# Credit Card Debt for Dummies

You don’t have to be a genius to get a credit card, but you want to be smart when you use it!

Credit cards are pretty convenient to have, but if you’re not careful, it’s easy to get into trouble with them.  Half the battle is knowing what you’re getting into before you begin.  Hopefully, this will help.

First, a credit card is like a little loan to help you pay for things.  If you pay off the entire balance each month when you get your bill then you won’t have any problems.  If you don’t pay off the entire balance, then the credit card company will charge you interest on the amount that’s left over.  That’s how they make money.  (That and the fees they charge the store owners for using credit cards.)

Let’s say you went out and purchased some new furniture for your home and spent \$5,000 on a credit card that charges an 18% interest rate.    The first bill comes in the mail and you see the minimum payment is \$100.  Now if you pay the full \$5,000 – cool, you pay no interest.  But what if you don’t have it and you only pay the \$100?

The credit card company takes their interest payment first – remember that’s how they make their money.  So, at 18% per year, that works out to be 1.5% interest per month.

\$5000 times .015 equals \$75.

So \$75 goes to the credit card company for the privilege of using the credit card to buy your stuff.  Since you only paid \$100 towards the debt, then that only leaves \$25 to reduce the balance.  You still owe \$4,975.

If you only pay \$100 a month to reduce the debt, you will have paid \$9,400 before the account is paid up in 7 years and 9 months.  Ouch!

Now, if you were to pay \$200 a month in the same situation, you’d have only paid \$6,400 and you’d be paid off in 32 months.  You’re throwing an extra \$100 a month towards the balance so of course it gets paid off faster!   That first \$75 will still go to the credit card company to pay the interest, but you’ll have paid \$125 towards the debt so you only owe \$4,875 the next month.  And this is where it’s so sweet.  The interest you pay on \$4875 is \$73.13.  The interest you pay on \$4975 is \$74.63.  Okay, not a huge difference, right?  But every month that gap keeps getting bigger and bigger.  So you save money by making a bigger payment on your credit card.

Another way to save money is if your credit card has a lower interest rate.  For example:  let’s say the interest rate is 12% instead of 18%, and you pay \$100 a month.  You’d pay off the balance in less than 6 years and pay only \$7,000 instead of \$9,400..

So here are the three things I want you to remember about credit card debt:

Paying off your credit card charges immediately will keep you from paying interest.

If you don’t pay the full amount, the money you do pay gets applied to interest first, then the balance owed.  The more you pay, the sooner you’re paid up.  Paying down the debt saves you money!

The lower your interest rate, the less you pay towards interest.

Hopefully, by seeing how much it costs to use your credit card will help you make good spending choices.

# How to Settle Your IRS Debt for Less: Taking the First Step

You’ve heard those commercials on the radio or seen them on late night television.  “Settle your debt with the IRS for pennies on the dollar!”  Those companies charge a lot of money for something called an “Offer in Compromise.”  I’ve dealt with a lot of people who’ve paid between \$5,000 and \$8,000 for those services and gotten nothing-NOTHING for their money.  That’s good money they could have used to pay off their debt!

So, before you spend that kind of money, you should see if you have a fighting chance at getting an Offer in Compromise (OIC) first.  And here’s the best part–you can test it out for free.  FREE!

The IRS has an Offer in Compromise Pre-Qualifier.  It’s a wonderful little tool that will let you know if you even have a shot at an OIC before you spend money trying to get one.  Here’s the link:  IRS Offer In Compromise Pre-Qualifier

The first page has some pretty basic questions.  Are you currently filing for bankruptcy?  The answer has to be no, you can’t have an OIC if you’re in bankruptcy.  If you’re in bankruptcy, you’ll have to wait until that’s over to file for an OIC.   The next question is have you filed all of your tax returns.  You have to say yes–otherwise the result will be no OIC.  You’ll have to file those returns before filing for OIC, but you’re just trying to figure out if you could qualify in the first place.

Same thing with making your tax payments.  Before you file for OIC, you’ll have to have your estimated payments caught up for the current year and self employed people must have their payroll deposits made.

So, just to get past the first page, you need to answer NO, YES, NA, NA.  If that’s not true, you’ll need to rectify the situation, but you need to answer that way just to get past that screen to get to the meat of the program.

The next page is about where you live and the amount of tax that you owe.  (This is one good reason why you need to file all of your returns before you make an offer–how can you settle your debt when you don’t know how much you owe?)  But this is just a pre-qualifier, it’s to see if you may be able to make an offer so make your best guess.

The reason they ask about where you live is because the cost of living is different in different areas.  A New Yorker will be able to claim more in housing expenses than someone from St. Louis because the cost of living is higher there.  On the flip side, New Yorkers don’t get an adjustment for their other expenses which can hurt them when trying to qualify for an OIC.  But that’s why the question about where you live is on the pre-qualifier.

From there, on the next page the IRS is looking at your equity–what are you worth financially?  How much money do you have in the bank?   What’s the value of your home?  How big is the loan on it?   How much is in your 401(k)?  Do you have any stocks?  How about the value of your car?  How much do you still owe on your car loan?   So where it asks for the equity in your car, it means what is the value right now minus how much you still owe on your car loan, that’s your car equity.

Home owners with a lot of equity and people with retirement assets often lose out right here.  If you have assets, the IRS figures you can sell them or cash them in to pay your IRS debt.  Be honest when filling this out (remember, no one is going to see it but you.)  If you apply for an OIC, the IRS will be able to substantiate everything you say, so you may as well tell the truth to yourself on the pre-qualifier.

If your assets are too high to qualify for an OIC, the pre-qualifer will stop right here.  You may want to double check your figures before giving up completely, but most likely you’ll need to pursue a different route to get settled with the IRS.

If you do get to the next section it’s all about your income.  Wages, interest, dividends, child support, alimony, distributions from partnerships and S corporations.  Anything else?  The IRS doesn’t care if it’s taxable income or not.  They include social security, pension income and even Veterans benefits as being money that you can use to pay your tax debt with.

The IRS is looking for monthly figures here.  So, let’s say you get paid every two weeks.  That means 26 paychecks a year.  You’ll take the gross on your pay stub multiply that by 26, and divide by 12 to get your monthly pay.  Lots of people would just double their pay check, because for the most part, you’re getting 2 checks a month.  But the IRS doesn’t count that it way.  They multiply by 26 and divide by 12 it makes a difference.  You need to know how they’re calculating if you want to win this game.

The next page is all about your expenses.  How much is your rent or mortgage?  How much do you pay on your cars?  What do you spend on gas and groceries?  Child care?  Child support?  Alimony?  Utilties?

Life insurance is on the list too.  Now what they mean here is term life insurance.  A whole life policy where it’s like an investment isn’t considered to be a cost of living expense, but term life is.

So now you’ve input your income, your expenses, your debt and your equity and the IRS computer runs all these numbers together and either says you may or may not qualify for an Offer in Compromise.  It will also say what the IRS expects your offer to be given the information you put in.

Here’s the thing:  the IRS tool is only as good as the information you put in.  Most people do the IRS Pre-Qualifier the first time around just guessing at the answers.  (I think I’d get this much if I sold my house today, I’m guessing my loan balance is about \$x.xx.)  This is just to get a ballpark.  To get a better picture, you’re going to want to really know what your home loan balance is.  Check out the fair market value of your house on Zillow.com.  Really look at what you spend for your utilities.   Get the actual numbers off your pay stub and do the pre-qualifier again with the actual figures.

Does it still look like you can do this?  Great.  Remember, page one?  Make sure all of your returns are filed first and you know how much debt you owe.  Don’t be in bankruptcy.  And most importantly, make sure that if you need to be making estimated tax payments, you’re caught up with making them.  Make sure these issues are taken care of before you submit an actual offer.  I suggest hiring a professional to do this, but if you’re going to do it yourself, start with the Offer in Compromise Booklet, here’s the link to that:  Offer in Compromise Booklet

And if you don’t qualify for an Offer in Compromise?  That’s still not the end of the world.  If you have exceptional circumstances, like huge medical expenses, you may still be able to make an OIC.  Be aware that your chances are significantly lower for getting accepted, but you can still make the offer.   But you’re going to have to demonstrate that your circumstances are exceptional and that paying the tax would create an undue hardship.  This seems silly, but I cannot stress this enough–simply not wanting to pay your tax is not considered an undue hardship.  (I get asked that question all the time.)  Paying for chemotherapy treatment for a cancer patient, that might get you somewhere.

Even if you cannot qualify for an OIC, you can still work out a payment arrangement with the IRS to get the debt handled.   You’re just going to have to pay the full amount of your debt.

# Budget Hero

Think you got what it takes to make a sound Federal budget?  Ladies and gentlemen get your calculators ready – it’s time to play Budget Hero!

This game was created and is owned by American Public Media and appears here with their permission.

# I Lost My Job and Can’t Pay the IRS

Photo by Timetrax on flickr.com

I write a lot about what to do if you can’t pay the IRS, but this is new stuff just for 2011 taxes.   If you’re out of work, or if you’re self-employed and your income is lower than last year, you may be able to apply for an extension of time to pay your 2011 income tax–so you don’t get hit with late payment penalties.

Who can qualify?
• First, your adjusted gross income (that’s line 38 on form 1040) must be less than \$100,000 (or \$200,000 if you’re married filing jointly.)
• Second, you need to owe the IRS less than \$50,000.
What’s considered a good reason for filing?
• Losing your job, for one.  If you were unemployed for at least 30 consecutive days in 2011 or the first part of 2012, then you can apply for relief.
• Or, if you’re self employed, if your business income is 25% or more less than what it was in 2010, then you also can qualify.
What other things do I need to know?
• The relief is only good for your 2011 taxes.
• It only helps with the failure to pay penalty, you’ll still have to pay the interest on your late payment (about a 3% annual interest rate.)  You’ll also have to pay any other penalties that you might owe.
• If you don’t pay the amount of tax you owe in full by October 15, 2012–then you’ll still wind up paying the penalty and it will be back-dated to April 15th.
• If you apply for the late payment relief, you must have your tax return or extension filed on time.
So if I want to apply, how do I go about it?
The form you need is called:  Application for Extension of Time for Payment of Income Tax for 2011 Due to Undue Hardship.   That’s a mouthful isn’t it?  Fortunately, it’s easier to fill out than it is to say.  The form number is called 1127-A.  Here’s a link to the IRS website so you can download it yourself:

http://www.irs.gov/pub/irs-pdf/f1127a.pdf

Besides stuff like your name and address, you only need to know your adjusted gross income and the amount of tax you owe.  You can’t e-file the form with your tax return, you have to print it and mail it in.  It doesn’t go to your regular tax office–it’s either going to be mailed to Huntsville, New York or Fresno, California.  Look at the instructions on page 3 of the form to learn where you should mail your form.

Why would I want to do this?
Basically, if you owe taxes and can’t pay, the IRS charges ½ of one percent on the balance due each month that you haven’t paid.  So, after 5 months–that’s a 2.5% penalty.   So if you owe \$5,000 that would cost you an extra \$125.  That might not seem like that much but why pay the IRS more than you have to?  If you think you can come up with the money within 5 months–why not take advantage of the break?
I wind up dealing with lots of people who just don’t bother to file their tax returns because they owe.  That’s a really bad decision.  You see, the penalty for paying late is only ½ of one percent per month, but the penalty for not filing is 5% per month.  So if you take that \$5,000 I mentioned earlier and you didn’t file your return because you knew you owed–well the penalty for that would be \$1,250 if you waited until October to file.  Now that’s a pretty serious chunk of change so make sure you file your return–or at least file an extension, by April 17th.   You really don’t want to give the IRS any more money that you have to, do you?

# What You Need to Know If Your Mortgage Debt Is Forgiven

Photo by Jeff Turner on Flickr.com

It’s happening all over the place. Homes are being foreclosed on and banks are forgiving loans. Having your loan forgiven can be a lifesaver, but being taxed on that loan forgiveness can be devastating. There are remedies to help ease the tax burden, but make sure you know the facts so that it doesn’t come back to bite you.

If your debt has been cancelled by the bank, you should receive a document called Form 1099C, Cancellation of Debt. This form also goes to the IRS. It must show the amount of debt forgiven and the fair market value of the property that was foreclosed. Once you get a 1099C, make sure that you check it over carefully. If anything is wrong on that form, you need to go back to the bank to have them change it. The two important numbers you’re looking at are the debt forgiven amount (that’s box 2), and the fair market value of the property at the time of foreclosure (box 7). These figures will be extremely important to you, especially if you have credit card debt or college loan money tied up in your mortgage.

The Mortgage Forgiveness Act of 2007 allows you to exclude up to \$2 million of debt forgiven on your principal residence. The limit is only \$1 million for a married person filing a separate return. You don’t have to be foreclosed on to exclude debt—you may also exclude debt reduced through a mortgage restructuring. This is really important for people doing a workout with their bank.