Buying a house is an exciting milestone in life, representing stability, investment, and the fulfillment of a dream. However, for individuals who owe back taxes, the path to homeownership can seem uncertain. It’s essential to understand the implications and challenges associated with buying a house while having outstanding tax debt. In this article, we will explore the factors to consider and strategies to help you navigate this unique situation.
Understanding Back Taxes
Before diving into the home buying process, it’s crucial to understand what back taxes are. Back taxes are unpaid taxes from previous years, either due to underpayment or non-payment. The IRS may assess penalties, interest, and other charges on the outstanding amount, which can accumulate over time. While it’s not impossible to buy a house while having a tax balance, owing back taxes can potentially hurt your ability to qualify for a mortgage.
Addressing Back Taxes
Addressing your back taxes is crucial before attempting to buy a house, especially since most lenders will not want to approve you for a mortgage if you haven’t made any attempt to resolve your tax debt. This is because if you owe back taxes and own a home, the IRS can place a tax lien on your property, which gives them first dibs at the home if you do not pay your back taxes. In other words, your lender would incur a major financial loss. Here are a few steps to help you address your tax debt:
Evaluate your options: The IRS may offer options for resolving back taxes, such as installment agreements, offers in compromise, or currently not collectible status. Consult a tax professional to determine the best course of action for your situation.
Establish a payment plan: If you can’t pay the entire amount upfront, consider setting up a payment plan with the IRS. This allows you to make monthly payments towards your tax debt over an extended period. Demonstrating a consistent repayment history will show lenders your commitment to resolving your financial obligations.
Consider professional help: If your tax debt is complex or substantial, seek the assistance of a tax professional. These professionals can negotiate with the IRS on your behalf and help you explore potential resolution options.
Prioritize tax debt repayment: Make it a priority to pay down your tax debt as much as possible. Dedicate a portion of your budget to regular payments, aiming to reduce your overall tax liability over time.
Qualifying for a Mortgage While Owing Back Taxes
Once you’ve made significant progress in addressing your back taxes, you can focus on qualifying for a mortgage. Here are a few considerations:
Credit score and history: Your credit score plays a crucial role in the mortgage application process. Maintaining a good credit score and demonstrating responsible financial behavior will enhance your chances of securing a mortgage.
Debt-to-income ratio: Lenders assess your debt-to-income ratio (DTI) to evaluate your ability to manage mortgage payments. Paying down your tax debt and minimizing other outstanding debts can improve your DTI ratio and increase your chances of mortgage approval.
Documentation: Prepare thorough documentation of your financial situation, including proof of income, tax returns, and documentation related to your tax debt repayment. This documentation will help demonstrate your financial stability and responsible approach to resolving your tax obligations.
Qualifying for a mortgage while owing back taxes can depend on the type of loan you are seeking. For example, FHA loans are more desired for buyers because they allow you to buy a home with looser financial requirements. If you are seeking an FHA loan but owe back taxes, you must have made at least three payments to an IRS installment agreement, and meet other conditions, to be approved.
Getting Approved for a Mortgage While Owing Back Taxes
If you do manage to get a lender to approve you for a mortgage while owing back taxes, you should expect your tax bill to have an effect on your monthly payments. Because you will be considered a high-risk borrower, your interest rate will likely be higher than that of a low-risk borrower. You may also be required to put down a much larger down payment if the lender feels this might mitigate the risk that you come with. It goes without saying that these terms are not favorable for buyers, and seeking tax help from a professional can help lower the cost and stress associated with buying a home. Optima Tax Relief is the nation’s leading tax resolution firm with over a decade of experience helping taxpayers with tough tax situations.
Last week, we discussed the tax benefits of health savings accounts (HSAs). HSAs are tax-advantaged savings accounts specifically designed for individuals with high-deductible health plans (HDHPs). For those who do not have an HDHP, there are other options when it comes to paying for medical expenses. Enter flexible savings accounts, or FSAs. These can help cover the cost of health care expenses, all while saving you money during tax time. Here’s an overview of flexible spending accounts, including what they are, how they work, and their tax benefits that can save you money.
What is a Flexible Spending Account (FSA)?
Like a health savings account (HSA), a flexible spending account (FSA) is a tax-advantaged savings account used to pay for qualified medical expenses. In addition, FSA contributions are made with pre-tax dollars. This basically means contributions are not included in your taxable income, thus reducing your tax liability for the year. Unlike an HSA, contributions made to your FSA do not carry over to the next year. Instead, they use a “use it or lose it” policy. This means that anyfunds that are unspent by the end of each plan year are forfeited to your employer. However, your employer may offer some exceptions to this rule. For example, some employers might give you an additional grace period of an extra 2.5 months to use the funds or allow up to $610 to carry over into the following year.
In 2023, the IRS allows you to contribute up to $3,050 to your FSA if you’re a single person. If you are married, your spouse may also contribute the same amount through their own employer. Although they are not required to, your employer may also contribute to your personal FSA. FSAs can cover things like medical deductibles, first aid supplies, eyeglasses, contact lenses, some dental expenses, copayments, some prescriptions drugs, and coinsurance. However, note that all FSA-eligible expenses are determined by the IRS. Unlike HSAs, FSAs are typically owned by the employer or the FSA administrator. When you leave your job, you generally lose access to your FSA.
How Does an FSA Work?
During your employer’s open enrollment, you can sign up for an FSA. You’ll need to decide how much money you want to contribute to the account for the upcoming plan year. Once you’ve enrolled in the FSA, your chosen contribution amount will be deducted from your paycheck on a pre-tax basis. As you incur eligible medical expenses throughout the year, you access your FSA funds to pay for them. Your employer will typically provide you with a payment card, which is similar to a debit card. Alternatively, they may have a reimbursement procedure to access the funds. You are liable for paying back your account if the benefits card is unintentionally or knowingly used for ineligible costs. Any unspent funds in your FSA at the end of the plan year may be forfeited.
Pre-Tax Contributions
While contributions to your FSA are not tax-deductible like those of an HSA, they are deposited pre-tax. So, contributions lower your total tax liability. For example, let’s say your annual salary is $50,000 and you contribute $3,000 to your FSA. Consequently, your gross income would then be $47,000. Any taxes owed, whether they are federal, state, or local, would be based on the gross amount. Because these funds are not taxed, you cannot claim a tax deduction for your contributions. However, FSA participants have an average 30% tax savings on the total amount they contribute to their account.
FSAs vs. HSAs
HSAs and FSAs are both popular tools for managing healthcare expenses, but they have some key differences.
FSAs
Generally available to employees with employers who offer these accounts
FSAs have lower contribution limits, with the maximum annual contribution limit of $2,850 per individual in 2023. This limit applies to each employee and is not based on family coverage.
No rollover, so “use it or lose it” policy, with some exceptions.
Contributions are made with pre-tax dollars, reducing your taxable income.
Contributions are tax-deductible.
Withdrawals for qualified medical expenses are generally tax-free.
HSAs
Designed for individuals with high-deductible health plans (HDHPs)
In 2023, the maximum annual contribution for individuals with self-only HDHP coverage is $3,650, while for family coverage, it’s $7,300. Individuals aged 55 or older can make an additional $1,000 catch-up contribution.
HSAs offer the advantage of rollover.
Contributions are made with pre-tax dollars, reducing your taxable income.
Contributions are tax-deductible.
Withdrawals for qualified medical expenses are generally tax-free.
If you’re thinking about getting an HSA or FSA, you should consider your specific circumstances, healthcare needs, and employer offerings to determine which option is best suited for you.
Today, Optima Tax Relief’s Lead Tax Attorney, Phil Hwang, discusses penalties and interest, including the most common penalties and how interest rates are calculated.
Failure to File Penalties
Owing the IRS is much more than just owing a tax balance. The IRS also charges penalties and interest, the most common penalties being the Failure to File and Failure to Pay. The Failure to File penalty is charged on tax returns filed after the tax deadline or tax extension deadline without a reasonable cause. It accrues at a rate of 4.5% per month, beginning after taxes are due. For example, if you filed for a tax extension, you have until the usual October 15th deadline to file before penalties and interest begin to accrue. In 2023, the deadline is October 16th. If you did not file an extension, the deadline is April 15th each year before the Failure to File penalty and interest begin to accrue. In 2023, the deadline was April 18th.
Failure to Pay Penalties
The Failure to Pay penalty, on the other hand, accrues at 0.5% per month for every month or partial month that a tax balance remains unpaid. The day the Failure to Pay penalty begins to accrue is dependent on whether you filed a tax extension. If you file a tax extension, the Failure to Pay penalty will begin to accrue after the October tax deadline. If you do not file an extension, it will begin to accrue after the April tax deadline.
IRS Interest Rates
The interest rates on these penalties are calculated based on the federal short-term rate, plus an additional 3%. Interest compounds daily until the balance is paid in full. The interest rates for underpayments in the first quarter of 2024 are as follows:
7% for individual underpayments
9% for large corporate underpayments
Interest rates are determined each quarter. You can find the most up to date news on quarterly interest rates on the IRS website.
Next week, Phil will discuss IRS enforcement. How long does the IRS have to collect back taxes? Can back taxes affect your credit score? Stay tuned for “Ask Phil” next Friday!
If You Are Being Hit with IRS Penalties and Interest, Contact Us Today for a Free Consultation
In today’s world, where healthcare costs are constantly rising, finding smart and effective ways to save money is crucial. One such method that has gained popularity in recent years is the Health Savings Account (HSA). Not only does an HSA allow individuals to set aside funds for medical expenses, but it also offers significant tax advantages. In this article, we will explore the tax benefits of Health Savings Accounts and how they can help individuals save money while maintaining their health and financial wellbeing.
What is a Heath Savings Account (HSA)?
A Health Savings Account (HSA) is a tax-advantaged savings account specifically designed for individuals with high-deductible health plans (HDHPs). HDHPs generally have low monthly premiums but higher deductibles compared to traditional health insurance plans. In 2023, these plans include deductibles of at least $1,500 for individuals and at least $3,000 for families. HSAs help these individuals save money for qualified medical expenses that their health insurance provider does not cover.
HSAs allow you to carry over any unused funds from year to year. Unlike other accounts that often have a “use it or lose it” policy, HSAs offer the flexibility of accumulating funds over time. In 2023, the IRS allows you to contribute up to $3,850 to your HSA if you’re a single person. This amount increases to up to $7,750 for families. Your HSA belongs to you, even if you change jobs.This makes them an attractive choice for individuals who want to save for future medical expenses or even use the funds as a retirement savings tool.
Contributions are 100% Tax-Deductible
Any money you contribute to your HSA is tax-deductible, even if you do not itemize your deductions. So, your contributions can be deducted from your taxable income during tax time, which lowers your tax liability and can potentially push you into a lower tax bracket. In addition, if you make contributions through payroll, this money is deposited pre-tax, which also lowers your total tax liability. In other words, these contributions can be excluded from your total gross income.
Contributions and Distributions are Tax-Free
Just like a brokerage account or an IRA, you can invest through your HSA. Once you fund your account, you can choose your own investments or allow the experts to do it for you. The best part is that these contributions grow tax-free. This means that you pay no taxes on the interest the account earns. On top of that, any distributions you use to pay for qualified medical expenses are also tax-free. If you use your HSA to pay for non-medical expenses, you’ll be subject to income taxes and an additional 20% penalty. If you are 65 years old or older, non-medical expenses will not incur the 20% penalty, but the income taxes will still need to be paid. This is also true if an individual suddenly becomes disabled or if they die.
HSAs Can Be a Last-Ditch Effort to Lower Your Tax Liability During Tax Season
As tax season approaches and we start receiving our income documents, we might want last-minute ways to lower our tax liability. Contributing to an HSA is a great way to do this for several reasons. One reason is again the fact that contributions to an HSA reduces your taxable income, which in turn reduces your tax liability. Secondly, you can continue to contribute to your HSA all the way up until the April tax deadline. This means that you have an additional few months of contributions to reduce your taxable income from the prior year.
Should I open an HSA?
Health Savings Accounts provide individuals with a unique opportunity to save money on a pre-tax basis, enjoy tax-free growth, and use the funds tax-free for qualified medical expenses. That said, they are definitely worth looking into. To qualify, you must be covered by a high-deductible health plan (HDHP) and have no other health insurance, except for worker’s compensation, specific illness-related insurance, or a fixed coverage per day if you are hospitalized. You cannot be enrolled in Medicare, and you cannot be claimed as a dependent by anyone else. By leveraging the benefits of an HSA, individuals can effectively manage their healthcare costs while maximizing their tax savings.
Marriage can be a wonderful milestone in life. But in the midst of planning a wedding and a future with your significant other, you may not be thinking about how your new union will affect your tax bill. One critical tax factor to examine is the concept of marriage bonuses and marriage penalties. These terms refer to how marriage can affect a couple’s tax liability. In this post, we will look at the fundamentals of marriage bonuses and marriage penalties, as well as how they might affect a couple’s tax situation as a whole.
What is a marriage bonus?
A marriage bonus happens when a married couple’s combined tax liability is less than the sum of their individual tax liabilities if they filed as single individuals. This is most common when one spouse earns much more than the other. By combining their wages, the couple can take advantage of reduced tax brackets, tax credits, and deductions that they might not have had access to as single filers.
Here’s an example. Let’s say an unmarried couple has a combined income of $120,000, one person earning $0 and the other earning $120,000 in 2023. As single filers, the first person would have a $0 tax liability, while the second higher-earning person would have a tax bill of $18,876. If this same couple got married and filed jointly, their combined tax liability would be just $10,921 because they would be able to claim a larger standard deduction and would be taxed at a lower marginal tax rate.
What is a marriage penalty?
Conversely, a marriage penalty arises when a couple’s combined tax liability as a married couple is higher than their total tax liability if they were still filing as single individuals. Because merging incomes in joint filing can drive both spouses into higher tax brackets, couples with similar incomes are more likely to pay marriage penalties than couples with one spouse earning the majority of the income.
Another factor to consider when calculating the marriage penalty for high-income earners is the net 3.8% investment income tax. This tax is levied on single filers with an adjusted gross income of $200,000 or more, as well as married filers with an adjusted gross income of $250,000. In addition, these same taxpayers will also be subject to an additional Medicare tax of 0.9% on earnings over $200,000 for single filers, and over $250,000 for married couples filing jointly.
Beyond federal marriage penalties, some states also impose their own marriage penalties, including California, Georgia, Maryland, Minnesota, New Mexico, New Jersey, North Dakota, Ohio, Oklahoma, Rhode Island, South Carolina, Vermont, Virginia, and Wisconsin.
How can I avoid a marriage penalty?
Understanding your tax situation as a married couple is essential for efficient tax planning. For example, you can always calculate different scenarios to estimate your tax liability before filing. Filing separately rarely results in a more advantageous outcome for couples, but you may find yourself under these special circumstances. You should also explore all eligible deductions and credits to reduce your overall tax liability. Married couples who file jointly have access to several tax credits, including the Earned Income Tax Credit, education credits, and the Child and Dependent Care Tax Credit. Be aware of phase-out limits that might affect your eligibility. If you’re still unsure how to navigate marriage penalties and bonuses, consider consulting a tax professional. Doing so can provide valuable insights tailored to your specific situation. Optima Tax Relief is the nation’s leading tax resolution firm with over a decade of experience helping taxpayers just like you.
