HELs: Handy Loophole in Tax Law
QUESTION: I recently heard a savings and loan association advertising a loan that I’ve never heard of before: an HEL. Do you know what it is?
--C. E.
ANSWER: HEL is short for home equity loan. This type of loan--a form of second mortgage--isn’t new. But its popularity has been rekindled with the enactment of the 1986 tax reform bill. Under the new tax law, all interest paid on first and second home mortgages remains deductible--as long as the sum of all outstanding loans on the home doesn’t exceed the purchase price.
But so-called consumer interest--that is, interest payments on car loans, credit card balances, school loans and the like--will be gradually phased out over the next four years.
It didn’t take long for homeowners to recognize that they could continue to pay off their consumer debt gradually and still deduct their interest payments, despite the new law. All they had to do was tap into the equity in their homes and pay off their existing car loans and other consumer debt with the new home equity loan--HEL.
According to the National Second Mortgage Assn., lenders made 3.5 million second mortgage loans last year for a combined total of about $75 billion; these figures are expected to rise slightly this year and to spurt sharply next year. It is widely estimated that there is still an estimated $3 trillion or more in untapped home equity in this country.
As always, there are several precautions you should take before rushing out to take advantage of this tax-law loophole. Most important, watch out for deals that look too good.
Some lenders, hoping to outsmart the competition, are offering extremely low interest rates initially. But virtually all of these lenders very quickly escalate the rate they charge.
Also, be sure to compare loan application fees, title search charges and the like. These can vary dramatically. Moreover, they can add up to such large figures themselves that it becomes impractical to take out the new loan--even if it does allow you to keep deducting the interest payments. So, be sure to sit down with your calculator before consolidating your debts into one home equity loan.
Q: Is it true that the new tax law contains a hidden provision to somehow do away with frequent flier bonuses for people like me who fly a lot on business?--P. L.
A: That is one employee perk that the tax reform act left untouched. But that doesn’t mean the controversy over these bonuses has died. The Internal Revenue Service is still searching for a way to tax employees who receive frequent flier points as a result of company business. These points entitle the traveler to free flights or to upgrade his travel accommodations from coach to first class.
The IRS argues that when the frequent flier points are earned on company business, they are another form of income and should be reported and taxed accordingly. Rules governing acceptance and taxation of these company perks are expected to be issued by the IRS in the next few months.
Q: I have read a lot of tax reform stories that refer to the AMT. But they never seem to explain what it is. Will you?--R. T.
A: The reference is to alternative minimum tax. This is the government’s way of ensuring that wealthy individuals and large, profitable companies with a lot of tax credits and tax deductions don’t entirely escape paying income taxes. The AMT formula is too complicated to recite here. But suffice it to say that taxpayers who claim certain types of deductions must pay a minimum amount of federal income tax--even if those deductions reduce their taxable income to a level where no tax would otherwise be owed.
The minimum tax has been back in the news because, under tax reform, more types of income will trigger an alternative minimum tax calculation.
