There's no question that our tax code causes a lot of confusion. But don't let confusion or misinformation from others lead to an audit or cause you to miss out on a deduction.
For example, here's a comment I received from someone participating in one of my recent online discussions: "I believe the person hoping to pay off their house early and get a mortgage-interest deduction for a vacation or second home is mistaken, as that deduction is only for your primary residence."
Nope. That is incorrect. Even if you have paid off the loan on your primary residence, the mortgage interest on a second home is generally deductible, according to the Internal Revenue Service. In fact, you don't even have to use the second home during the year.
However, in general, if you have a second home and rent it out part of the year, you also must use it as a home for a short time during the year for it to be a qualified home. You must use this home more than 14 days or more than 10 percent of the number of days during the year that the home is rented at a fair price, whichever is longer. If you do not use the home long enough, it is considered rental property and not a second home, and therefore you cannot deduct the mortgage interest, according to IRS spokesman James Dupree.
Get IRS Publication 936, "Home Mortgage Interest Deduction," for more information. You can read it online by going to www.irs.gov.
Spouses and IRAs
During that same chat, I received a number of other tax-related questions, such as: "I'm confused about spousal IRAs and the age 50-plus catch-up provision."
Well, a working spouse is allowed to make a contribution to a separate IRA for a spouse with little or no income if they file a joint return. The total contribution to both your IRA and the spousal IRA is limited by certain factors such as your taxable compensation, contributions to a traditional or Roth IRA and your age. For tax year 2006, you can contribute up to $4,000 to a spousal IRA. If your spouse is at least 50, you can contribute up to $5,000. This contribution limit also applies to the working spouse.
"My family moved to Maryland in 2006. We already had 529 plans for our kids, but now we find out that Maryland allows you to deduct contributions to a Maryland 529 plan. Should we (a) switch everything over to a Maryland plan to get the tax benefit, (b) keep on growing the other plan, or (c) just open a separate Maryland 529 plan?"
This is a perfect question to address a mistake many people make: You should never make an investment decision based solely on the tax implication.
In this case, yes, factor in the state tax deduction. For Maryland, the tax deduction is limited to $2,500 per tax year per account.
Before moving funds, there are a number of factors to consider in addition to the tax benefit, says Joseph Hurley, founder and CEO of www.savingforcollege.com, a Web site where you will find up-to-date information on 529 plans.
For instance, compare returns for the two state plans, keeping in mind that past performance is no guarantee of future returns. Compare investment options. Also take into account fees and expenses.
"Over some period of time, the investment performance is going to be a bigger factor than a state tax deduction," Hurley says.
For a comparison of state 529 plans, including fees, expenses and investment options, go to www.savingforcollege.com. Click on the link for "529 Plans" and then click on "Compare 529 Plans." On the site you will also find a new fee table to compare expenses.
Finally, should you be fearful of filing electronically? One reader is.
"I'm very leery of e-filing my tax return because I just don't want to give the government my IP (Internet Protocol) address, what with all the illegal surveillance that has been authorized by the current administration. Do you have any information that would allay my concern?"
When you file your federal tax return electronically, it doesn't go directly to the IRS. It goes to an Intermediate Service Provider for processing, then to a transmitter who sends only your return information to the IRS, according to Dupree.
"The security of taxpayer accounts and personal information is a top priority for the IRS," he said. "It is the responsibility of each authorized IRS e-file provider to have security systems in place to prevent unauthorized access to taxpayer accounts and personal information by third parties. Your IP address is not recorded or sent forward."
There you go. As Ralph Waldo Emerson said, knowledge can take fear out of the heart.
Listen to Michelle Singletary discuss personal finance every Tuesday on NPR's "Day to Day." Readers can write to her c/o The Washington Post, 1150 15th St. N.W., Washington, D.C. 20071. Her e-mail address is firstname.lastname@example.org.