Ask Liz Weston

Get smart with your money

q&a

Does Paying Off Old Debts Help Your Credit Score?

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Dear Liz: How can I get a clear and complete picture of the debts that are hurting my credit score? I have my credit report already. I’m a bit lost and I need to get my credit cleared up to buy a home.

Answer: You actually have three credit reports, one at each of the major credit bureaus: Experian, Equifax and TransUnion. Your mortgage lender is likely to request FICO credit scores from each of the three, so you need to check all three reports.

You get your reports for free at one site: http://www.annualcreditreport.com. There are many sites masquerading as this free, federally mandated site, so make sure that you enter the URL correctly. You may be pitched credit scores or other products by the credit bureaus while you’re on this site, but you won’t be required to give a credit card number to get your free reports. (If the site is demanding that you give your credit card number, you’re at the wrong site.)

You should understand that old, unpaid bills may be depressing your scores, but paying them off may not improve those scores. In other words, the damage has been done. You may be able to reduce the impact if you can persuade the collectors to remove the accounts from your reports in exchange for payment, something known in the collections industry as “pay for delete.” But you probably can’t erase the late payments and charge-offs reported by the original creditor before the accounts were turned over to collections, and those earlier marks against you are even more negative than the collection accounts.

That’s not to say you should despair. Over time, your credit scores will improve as you handle credit responsibly. But you shouldn’t expect overnight miracles.

Triggering the Gift Tax

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Dear Liz: In 2007, my parents signed over their house deed to my name. Does this trigger the gift tax? They never filled out a gift tax form. Is it too late? Dad has passed on but Mom is still with us. She has Alzheimer’s disease, and I have her power of attorney. Are there no taxes due because of the lifetime exclusion?

Answer: Yes, a gift tax return should have been filed, but no, the gift tax itself almost certainly wasn’t triggered. In 2007, each of your parents would have had to give away more than $1 million in their lifetimes before gift tax would be owed. The gift tax exemption limit has since been raised to more than $5 million.

A tax professional can help you file the overdue return. Then you should consult an attorney about what to do next.

If your parents’ intent was to avoid taxes by transferring the home to you, they probably made a mistake. By giving the house to you, they also gave their tax basis. That means that when you sell the house, you would have to pay capital gains taxes on the difference between the sale price and what they paid for it, perhaps many years ago. The capital gains would be decreased by any improvements made in the subsequent years and by selling costs, but you still could face a substantial tax bill.

If you’d inherited the home after their deaths, on the other hand, you would get a new tax basis that essentially makes those gains tax-free.
You could undo the gift by transferring the deed back to your mother and filing another gift tax return. (Again, no tax probably would be owed.) But that’s probably not something you’d want to do if your mother will qualify for Medicaid, the government program that pays nursing home expenses for the poor, said Howard Krooks, an attorney with Elder Law Associates in Boca Raton, Fla., and president of the National Academy of Elder Law Attorneys.

Medicaid looks back at the previous five years to see if the family transferred assets for less than fair-market value and delays eligibility if such transfers are found. Since you’re outside the five-year mark, you may want to leave things the way they are if Medicaid is in your mom’s future, Krooks said.

An elder law attorney can help you sort through the options. You can get referrals from the National Academy of Elder Law Attorneys at http://www.naela.org.

Charitable giving can help keep tax deductions steady

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Dear Liz: Regarding the reader who was worried about not having sufficient tax deductions: I recommend charitable giving. As our mortgage interest per payment fell, I augmented it with charitable giving to maintain the same annual total for income tax deductions (interest plus charity). As the years go by, our interest decreases and charity increases. Payments to charity accomplish a social benefit, while interest payments just line the pockets of bankers. We give to a broad variety of charities: national, local and international organizations, religious and secular, health and social care, care for children at risk, veterans, Red Cross, etc. The great thing about charitable giving is that we get to choose whom we wish to help. When asked, most organizations will keep your demographic information private so that you are not inundated with requests via the sale of donor lists.

Answer: Thanks for sharing your approach, but people should understand that it requires paying out more money over time to maintain the same level of itemized deductions.

Mortgage payments typically remain the same over the life of the loan, with the amount of potentially deductible interest shrinking and the amount applied to the principal increasing with each payment. So as the amount of deductible interest declines, you would have to increase your contributions to charity in addition to making your mortgage payment each month if you wanted to keep your itemized deductions unchanged.

How should couple with age gap tap Social Security spousal benefits?

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Dear Liz: I am 55 and my wife is 65. She only worked a few part-time jobs as she spent most of her working years raising our nine beautiful children. My question is, since she does not have enough credits to collect Social Security on her own work record, can she claim spousal benefits on my work history? If so, at what age and how will it affect my benefits?

Answer: Your wife can receive spousal benefits based on your work record, but those checks can’t start until you’re old enough to qualify for benefits at age 62 (when she’s 72).

If you apply at 62, however, you’re typically locked into a check that would be about 30% smaller than what you’d get if you waited until your “full retirement age” to start. Full retirement age used to be 65, but it’s now 66 and will gradually increase to 67 for people born in 1960 or later.

At your full retirement age, you have the option to “file and suspend,” in which you file for retirement benefits and then immediately suspend your application. Your wife can start receiving spousal benefits, but because you aren’t actually receiving checks, your benefit can continue to grow until it maxes out at age 70.

For many couples, it makes sense for the higher earner to delay starting benefits as long as possible. Given your big age gap, however, you may be better off with a hybrid approach: starting your own benefits (and your wife’s spousal benefit) at age 62 and then suspending your benefit when you reach full retirement age, said economist Laurence Kotlikoff, a Boston University professor who created the site MaximizeMySocialSecurity.com to help people analyze their claiming options. Your benefit would grow 8% a year from the time you suspend to the time you restart at age 70. Your wife would continue to receive her spousal benefit in the interim.

Because your wife will be older than her own full retirement age of 66 when she starts receiving checks, she will be entitled to half of the benefit you’re scheduled to get at your full retirement age. What she gets doesn’t diminish what you get. Spouses who haven’t reached their full retirement age when they apply for spousal benefits have to settle for a discounted check.

Clearly, claiming decisions can be complicated, especially for married people and even more so when there’s a big gap in their ages. AARP has a free calculator that can help most people understand their options. T. Rowe Price also has an easy-to-use calculator, but it doesn’t work for married couples with more than a six-year age gap.

For a more detailed and customizable calculator, you may want to pay $40 to use the software at sites such as MaximizeMySocialSecurity.com or SocialSecurityChoices.com, co-developed by economist (and Social Security recipient) Russell F. Settle.

When inheritances don’t come

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Dear Liz: I read with interest the question you received from the widower who thought he should inherit from his father-in-law, despite the death of his wife. Your answer was great, but it got me thinking about the mind-set that makes someone even think to ask the question. It’s obvious that the asker and his late wife clearly lived their life expecting to inherit a large amount of money. Which leaves unasked, how did they live and what did they save on their own? Did they take vacations instead of save? Did they not save at all? The bottom line here is that you need to reinforce that there is no “sure thing” in expected inheritances and encourage people to amass wealth on their own. Someone else’s money is someone else’s money, and even if he intends to leave it to you, an illness, a lawsuit or some other loss could wipe out anything he meant you to have.

Answer: People who expect an inheritance to save them from a life of not saving are courting disappointment.

About half of those who die leave less than $10,000 in assets, according to a 2012 study for the National Bureau of Economic Research. Many failed to save adequately during their working lives, but even those with substantial assets can find their wealth eroded by longer lives, market setbacks, chronic illness and nursing home or other custodial care.

Hopes of an inheritance also can be dashed by remarriages, poor planning or both. For example: Dad dies without a will and Stepmom inherits the bulk of the estate, which she gives to her own kids. Or Mom thinks she’s tied up everything in a trust, but her surviving spouse figures out a way to invade the principal. Or Grandma gets victimized by a gold-digger or a con artist, leaving nothing but hard feelings.

Most of those who do inherit don’t get fortunes. The median inheritance for today’s baby boomers is $64,000, which means half get less, according to a 2010 study from the Center for Retirement Research at Boston College.

So you’re right that the best approach for most people is to prepare as if there will be no inheritance, since if there is one, it probably won’t be much.

Employee secretly reclassified as contractor

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Dear Liz: I just received my tax forms from my employer for last year. I was originally a W-2 employee, paid hourly, as a receptionist. But it seems that at some point during the year, my employer changed me to a 1099 employee without telling me or having me fill out paperwork. After researching the characteristics of a 1099 employee, I found I do not qualify at all. I am upset that I will have to pay taxes on this income, since I thought they were being withheld from my pay. Do I have any recourse?

Answer: Your employer has put you in an impossible situation. If you tell the truth, you’ll tip off the IRS to the company’s deception, which could put your job in danger. If you go along with the lie, you’ll have to pay your boss’ share of taxes in addition to your own.

“The good news is the IRS is really busy and probably won’t [audit your employer] for a couple of years,” said Eva Rosenberg, an enrolled agent who runs the TaxMama site. “By then, you should have a better job elsewhere.”

To fix this, first report your income from this job as “other income” on line 21 of your 1040 tax return, Rosenberg said.

If you got both a W-2 and a 1099, you can use IRS Form 8919 to pay only your share of the Social Security and Medicare taxes. You’ll pay 7.65% instead of the 15.3% you normally would pay with 1099s, Rosenberg said. You’ll have to select a “reason code” for why you’re using the form. You can use code H, which says that the amount on the 1099 form should have been included as wages on Form W-2.

If you got only a 1099, you’ll need to fill out Form SS-8 to explain why you’re an employee, not a contractor, Rosenberg said. Then use Form 4852 as a substitute for your missing W-2. Use the data from the last pay stub that shows your year-to-date withholding as a W-2 employee so you can get credit for those taxes paid. This process is complicated but is the approach a tax pro “would and should use” when an employee is misclassified as an independent contractor, Rosenberg said.

The forms you’re filing will alert the IRS to your company’s chicanery. Some employers pretend that their employees are independent contractors as a way to reduce the company tax burden and perhaps dodge new health insurance requirements. It’s a scam that tax authorities are keen to uncover and penalize