If you’ve been paying attention, you know that the Federal Government offered a $7500 income tax credit to first time home buyers (http://www.irs.gov/taxtopics/tc611.html) who purchased homes in 2008.  Of course, like any government program, there were exceptions (you can’t make too much money, you greedy #$&%!) and unlike other “credits” this one had to be paid back.  The pay back can be over 15 years and is interest free, so it’s essentially an interest free loan – still a pretty good deal.

Well, in 2009 the deal is even better because it’s now an $8000 (real) credit and you don’t have to pay it back (http://www.irs.gov/taxtopics/tc612.html).  You must purchase the house after December 31, 2008, and before December 1, 2009 and keep it for at least 36 months to qualify for the credit.  And for those of you that purchased a home early in 2009 and claimed the $7500 “non-credit credit” – EUREKA! You can file an amended return and get the $8000 non-refundable credit.  For some FAQ’s on this subject check out http://www.irs.gov/newsroom/article/0,,id=206293,00.html.

With the housing market still not out of the woods, this alone wouldn’t necessarily tempt me to buy at this time.  However, I just don’t believe interest rates are going to stay this low very much longer.

Since 1992 rates for a 30 year fixed mortgage have ranged from a high of 9.2% to a very recent low of just under 4.8% *. During the late 70′s and early 80′s, a time of rampant inflation, mortgage rates peaked above 18% *. With Uncle Sam spending money like a drunken sailor (no offense to our men and women in uniform), inflation and interest rates are going to soar. Unless, of course, Washington and the Fed…  Ok, this isn’t a fantasy blog; my opinion – buy now.

* Source:  Federal Home Loan Mortgage Corporation’s (Freddie Mac) Weekly Primary Mortgage Market Survey (PMMS)

Advanced Earned Income Tax Credit

The Advanced Earned Income Tax Credit is an extension of the Earned Income Tax Credit that apparently allows people with children eligible for the EITC to receive a portion of the credit through their paychecks (reduced witholding) instead of at filing time. The AEITC is used by a relatively small percentage of people (3% of those eligible for EITC) and is error prone. Cutting this program is estimated to save $125 million.

What I learned from this, is that if 514,000 people used this program, then that means there are about 17 million people claiming the Earned Income Credit.

C-17 Strategic Airlift Aircraft

Well this saves about $91 million.  Supposedly we are dropping this because we have enough of these already.  But I don’t have one, do you?

Christopher Columbus Fellowship Foundation

Yes I think the word is out, the Earth is round and the East Indies turned out to be farther than he thought. Here we save $1 million, but it makes me wonder what Chris C. would think about cutting the program.

Combat Search and Rescue Helicopter (CSAR-X)

Here we save $144 million dollars by eliminating this single purpose helicopter. From the budget: “The Department of Defense is questioning the need for a single-purpose helicopter. Unlike the other services, which carry out this mission with multiple-purpose helicopters, the Air Force has traditionally carried out this mission with single-purpose aircraft.”

Well they call it single purpose, but it searches and it rescues.  Seems like a winner to me!

Cotton Storage Payments

Cotton storage payments appear to amount to planned price fixing by the U.S. Government. They would never do that, would they?  This item allowed credits for storing cotton until prices increased.  The program is being eliminated since storage costs for other commodities are not funded by the Government.  I could see going either way on this, either have the U.S Government pay to store nothing… or, why not have them store everything?

Storing cotton costs around $570 million, so maybe that is why we don’t extend this program to polyester storage, etc.

Inner City Bus Security Program

Costing us $12 million, this program is being eliminated because it does not appropriately factor in risk when determining where the funding goes. If we wanted to factor in risk, I would start by looking for buses that Keanu Reeves is on.

Joint Strike Fighter Alternative Engine

I love this one!  At the tune of $465 million, we had two separate contractors building two different designs of an engine for the same airplane! Perhaps instead of cancelling the program, we could use the losing engine in one of our new GM cars.

Loran-C

This is being replaced because it is a legacy technology that GPS handles better. Loran-C acted somewhat as a backup for GPS, at least according to the budget document (you never know if the scope of the cut is as accurate as the Government believes). But what struck me in the document was the following statement, “Accounting for inflation, this will achieve a savings of $36 million in 2010 and $190 million over five years.”  I just find this funny, that the savings included account for inflation, considering the source of the inflation is primarily the government anyway. Maybe we should just increase inflation to meet our budget targets.

Oil and Gas Company Subsidies

This is one we all heard about during the campaign (if we were listening anyway).  This won’t save us anything in 2010, but the proposal states that we still save $26 billion between 2011 and 2019. Despite the belief of the budget document, it is difficult for me to imagine that this would not impact the price of gasoline. But I will take their word on it, they wouldn’t lie.

Oil and Gas Research and Development Program

Presidential Helicopter

This program subsidizes R&D efforts for improving extraction and delivery of oil and gas products. The budget states that oil and gas companies have the means to fund this work on their own.  I agree with this, they should compete on a level playing field with alternative energy source companies.  So far, from a product cost perspective, they have been winning hands down. This saves the taxpayers $250 million.

Presidential Helicopter

Last, but not least, the Presidential Helicopter! The cost of this beast has grown to $13 billion. This is an entire helicopter program for a single person.  The program is 5 years over schedule. The good news is that the budget has been cut to just enough funds to end the program and evaluate options for the current fleet and an alternative program. The bad news?  The alternative program likely starts the whole process over again.  Maybe we should have another bake off — hire two contractors to deliver two Presidential Helicopters and see which one flies better.

Conclusion

Well this was a short look at some of the terminated programs from the 2010 proposed budget. Hopefully your favorite program did not get cut. If it did, I apologize if I made fun of it in any away.

In our case, the audit disputed our income for 2007, stating that we received a normal 403(b) distribution and owed both taxes and a penalty on that distribution. We had executed a rollover distribution from Fidelity to my wife’s new 401(k) that year. Strangely it took a lot of effort to get the rollover figured out. My wife had a lot of trouble with Fidelity, to the point where she had to get T. Rowe Price and Fidelity on the phone at the same time to work this out.  This isn’t consistent with our usual experience with Fidelity, but perhaps because it was a 403(b) and not an IRA or 401(k) we were talking with the black sheep of the company.

Fortunately enough for us, the error was not ours but was Fidelity’s. They had placed a distribution code of 1 on the 1099-R instead of a G, indicating that it is a normal distribution.  This is really something that I should have caught (which I did) in 2008 when I was filing the taxes. It was also something I should have corrected (which I did not) at the same time. In fact, using Turbo Tax I was able to use distribution code 1 and still identify it as a rollover from Turbo Tax’s perspective.

Looking back on this whole effort, what are some of the things I should have done better when filing 2007 taxes and what are some additional lessons learned from this?

1. Correct Mistakes Immediately
2. Avoid Mistakes by Filing Electronically
3. Keep Good Records
4. Don’t Cash Out your Retirement Accounts Early
5. Don’t Fear the Audit (At Least Not Right Away)

Correct Mistakes Immediately

This probably seems obvious. However I filed our taxes through Turbo Tax and because I was able to convince the software that it was a rollover, I brushed this off as a minor mistake. If we had called Fidelity immediately this would have been addresses pretty quickly and the audit would have been avoided.  Ironically we had significantly less trouble getting Fidelity to fix this mistake and send a corrected 1099-R than we had trying to get the rollover in the first place.

Avoid New Mistakes by Filing Electronically

If you do your taxes yourself, and use software — don’t depend entirely on the software.  Know the relevant portions of the tax code and triple check your work.  If you don’t use software, consider using it. On-line tax filing is free for those with Adjusted Gross Incomes (AGI) less than $56,000 (for 2008).  That offer is well worth the benefits of filing electronically, which while it would not have caught our 1099 error, it can catch many other mistakes.

Double and triple check everything, including the forms sent from employers, investment firms, and banks.  And of course, if you receive a correspondence audit, do not assume it is your mistake!

Keep Good Records

Even though it was difficult to remember back to a previous year’s taxes, keeping all of the records made it easy to investigate what had happened. In this case I had copies of the 1099-R, paperwork from both Fidelity and T. Rowe Price, and a copy of the check that was made out to the qualified plan we were rolling the money into. Although I often try to keep solid records, I admit I don’t always keep as much information as I did in this instance. We even had an entry logging the teleconference my wife had between Fidelity and T. Rowe Price.

For taxes we keep electronic copies of our records and paper copies forver.  I will talk more about our “paperless” records system in the future.

Don’t Cash Out your Retirement Accounts Early

Although we were doing a rollover, this correspondence audit gave us an insight into exactly what we would have paid if we simply cashed the money out.  And unless we were facing foreclosure or having trouble paying for food, there is no way that it would be worthwhile to cash out the account.  The taxes, interest, and penalties in this case was over half of the value of the account. Even the past year’s market crash has been more gentle on the account than cashing it out would have been.

Don’t Fear the Audit (At Least Not Right Away)

Getting the letter from the IRS we were instantly worried, but we did not need to be. My first thoughts were to call an accountant or tax attorney. But after reading through the paperwork and documentation, and realizing what had happened, we calmed down. Depending on the type of audit (whether it is a correspondence audit, IRS office audit, or a field audit) and the complexity of your return, you may need to get assistance from a professional. If we had been requested for an IRS office audit, we would have hired a professional.

Conclusion

We submitted the response this week to the IRS, and we should receive a response within the next couple of weeks.  Since we have corrected the root of the problem, we believe the issue will be resolved. But we cannot know for sure whether the IRS will want more documentation. So I will update the status of this in a future post.