Let’s face it you’ve heard it before and probably have from time to time have taken the advice from your uncle Freddy or your really smart tax-preparer who explains how they can help you avoid $1k, $2k or much greater sums of money in taxes just by using some available tax deductions. They may even be legal. But there-in lays the problem. Just because the deductions are legal doesn’t mean they won’t come back to bite you when it comes time to qualify for financing of your dream home or refinancing that high interest loan. In this article I will highlight two blunders and provide others in a series of 5 articles
Unreimbursed employee expenses
Over the past years as employers have pulled back on employee perks such as paid cell-phones, mileage reimbursements and/or paid marketing lunches I have seen unreimbursed employee expense increase on individual’s tax returns. An unreimbursed employee expense is an expense deemed necessary to conduct your job or create business as a W2 employee for which your employer does not reimburse you. Think sales representative for a large company. This is a completely legal expense. So why does this matter? By taking this expense what you are declaring is that it costs a certain amount of money for you to produce your salary. Let’s take a simple example. Let’s say you have a salary of $60k per year but take a $3k unreimbursed expense for car use and cell phone charges. When it comes time to qualify for the mortgage you will only get credit for $57k in annual income which is 5% less and could mean up to $25k in less financing for you!
Not declaring profit on self-employment income
As companies have shed they workforce more and more of us are braving the world of self-employment. Many of you are actually doing better than you were as an employee and working less time. However, you never would know it from your tax return. As a self-employed individual you typically do not receive a steady engagement from one contractee thus the tax code allows you to prepare your own profit and loss statement called a Schedule C. This schedule accounts for all income and expenses of running your self-employment. Here’s the key, don’t fall into the trap of either under accounting your income or over accounting for expenses that aren’t necessarily required to run your business but for which you could make an argument. Both lead to a reduced profit or typically a loss. This is a very common practice of self-employed individuals and is a death knell when it comes time to qualify. Remember, as a self-employed individual it is not the gross income that will be used to qualify your mortgage but rather your profit or loss from running your self-employment. By the way, underwriters will be looking back at least 2yrs on your tax returns, so if you are counting on buying a home in the next 2yrs it would be best start showing some profit now.
You may wondering if the blunders above cause so much problems for people obtaining home financing why are these blunders for so common? The answer is really quite simple. Keep in mind a tax preparer’s main objective is to limit your tax liability but in doing so their reduce your taxable income. Whereas, I as a mortgage broker main goal is to fulfill your financing needs and in order to facilitate that I need to prove income, the higher the better. So by definition our goals are at separate ends and typically in conflict.
Other common blunders to be discussed in follow-up articles:
1. Losses on rental properties
2. Going from W2 to Self-employed
3. Not declaring rental properties
4. Owning more than 25% of a partnership /LLC for which you are an employee
5. Retiring without declaring IRA distributions / Pensions / annuities
6. Expensing a car loan as a business expense could hurt you twice
7. Meals / entertainment expense really counts twice
8. Under-declaring income for service jobs (waiter)
