpayers have to pay in the lesser of 2 numbers in equal installments before the end of the tax year:

(1) 90% of the current year’s liability; or

(2) 110% of the previous year’s liability (non-high income taxpayers use 100% instead of 110%).

However, under California law, high income taxpayers with more than $1 million of AGI must pay in 90% of the current year’s liability, as these taxpayers are ineligible for the prior-year safe harbor.  Furthermore, unlike federal, California taxpayers must front load their estimated tax payments in the 1st and 2nd quarters (30% and 40% in each, with the remaining 30% due in the 4th quarter).

It may seem simple, but I find that many tax preparers are not adequately (or at all) instructing their clients about their responsibility to pay estimated tax payments.  Failure to pay in your estimated tax payments results not only in big tax bills in tax season, but also non-deductible penalty payments.  With bank savings account interest rates hovering around next to nothing, it is a no-brainer to pay in your estimated taxes as required and avoid penalties in tax season.

Backdoor Roth IRA’s

Reading President Obama’s recently released budget proposal for 2016 is like reading a tax attorney’s playbook – many of the good tax savings ideas are in there, except the President wants to end them!  One such proposal is to limit Roth conversions to pre-tax dollars.  While I don’t expect any serious tax reform bills to be signed into law anytime soon, it is a good idea to familiarize oneself with existing “loopholes” in order to maximize tax savings while available.

What is it?  A “backdoor” Roth IRA conversion refers to contributing after-tax money to a traditional IRA and then converting that traditional IRA into a Roth IRA.  The reason for undertaking this convoluted procedure is that while contributions to a Roth IRA are limited based upon income levels, contributions to a traditional IRA are not, although the ability to obtain an income tax deduction by contributing to a traditional IRA is limited by income.  Thus, a backdoor Roth IRA allows an indirect contribution to a Roth IRA when a direct contribution would not otherwise be allowed.  No income tax is owed on the conversion of the original contribution dollar amount (since the traditional IRA contribution was, in this scenario, non-deductible) and the money can grow tax free in the Roth IRA.  Furthermore, Roth IRA’s do not have required minimum distributions and are not subject to income tax upon receipt.

What would President Obama’s proposal accomplish?  Roth IRA conversions would be limited to pre-tax contributions (and earnings thereon) to traditional IRAs, so this loophole would effectively be closed.  The ability to convert pre-tax dollars in a traditional IRA would still be available, but income taxes will be incurred by the conversion.

Strategy: If this retirement savings/wealth accumulation strategy sounds interesting, get started.  If you wait, you could miss out if tax reform is ever implemented.  It is important to note, however, that there are pitfalls to any tax minimization strategy, and this one is no different.  Consult your tax advisor prior to making the conversion to determine the tax effects, especially if you have other pre-tax retirement accounts.

401(k) Loans and mortgage interest expense

Most people think of their 401(k) as a “hands off” asset that can’t be touched until retirement.  Although this is sound strategy for retirement planning, the 401(k) can be a source of short-term funding that will continue to grow despite being withdrawn now for other purposes.  Depending upon your plan policies, 401(k) participants can take a loan from their accounts in an amount up to $50,000 (limited to 50% of your account value) at a 3.25%-5.25% interest rate without recognizing the loan amount as income (as would otherwise happen upon receiving a distribution from a 401(k)).  This means that although retirement account assets have been diverted away from the account for 5 years and the participant has lost out on 5 years worth of stock market appreciation (or losses), there has been a guaranteed 3.25-5.25% per year return by simply paying the loan back.  And since the 401(k) is yours when you retire, you are paying yourself back by simply shuffling money from one pocket to another.

What if you could turn the otherwise non-deductible 401(k) loan into a tax deductible loan by securing the loan with a deed of trust on your residence?  That would be the best of all possible worlds – guaranteed returns of 3.25%-5.25%; paying oneself instead of someone else; and deducting the interest paid for a tax benefit.   It is possible, but unfortunately, only in very limited situations, such as for non-key employees.  Furthermore, tax deductions for interest is limited to interest accrued on non-elective deferrals (i.e. appreciation in the account or employer-deposited amounts). However, if you fall into this small category of individuals, the results can be worthwhile, as illustrated below.


  1. Non-key employee;
  2. 401(k) with a significant non-elective deferral balance;
  3. $50,000 of student debt at a 8% interest rate (which is entirely or partially non-deductible, depending upon income level); and
  4. Also owns a home.

If this person were to take a $50,000 loan from the 401(k) at a 3.25%-5.25% interest rate and secure the loan with a Deed of Trust on the home, this person could deduct the interest expense on the $50,000 401(k) loan and save 2.75% – 4.75% (the difference between 8% and 3.25%-5.25%) on the interest rate over the life of the loan.  Furthermore, by securing the 401(k) loan with a Deed of Trust, the 5 year repayment period can be extended, thus reducing the monthly payment.


Although this seems like a no brainer, there are many potential issues with this plan to consider (other than the issue presented above relating to key employees and elective deferrals) and you should consult your tax adviser prior to taking out a 401(k) loan.  For example, all of the benefits (such as forbearance and deferment) of having public student loans disappear when you pay them off with the 401(k) loan.  Furthermore, itemized deductions can be limited based upon your income levels and home equity debt is limited by the Alternative Minimum Tax.  Lastly, if the stock market has a gangbuster year, you could miss out on significant appreciation.  On the flip side, though, if the stock market has a bad year, you will have had a good year simply by paying yourself interest.


How to avoid repaying the 2008 first-time homebuyer credit

If you purchased a home in 2008 and took a first-time homebuyer credit on your 2008 tax return, you know that this credit is really more like a loan – you have to pay it back in $500 increments over 15 years.  You likely also know that if you sell your home before the 15 years is up, that you have to repay the loan on your tax return in the year of the sale.  But did you know that if you sell your home for a loss (as adjusted by closing costs and the unpaid amount of the loan) that you don’t have to repay the loan?  If you are selling your home for a loss or near breakeven, then this could be a ~$5,000 windfall for you.  If you are contemplating selling your home in 2015, this windfall could help make selling for a loss a little easier to bear.


Flashback to 2014: IRA Transfers to Charity – Why you should start planning for year-end charitable transfers now.

If you had blinked, you would have missed it – nontaxable IRA transfers to charity were approved and then expired within a 2 week period this last December.  Since it seems that every year Congress re-authorizes expired tax breaks, my guess is that we will see a repeat in 2015 and taxpayers will again have a limited window to transfer IRA assets to charity.  If you are charitably inclined and in a higher tax bracket, you should take this strategy into account for your 2015 charitable planning.

What is it?  An IRA to charity transfer is a direct distribution of up to $100,000 from an IRA account to an eligible charity.  The only catch is that the IRA account holder must be 70 1/2 or older.  The provision authorizing this procedure expired on December 31, 2013, but in December, 2014, the expiration date was extended to December 31, 2014.  This means that taxpayers that made an IRA to charity transfer anytime in 2014, even if it was not good law at the time, are entitled to reap the tax benefits of the transfer.

What are the tax benefits?

  1. The transfer qualifies as the required minimum distribution, meaning any amount transferred reduces the amount that would otherwise be required to be withdrawn and recognized as income.
  2. The amount transferred does not count as income, but there is no deduction for a charitable contribution.
  3. Lower income is almost always a good thing from a tax perspective – lower marginal tax rates, avoidance of the Medicare surtax on investment income, lower taxation of social security benefits, and avoidance of income-based itemized deduction and exemption phaseouts.

So what should I do?  You have 2 options – you can assume that the provision will be extended again and make the transfer now, or you can wait until the end of the year to see what happens.  If the provision is not extended and you make the transfer now, you will be in no worse position so long as you don’t transfer more than your required minimum distribution. If you wait and see and the provision is not extended, then you may have to squeeze all your planned charitable contributions into the end of the year.


PSA: That’s probably not the IRS on the phone…

Unfortunately, scammers are simply a fact of life.  If you receive a phone call from someone claiming to be from the Internal Revenue Service or the Franchise Tax Board, it is most likely a scam.  Remember, the IRS and FTB will never call you without first sending a notice and they will never demand payment over the phone via credit card.

The IRS has recently posted a video which covers ways to protect yourself:

The FTB will make automated collection calls (see:, but anyone from the FTB demanding immediate payment over the phone is a scammer.

If you are ever unsure if the alleged tax collector on the other end of the line is legitimate, simply ask for their contact information where you can call them back and ask for a notice to be mailed.  If you are uncertain whether you owe taxes, please do not hesitate to contact us.  Remember: do not give anyone your personal information over the phone!


California Tax Planning Part 1 – Turn your Charitable Deductions into Charitable Credits

Although most tax planning contemplates minimization of your IRS tax bill, there are other strategies for reducing your ever-increasing California income tax bill too.

Part 1: Make a donation to the California College Access Tax Credit Fund, which funds the Cal Grant Program.

Donations to the California College Access Tax Credit Fund are deductible on your federal return and 60% of your donation is a credit on your California tax return.  As will be explained below, the transformation of a deduction into a credit provides more bang for your charitable buck and provides an opportunity for those who have already reached their limit on deductible charitable contributions in 2014 to continue giving to charity while receiving valuable tax benefits in return.

Normally, deductions reduce your tax bill by your marginal rate while credits provide a one-for-one reduction of your tax bill. For example, assume $100 of income, $50 of deduction, and a 25% tax rate.  In this scenario, your tax bill is $18.75.

100 Income

(25) Deduction


75  Net Income

x 25%


18.75 Tax bill

Assume instead that your $25 of deduction is actually $25 of credit.  In this scenario, your tax bill is zero.

100 Income

(0)   Deduction


100 Net Income

x 25%


25 Pre-Credit Tax Bill

(25) Credit


0 Tax Bill

With this tax credit, the credit is only worth 60% of the donation amount, so instead of a zero tax bill, the tax bill would instead be $10, which is still less than the $18.75 tax bill from the first scenario.

As you can see, credits are much more valuable than deductions, which reduce your tax bill at a lower rate and which can be phased out depending upon your income level.  This tax credit is being phased out over 3 years (the credit about is 55% in 2015, 50% in 2016, and disappears in 2017) and cannot be used to reduce Alternative Minimum Tax, although unused credits carryover for 6 years.

If you have any questions about how a donation to this Tax Credit Fund will affect your individual tax situation, please contact us to set up a consultation.

The individual health insurance mandate begins in 2014.

Due to Obamacare/the Affordable Care Act, tax preparation for tax year 2014 is going to be even more complex and time-consuming than ever.  The “individual mandate” to have health insurance began in 2014 and starting this upcoming tax season, I and other tax preparers are going to need to collect additional paperwork from our clients.

First, the following is a recap of the relevant tax provisions:

  • All individuals are required to have insurance for at least one day in a month, qualify for an exemption, or pay the individual mandate penalty (officially, the “shared responsibility payment”).
  • All individuals who are required to file a tax return must report their insurance on that tax return and report themselves as one of four categories:
    • Individuals who have qualifying insurance through the exchange;
    • Individuals who have qualifying insurance through an employer or Medicare;
    • Individuals who did not get qualifying insurance and do not have an exemption (and who will pay the penalty); or
    • Individuals who did not get qualifying insurance but an exemption to the penalty exists.

Please note that not all members of your family will necessarily have the same category as each other.  Furthermore, each individual may have multiple categories during the year, since the insurance mandate is tested on a month-by-month basis.

Once we have determined the proper categorization for each individual, it will be necessary to collect the information required to be reported on your tax return.  Those who have insurance through an exchange will receive Form 1095-A, Health Insurance Marketplace Statement.  Those who have insurance from Medicare will receive a statement from Medicare.  Those who receive insurance through an employer will receive Form 1095-B or 1095-C, however, if neither of these forms are available, a copy of the insurance policy will provide us with the necessary information.  If you are unable to provide any documentation to us but know that you had qualifying coverage, we will prepare a statement for your signature certifying that you have qualifying coverage.

Lastly, those who are exempt from the individual mandate will not have to pay the shared responsibility payment.  However, some exemptions require a certificate from an exchange and we will be unable to claim an exemption without a copy of the certificate.  Examples include those who are members of certain religious sects, those who are unable to afford “affordable coverage”, those whose health insurance plan was not renewed and other plans were not affordable, and those who had other issues, such as foreclosures, bankruptcy, illness or death in the family, etc. that prevented them from getting insurance.

As with all new tax laws, correctly reporting your tax liability is getting more complicated, not less so.  If you think that you may qualify for an exemption or if you would like to discuss the individual health insurance mandate as it applies to your individual tax situation, please contact us to schedule a consultation.



Credit card frequent flyer miles are not taxable – but miles earned for opening a bank account are.

I don’t often get to think about the tax implications of my personal hobbies.  Perhaps if I was an amateur horse breeder, I would have more opportunity.  However, as an avid frequent flyer miles collector, the following case makes me nervous.

The Tax Court recently ruled in Shankar v. Commissioner (2014, 143 T.C. 5) that the value of an airline ticket redeemed with frequent flyer miles was an item of gross income.  In this case, Shankar opened a Citibank bank account in 2009, received 50,000 Thank You points for opening the account, and then redeemed them in 2009 for a domestic round trip ticket.

It is accepted practice (Announcement 2002-18, 2002-1 C.B.621) that frequent flyer miles earned by flying an airline, earned by signing up for a new credit card, or earned through regular credit card spending is a non-taxable refund or discount on the the purchase price of an airline ticket (or a discount of other credit card spending if received on a cash back credit card).  It is also accepted law that cash bonuses earned on opening new checking accounts are taxable as interest in the year of receipt.

For years, Citibank has issued Form 1099-MISC’s to customers who opened bank accounts and received noncash points, with Citibank assigning a value of 2.5 cents per point.  However, in the Shankar case, Citibank took it a step further and used the actual cash value of the airline flight redeemed for points.  In this case, the cash value of the flight resulted in taxation of 1.3 cents per point, less than the 2.5 cents that Citibank has previously been using.  However, if Shankar had instead redeemed his points for a first class ticket worth thousands of dollars**, the economics of this dispute would have been completely different. Furthermore, it is unclear how Citibank is going to proceed when points are redeemed in a future year.

Going forward, it is important to recognize that cash bonuses earned when opening bank accounts are taxable income.  It is currently unclear how other banks will be handling the award of noncash points when a bank account is opened, but it is safe to say that I would avoid opening a bank account at Citibank if at all possible.  Who knows why Citibank is prompting the IRS to act when the IRS really has no desire to do so.

**Yes, this is why this is a legitimate hobby.  Getting free travel for doing something that you were going to do anyway is fun.