The IRS tax tables for 2012, for use in filing 2012 taxes by April 2013, will be published in the fall of 2012.

However, the estimated tax withholding tables give an accurate assessment of how the 2012 tax tables from the IRS will look. Note that these 2012 tax bracket tables are no to be used for calculating your 2011 taxes that you file before April 2012, but rather for the tax year from January 2012 to December 2012. Those taxes will be filed in 2013, but estimated tax payments calculated throughout the 2012 year should use these IRS tables.

The 2012 standard deduction amount is the same.

2012 Estimated Tax Tables

If your 2012 filing status will be Single then your tax rate for estimated payments is:

• Income under $8,700 = 10%
• Income over $8,700 but under $35,350 = $870 + 15% of amount over $8,700
• Income over $35,350 but under $86,650 = $4,867.50 + 25% of amount over $35,350
• Income over $86,650 but under $178,650 = $17,442.50 + 28% of amount over $85,650
• Income over $178,650 but under $388,350 = $43,482.50 + 33% of amount over $178,650
• Income over $388,350 = $112,638.50 + 35% of amount over $388,350

If your 2012 filing status will be Married Filing Jointly then your tax rate for estimated payments is:

• Income under $17,400= 10%
• Income over $17,400 but under $70,700 = $1,740 + 15% of amount over $8,700
• Income over $70,700 but under $142,700 = $9,735 + 25% of amount over $35,350
• Income over $142,700 but under $217,450 = $27,735 + 28% of amount over $85,650
• Income over $217,450 but under $388,350 = $48,665 + 33% of amount over $178,650
• Income over $388,350 = $105,062 + 35% of amount over $388,350

Remember that whenever you are required to make estimated tax payments there is a general rule provision that you can use instead of calculating your estimated payments with the EST tax tables. The IRS decrees that if you pay 100 percent of the amount of taxes you paid the previous year, then you will not be subject to underwithholding penalties.

However, this does not mean that you will not owe taxes. Your tax rate will still be calculated based upon your actual income for the year. What it does mean is that you can make smaller quarterly estimated tax payments without being penalized for underpayment. You do need to be sure that you will be able to make your tax payment the following spring when you file your taxes, or you may be subject to interest and penalties at that point.

For higher incomes, those with an adjusted gross income (AGI) above 150,000, the general rule requires that your estimated tax payments equal 110 percent of your previous year’s taxes to avoid paying an under withholding penalty.

Other 2012 tax tips and advice is available here on Finance Gourmet.

Related posts:

1. Tax Due Date 2012
2. 2012 Standard Deduction Amount Set

2012 Tax Tables originally published at Personal Finance Blog - FinanceGourmet.com

The Internal Revenue Service, or IRS, doesn’t have a very good way for taxpayers to check in on the status of their accounts. This is because, in general, taxpayers are expected to basically keep track of their own tax accounting. If you have a salaried job, your withholdings are printed on your paystub. If you own own business, you are expected to keep track of your own quarterly payments. And, if there is another situation, you are supposed to have records anyway, to use for filing your taxes, if nothing else.

But, what if your account situation isn’t so simple?

Tax Return Transcript

The first reason you might want a tax return transcript is that you don’t have a proper record of what information you filed on your tax return. You are supposed to keep a copy of your return for your own records, but even if you do, it can get lost or destroyed in any number of ways. Fortunately, you can order a Tax Return Transcript directly from the IRS.

A Tax Return Transcript shows most of the line items from your original tax return including important information like your total wages,adjusted gross income and taxable income. The transcript also includes the various forms you filed with your income taxes. For example, a Schedule C for your business would have its various line items reported as well.

Using the adjusted gross income from your transcript allows you to determine what tax bracket you are in, or maybe what tax bracket you’ll be in if you get married, without having to guess what your gross income turns into on your tax returns.

For some lenders, a tax transcript is good enough if you don’t have a copy of your taxes. If it isn’t, download the proper year IRS Form 1040 and recreate it with your tax transcript’s information. Just fill in the blanks. Where it says to sign and date it, just write, “Copy for File,” or something similar. Then, make a copy and give it to the lender.

Tax Account Transcript

A Tax Account Transcript is a little bit different. Rather than showing you what the lines of your tax return were, this transcript shows you what happened to your account when. For example, you may know what date you mailed your quarterly tax payment, but you wonder when the IRS actually got it, this will show.

Also, if you didn’t pay your taxes on time and had to setup a payment plan or otherwise make tax payments, the account transcript will show you when each of those occurred. A tax account transcript is also useful to verify that payments have been made by a third-party. For example, if you file bankruptcy your bankruptcy estate might make a payment toward any back taxes you owed when you filed. This is one way to find out how much that payment was, and when it occurred.

To order a tax transcript, go online directly to the IRS. Choose click the link to order your tax transcript and then choose whether you want an account transcript (payments, interest, penalties, credits) or a return transcript (what was on your 1040). Enter your Social Security number, name, date of birth and address. The automated system will send your transcript automatically in 5 to 10 days.

Keep in mind that you can only use the online system if you don’t need the transcript sent to another address, as the system will send it automatically to the address the IRS has on file for you.

No related posts.

Tax Transcript from IRS originally published at Personal Finance Blog - FinanceGourmet.com

Taxes for 2011 are almost due. As always, the IRS tax filing deadline for 2012 is April 15th, only it isn’t.

April 15th is a Sunday and taxes are not due on weekends, especially Sundays. You don’t expect government bureaucrats to work on the weekend, do you? Not to mention, you can’t get a postmark on Sunday because the Post Office is closed.

So, your taxes should be due on April 16th, but they aren’t due then either.

Just like last year, the Monday your taxes would normally be due on is a holiday. It isn’t a Federal holiday, but it is a holiday in Washington D.C. and when it comes to the Internal Revenue Service, the holiday schedule includes those D.C. holidays.

After all of that, it comes down to for 2012 taxes are due on Tuesday April 17th. Technically, of course, that means that your taxes must be postmarked by midnight April 17th. As always, there will be certain post offices open late, some until midnight, where you can mail your taxes right up to the deadline and still get that all important postmark.

If you don’t file your taxes on time, you’ll owe penalties and interest. If you don’t pay your taxes, it’s the same story. Don’t forget, though that you can get a free, no questions asked, automatic filing extension just by filling out the form and mailing it in by the same due date as your regular income taxes. So mail your 2011 tax return or your extension request by April 17, 2012.

Related posts:

1. 2012 Standard Deduction Amount Set
2. 2012 IRA Contribution Limits

Tax Due Date 2012 originally published at Personal Finance Blog - FinanceGourmet.com

Doing income taxes can be a trying time for many taxpayers. There are numerous forms to fill out, cumbersome calculations to perform, not to mention, the rules change every year. When you finally finish, you might end up owing a lot of taxes to the government. The IRS isn’t know for being forgiving, but that doesn’t stop people from wondering, what happens if I don’t pay my taxes?

Failure to File Taxes

First, it is important to distinguish between not filing your income taxes, failure to file, from not paying your income taxes. There are significant additional penalties for not filing your income taxes on time. If you can pay your taxes, but can’t get them done on time, then consider filing a Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax. Filing this form grants taxpayers an automatic extension of time to file. This form must be filed by the April 15th filing deadline just like a regular tax return would be. Once filed, the new deadline for filing your taxes moves to the beginning of October.

Beware, even if you file for an extension, you do NOT get any additional time to pay your income taxes. Just because you haven’t submitted the forms doesn’t mean the taxes aren’t due. You have to estimate how much you will owe and send the IRS a check. Keep in mind that penalties and interest for not paying your taxes are percentage based, so even if you are off in your estimate, submitting a payment will lower any potential charges. If you are expecting a refund, there is no need to send any additional payment with your extension request.

Failure to Pay Taxes

One of the first questions asked is often, “Can the IRS send me to jail if I don’t pay my taxes?”

Technically, the IRS cannot send you to jail. However, a judge can order you to serve jail time for failure to pay income taxes. However, this is not a common occurrence. The IRS actually has many other remedies at its disposal that it uses instead. After all, sending someone to jail doesn’t bring any money in to the government.

If you don’t pay your taxes on time, the IRS will begin charging you penalties and interest. The interest rat the IRS charges is set on a quarterly basis and is equal to the federal short-term rate plus 3 percent. In addition, there is a late payment fee of 1/2 of one percent of the amount owed for each month that it is owed, up to a maximum 25 percent penalty.

If you do not pay, the IRS will eventually begin what are called enforcement actions. There are a wide range of possible actions. The most common are an IRS levy and garnishments. With a levy, the IRS takes money or property that you own in order to settle your tax debt. A garnishment occurs when the IRS intercepts payments (typically a paycheck) before they are made to you.

The most common IRS levy is made against any tax refunds you might have. It goes without saying that the IRS will take any tax refund you are due in future years to pay off any unpaid prior year taxes. In addition, the IRS will also intercept any state income tax refund you might be due. A notice of levy will be sent to the taxpayer before each event.

Stopping IRS Levy or Garnishment

It is surprisingly simple to stop IRS enforcement actions such as a levy or garnishment. The IRS offers most taxpayers, who are delinquent for a single tax period, the ability to enter into a payment plan with the IRS. Although not required, the IRS typically stops all enforcement actions once a payment plan has been filed.

You can request a payment plan online and be informed immediately if your plan has been accepted. The monthly payment requirements can be relatively low. A $100 per month payment may be accepted for tax due amounts over $5,000 or more.

Although the interest charged for paying late does not stop, the penalty is reduced from one-half of one percent to one-quarter of one percent. Still, it is in your best financial interest to pay down your balance as quickly as possible to lower these fees. However, keep in mind that additional payments DO NOT pre-pay your installment agreement. That means if you agree to pay $100 a month and then you send in an extra $500, you still have to make next month’s $100 payment. You do not get credit for five months worth of payments.

There is a fee to setup a payment agreement and the consequences for failing to follow through on such an agreement can get nasty quickly since you have now not only failed to pay your taxes, but failed to honor your installment agreement as well.

Use the online installment agreement tool and choose the lowest amount possible, even if you can pay more. You can always send in extra money if you have it, but you won’t be stuck with a too high payment later if something goes wrong.

Related posts:

1. How To Deduct Property Taxes
2. Taxes Not Due Today – April 18 not 15

What Happens If I Don’t Pay My Taxes originally published at Personal Finance Blog - FinanceGourmet.com

The following is a guest post from Michael at Credit Card Forum.

Yep, it’s that dreaded time of year again… tax time! And if you’re a small business owner, the process of doing taxes is especially arduous. Not only do you have to categorize all the business-related expenses from last year, but you also have to figure out the proper way to deduct them. So when it comes to interest, what does the IRS have to say about it?

Well first of all, let me start out by saying I am not a tax professional. Therefore the information that follows is not tax guidance, nor is it professional advice. Please consult an accountant or tax attorney for that.

Rather, I’m only coming to you as a real-life business owner. I have been 100% self-employed for the past couple years and before that, partially self-employed. So I know firsthand the headache and confusion of dealing with this issue.

What does the IRS say?

On the IRS website, you will find the “Tax Guide For Small Business” and Chapter 8 specifically addresses the deduction of interest. They start out by saying:

“You can generally deduct as a business expense all interest you pay or accrue during the tax year on debts related to your business.”

This is a pretty clear statement, except having the word “generally” in there definitely leaves it a bit vague. This is why you have to keep reading…

“Interest relates to your business if you use the proceeds of the loan for a business expense.”

Read that sentence twice. You need to make sure the proceeds of the loan (or credit card) are going directly towards the qualifying business expense(s). That will seem like common sense to most people, but I had a friend who erroneously believed he could deduct his student loan interest because the education would help him run his business. Sorry, but semi-related scenarios like that will not qualify.

As a rule of thumb, if the expense in question isn’t included in your business deductions, then it’s safe to say any interest you incurred from it won’t qualify, either.

The IRS also sets out 3 specific requirements which must be met in order to deduct business-related interest:

1. “You are legally liable for that debt.”

So if the debt was guaranteed by say, your mother’s credit instead of you/your business entity’s credit, then it doesn’t meet this requirement.

That being said, if a formal debtor-creditor relationship was established between you and your mother (to make you liable) then perhaps there might be a way to make it work, but you will need to consult a tax professional to find out whether or not that’s possible.

2. Both you and the lender intend that the debt be repaid.

If you have a loan from a bank or owe money on a business credit card, then of course the lender expects you to repay them. However if there are circumstances where your debt might be forgiven, then it probably wouldn’t pass this requirement.

3. You and the lender have a true debtor-creditor relationship.

Without a doubt this is one of the biggest mistakes I hear small business owners make. They think that if they informally borrow $5,000 from Mary Sue and Uncle Bob, it counts as a loan… it won’t. Consult with a tax professional as to whether you have a “true debtor-creditor relationship” with the other party, but be aware that some of the things it must include will be a repayment schedule, maturity date, and default provisions (and of course interest charges). Not all promissory notes have those components.

How is the interest deducted?

There are many rules, so to summarize them in a few paragraphs wouldn’t be possible. Please reference Publication 535 from the IRS (chapter 4 is about interest). The most recent version can be found here. At the time of writing, if you open the PDF version of Publication 535 and turn to page 11, it will be the start of the section about interest and how to allocate it under different circumstances.

About The Author: Michael runs an online business, Credit Card Forum. There you will find an extensive section he has written about choosing the best business credit card.

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2. More Tax Deductions for Small Business Owners and Sole-Proprietorships

What Does The IRS Say About Deducting Business Related Interest? originally published at Personal Finance Blog - FinanceGourmet.com

An IRA is an Individual Retirement Account. The IRA allows taxpayers to save money for retirement in a tax-advantaged manner. There are two types of non-business IRA accounts. With a traditional IRA, contributions are tax deductible for certain taxpayers. In addition, all monies within the account grow tax-deferred until withdrawal. A Roth IRA offers no deduction for contributions. However, the Roth account also offers tax-deferred growth. More importantly, money withdrawn from a Roth IRA account in retirement is tax-free.

To prevent abuse of the powerful tax advantages offered by IRAs, the IRS limits the total allowable IRA contribution each taxpayer can make. In addition, there are income limits for tax-deductible IRA contributions as well as limits on high-income taxpayers making Roth IRA contributions.

IRA Contribution Limits 2012

The 2012 IRA contribution limit is the same as it the 2011 IRA contribution limit. Taxpayers under age 50 may contribute up to $5,000 annually to an IRA account. Taxpayers age 50 and older may make an additional catch-up IRA contribution of up to $1,000, for a total IRA contribution of $6,000 each year.

2012 Roth IRA Income Limits

Contributions to a traditional IRA are allowed for all taxpayers regardless of income. However, contributions are only tax deductible for those whose income falls beneath certain limits.

For Roth IRAs, contributions are only allowed for taxpayers whose modified Adjusted Gross Income, or MAGI is below certain thresholds. For 2012, the Roth income limits were adjusted for inflation and set by the IRS in late 2011.

Taxpayers who are married filing jointly may contribute the full amount to a Roth IRA if their MAGI is less than $173,000 for 2012. For married couples with an MAGI between $173,000 and $183,000, the allowable contribution is reduced. Married taxpayers with MAGI over $183,000 are not allowed to make a Roth IRA contribution.

For single taxpayers, the limits are lower. Taxpayers with an MAGI of  less than $110,000 may make the full $5,000 Roth IRA contribution ($6,000 if over age 50). Single taxpayers with MAGIs above $110,000, but less than $125,000 may make a reduced Roth IRA contribution. Those with incomes above $125,000 may not make a Roth IRA contribution for 2012.

Keep in mind that the income limits for Roth IRA conversions were eliminated permanently. That means high-income taxpayers can still get money into a Roth IRA by doing a conversion from a traditional IRA account.

To do a Roth conversion, contribute to a regular IRA account. Convert the traditional IRA account to a Roth IRA account by paying the taxes that would be due on the IRA monies if they were withdrawn. (No penalties, however). Since the amount contributed counts as part of the basis, the taxable amount may be relatively low.

Related posts:

1. Spousal IRA Contribution Limit 2011
2. 2011 Roth IRA Income Limits

2012 IRA Contribution Limits originally published at Personal Finance Blog - FinanceGourmet.com

Shortly after publishing my post about your odds of being audited by the IRS, a reader sent me a message with a link to a CBS News article suggesting that your chances of being audited were actually much higher than previously thought. That is what the bold type headline screams, at least.

In reality, if you read the entire article, you’ll find that the odds of triggering an IRS audit are pretty much right in line with what I said in my article. What this other news article points out is that there are ways for the IRS to contact you that aren’t really audits. If you include these not-audits in the count of actual audits, then you get, not surprisingly, a much higher number of audits. In particular, the article focuses on ominous letters that IRS sends out to taxpayers, which are very much not audits. In fact, the letters cited in the article are about as far from an audit as you can get.

One of the letters informs taxpayers of a math error in their tax returns. This is not an audit. This is a notice that you messed up your math and therefore need to pay your taxes based upon the correct math. This scenario in no way results in anyone questioning your deductions or asking you to prove anything on your tax return with financial records. An audit is a re-examination of your tax return, not a request for you to fix a math error. Assuming you use tax software and take the 2011 standard deduction, there is a small chance of filing a return with a math error in it.

Another of the letters mentions the electronic system the IRS has to match reported data with the amounts listed on a tax return. I did allude in my post to the fact that the IRS matches information reported directly to it by your employer and other financial relationships with the amounts you actually report on your income tax forms. I even mentioned that this is an are where only a fool tries any funny business. Again, the result of this scenario is a letter in which the IRS in no way re-examines your return except to change the results of your calculations based upon the numbers that are reported to the Internal Revenue Service directly. This is not an audit either.

The point of my article about the low chances of being audited was not to encourage people to cheat on their taxes, nor to suggest that anyone cheat because the risk of audit is so low. Rather, I hoped to make filing income taxes a little less tense. People get so worked up about getting audited that they don’t take tax deductions or credits that they qualify for, for risk of being audited. That isn’t smart personal finance strategy, but neither is cheating.

Go into doing your taxes realizing that they can be a bit complicated, although there are tax prep software packages that help, but there is no need to walk around in fear of a potential audit. It might happen, but chances are it won’t. Just don’t freak out about it for no reason.

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Higher Tax Audit Chances? originally published at Personal Finance Blog - FinanceGourmet.com

As tax season approaches, America’s thoughts turn to the required filing of income taxes. Theoretically, America’s tax system is a voluntary reporting system, however, that voluntary part is backed up by a pretty big stick, IRS audits.

Odds of Being Audited

According to IRS statistics, the chances of being audited by the IRS is about one in 100, or one percent. A deeper look, however, reveals the the IRS audits certain tax returns much more often than other returns. IRS audit statistics suggest that high-income taxpayers and those who own small businesses are more likely to be audited that middle and low income taxpayers who earn the majority of their income from wages and salary or brokerage-style investments.

The reasons certain groups get audited more than others are two-fold. First, and foremost, there is more money to be gained by auditing higher income taxpayers. For example, consider a middle income wage earner, who is married filing jointly, bringing down a salary of $70,000 with no other income. Taking the standard deduction for 2011, of $11,600 for married couples filing joint, that leaves $58,400 of taxable income.

Do the math and that taxpayer isn’t going to pay any more than around $7,500 and likely much less if there are any kids. Assuming that our fearless taxpayer files his income taxes and fudges a child care credit or student loan interest deduction, he might shave a few hundred bucks off his total. If he is caught and audited, then the IRS can recover that and penalties and interest (particularly if it is proven to be fraudulent). Either way, the sum total of collection by that IRS audit won’t be more than a $1,000. That’s hardly worth the time and effort.

Don’t get me wrong, the IRS can and does audit returns like this all the time, primarily to avoid the appearance of “never” auditing certain kinds of tax returns. All it takes is one person getting audited to scare-straight dozens of their friends and acquaintances. However, at the end of the day, this taxpayer isn’t really “worth” the cost of an audit.

Who Gets Audited By the IRS?

A high-income taxpayer on the other hand can generate a significant tax recovery. When someone’s total tax liability is $5,000, even a big cheater won’t owe too much extra if audited. However, when someone’s total tax liability is $25,000, $50,000 or more, a successful audit might recover $10,000 or more, especially if there are penalties and interest involved.

The other reason higher earning taxpayers get audited more often is that they have more ways to cheat. Someone who earns a salary and takes the standard deduction has very little room to be sneaky. After all, their salary is reported to the IRS as well as the taxpayer. Trying to cheat on that number is flat-out stupid, considering a computer will crosscheck each and every one of those.

On the other hand, higher salaried taxpayers tend to itemize their deductions. Many of those tax deductions, such as mortgage interest are also reported to the IRS and thus not likely to be underreported. However, there are plenty of deductions that can be exaggerated very easily. Catching these things is the bread and butter of audits.

For the same reason, small business owners are frequent audit targets. There are many deductions for small business owners and other than the requirement to keep receipts and records, many are completely undocumented directly to the IRS. The 2011 Section 179 tax deduction alone is worth up to $250,000 this year. That’s some real money worth collecting.

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1. Mortgage Tax Deduction End of Year
2. 2009 End of Year Tax Strategies – Calculate Dollar Amount of Tax Moves

IRS Audit Odds originally published at Personal Finance Blog - FinanceGourmet.com

When you sell certain assets or investments that have appreciated in value, you may owe taxes on the increased value. The difference between what you paid for the investment and the amount you sold the investment is a capital gain and it is subject to capital gains taxes. However, if you lose money on an investment you can deduct the capital loss.

2011 Capital Loss Deduction

When it comes to taxes, the more tax deductions the better. And, when you lose money on an investment, a tax deduction can take out a little of the sting. However, deducting capital losses can be tricky. Get the rules straight to save on taxes and avoid making mistakes.

Just like with capital gains, there are two kinds of capital losses, short-term capital loss and long-term capital loss. Generally, a long-term capital loss occurs when you have a loss on an investment that you have held for at least one year. Conversely, a short-term capital loss occurs when there is a loss on an investment held for less than a full year.

The tax deduction for capital losses is limited to $3,000 per year against regular income. That means that you can get a full deduction of up to $3,000 each year, regardless of whether you have any other capital gains. Capital losses are a itemized deduction, so they won’t help if you are taking the standard deduction.

Offset Capital Gains with Capital Losses

However, you can offset an unlimited amount of capital gains with corresponding capital losses. For example, if you had an investment that gave you a $10,000 capital gain, and you have another investment that generated a $10,000 capital loss, you can offset the entire $10,000 gain. That means that you do not pay any capital gains taxes on the $10,000.

There is a catch, however.

In order to offset gains with losses, the type of loss must match the type of gain. In other words, in order to offset long-term capital gains, you must have long-term capital losses. You cannot use a short-term capital loss to offset a long-term capital gain, or vice versa.

It does not matter if your capital loss is short-term or long-term when it comes to deducting the $3,000 above and beyond any investment gains that you have for the year.

Capital Loss Carryover

If you have more losses than gains to be offset, only the first $3,000 of the losses can be deducted from ordinary income. However, the remaining amount is not lost. Rather, losses can be carried forward to be used on future year’s taxes.

Revisiting our example, assume that you have a $10,000 capital gain for the year, but you have $20,000 in capital losses. You can completely offset the $10,000 gain, meaning you owe no capital gains taxes this year. However, you can only deduct $3,000 of the remaining $10,000 of losses against your regular income. That leaves $7,000 of loss that can be carried forward to next year’s taxes.

In the following year, you can use the entire $7,000 to offset any capital gains. If you have no gains, you can still deduct the $3,000 allowance against ordinary income for the year.

So, if the following year you have $5,000 in capital gains, you can offset all $5,000 and still use the remaining $2,000 in losses as a deduction against ordinary income.

How To Claim a Capital Loss

Capital gains and losses are calculated and reported using Schedule D of Form 1040 and entered on Line 13 of Form 1040.

What is most important about capital losses is that you remember to carry them forward. Users of tax software like Turbo Tax or Tax Cut have this data automatically carried forward by the program if you import last year’s tax returns when you start filing your taxes with the software. However, taxpayers who do their taxes by hand or that switch accountants or tax software need to ensure that their previous year losses are carried forward. Large losses can take years to use up if there are no corresponding large gains to use them against.

Many people have big capital losses to use thanks to recent market volatility. Even if you have tens of thousands of dollars of losses or more, be sure to continue to carry the amount forward. Some day, you’ll make money on an investment and those losses will keep you from having to pay taxes on your gains.

Capital losses can be carried forward forever with no limit on how long they may be used.

Be sure to also understand short sales for capital gains.

Related posts:

1. 2011 Section 179 Deduction Limits for Small Businesses Taxes
2. Standard Deduction 2011 and 2011 Tax Brackets

Capital Loss Tax Deduction 2011 originally published at Personal Finance Blog - FinanceGourmet.com

Every year a plethora of financial articles come out telling people how to save money on their taxes at the end of the year. It’s a fine idea, and frankly, no stone should go unturned. However, the best tax planning takes happens year round. That being said, there are numerous last-minute ways to cut income taxes by making last minute moves in December. Today, we examine one of the most common end of year tax moves, paying your mortgage early.

Check here to learn how to deduct mortgage interest on your taxes.

Make Mortgage Payment Early to Deduct More

One of the biggest tax deductions that is available to ordinary taxpayers is the mortgage interest deduction. Simply put, the 2011 mortgage interest deduction is the ability to deduct whatever amount you pay in mortgage interest from your income taxes. There are several rules and exclusions, but they don’t apply to most taxpayers unless you have more than $1 million in mortgages or several houses. This is one of those tax deductions with no income limits.  You do need to itemize your deductions in order to claim the mortgage interest deduction. For many people, the amount of their mortgage interest deduction determines whether it is best to itemize or claim the 2011 standard deduction amount.

In a normal year, you make 12 mortgage payments. Add up the total amount of interest paid, and that is how much you get to deduct. Your mortgage company will actually do it for you because they are required to submit a 1099-INT to both you and the IRS. This means the IRS knows how much money you actually paid on your mortgage, so this isn’t a good place to get creative. You can find the 2011 1099-INT forms on the IRS website. (Update: The 2011 1099-INT forms are now also available.)

However, as with most tax deductions, you get to claim the amount amount you pay during the year regardless of when it is actually due. Thus, if you pay your January mortgage payment in December, you get to deduct it on this year’s taxes. That means you get to deduct the amount of interest paid on 13 payments instead of just 12.

For example, let’s assume for the ease of math that you pay $1,000 per month in interest on your mortgage. (Keep in mind that only the interest part of your payment is deductible. The amount that goes to principal and the escrow payment is NOT deductible.) If you made all the payments at the regular time during 2011, then your 2011 mortgage interest deduction would be $12,000.

That’s not too shabby. But, if you pay your January 2012 payment during December 2011, then you have made 13 payments during the 2011 tax year instead of 12. That means that on your 2011 taxes you can deduct $13,000 instead of just $12,000. That extra $1,000 deduction can be very valuable especially at higher tax brackets. In the 30 percent tax bracket, making your payment just a few days early saves $300 on your taxes.

The Catch to Paying Your Mortgage Early

There is, of course, a catch to using the tax trick of paying off your mortgage early.

By making your January 2012 payment in 2011, you have eliminated one of the payments you would normally make during 2012. That means that you can only deduct 11 mortgage payments worth of interest in 2012 because the January payment was not made during 2012, it was paid in 2011.

In our example above, by paying the January 2012 payment early, you got to deduct $13,000 in 2011. But, that means you will only be able to deduct $11,000 on your 2012 taxes. There is a way around this. If you make your January 2013 payment during December 2012, then you can deduct the full-year of interest of $12,000. However, there is no way to get that extra deduction again until you bite the bullet and take only 11 months worth of interest payments as your mortgage deduction in some year.

Mortgage Interest Deduction Audits

Here is the mistake that many taxpayers accidentally make.

In 2011, they read about this really great idea to make their January mortgage payment early in order to get a bigger interest deduction. So, they pay 13 months worth of payments during 2011 and they deduct 13 months worth of interest. So far, so good.

However, in 2012, they forget that they did that. The mortgage company sends them a 1099-INT that shows a full 12 months of interest payments for 2012 and they deduct the full 12 months of interest, even though they can only legally deduct 11. Then, are those who try and use the trick again in 2012 by paying their mortgage early and deducting 13 months of interest when they only qualify for 12 months of interest payments.

Remember those 1099-INT forms that the mortgage company sends to both you and the IRS?

That is how you get caught. The IRS computers run the numbers on the forms against the numbers you claim and sometime in 2013 or 2014, a letter shows up in the mail saying that a routine examination of your return has discovered a possible error. If you are really unlucky, your return will get flagged for a full-scale audit. Typically, however, you’ll just be subject to an “information audit” where the IRS will require you to provide documents to support your deductions.

It won’t take long for cancelled checks and mortgage statements to reveal that you claimed too many deductions in 2012 and owe back taxes and interest on the amount. Theoretically, if the IRS can prove you did it on purpose, you can also be on the hook for fraud and additional penalties, but this kind of mistake happens all the time and non-accountants routinely fall victim so they probably won’t go after you for that.

How To Maximize Tax Deductions by Paying Mortgage Early

Paying your mortgage early to increase your mortgage deduction amount in 2011 works best for people who either have income that varies from year to year, or people who know that they are going to get hit with a big tax bill and will adjust for it on their 2012 taxes.

If your income varies because you earn commissions, own your own business, or you get bonuses that are different sizes each year, then you want to pay your mortgage early in a year where your income will be high. Even if it is high the next year, you can pay early again and keep your full-year interest deduction. Eventually, when you have an off year or your bonus is smaller than usual, you can not pay early and only deduct 11 months of payments. This “reloads” this tax deduction increase trick for another year when your income is higher.

For people who get an unexpected windfall during the year that may result in a higher tax bill, that extra $300 deduction will give you some extra room when filing in 2012 for your 2011 taxes. Just be sure to adjust your withholding for 2012 so that you don’t come up short again.

Paying your mortgage early is a good end of year tax tip. However, be sure you fully understand what you are doing and how it affects your future taxes. If you pay early this year, you have to pay early for every other year until you are ready to take the smaller 11-month size deduction.

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Related posts:

1. 2012 Standard Deduction Amount Set
2. 2009 End of Year Tax Strategies – Calculate Dollar Amount of Tax Moves

Mortgage Tax Deduction End of Year originally published at Personal Finance Blog - FinanceGourmet.com