Filed under: Investing
Tax season is in full swing. Thanks to tax preparation software, a lot of the common mistakes (i.e., missing social security numbers) are now automatically detected.
Still, they are only capable of checking for math accuracy and missing fields. They can't optimize a tax return to get the maximum amount possible or compensate for our misunderstanding of the complicated tax code. I have been using tax software and/or tax professionals ever since I started filing in 2003.
In these ten years, I have learned that no matter what software or tax professional I use, the onus is on me to know what is best for me and what mistakes to avoid. Here is a list of dos and don'ts based on the mistakes that I have personally made or have come across in recent years. Use this as a checklist to make sure you avoid them too.
- Don't assume you can't itemize: When I started filing taxes as a student, I spent a total of 10 minutes filing my taxes. I didn't know anything about itemized deductions. I just assumed it is for people who have a lot of expenses like a mortgage or kids. When I started working, I continued with my belief that the standard deduction is the best for a single-filer without a home. When I got my first job, I decided to use one of the "professionals" at a big tax preparation chain. After a few nightmarish meetings with so many mistakes that I could spot, I decided to spend a weekend doing my taxes by hand. That is probably the best thing I did for my finances. It was an eye-opening experience to actually read all the IRS publications to see what I qualify for and don't. The professional never asked if I ever donated to charity; she just assumed I don't. That weekend I understood there is much more to itemized deductions than just a mortgage. Just because you are single, don't assume you can't itemize. Read up on the itemized-deduction publication and start collecting the relevant supporting documents throughout the year. You might be surprised to see a lot of small things adding up to a total of more than the standard deduction.
- Don't assume a deduction is not worth the effort: This mistake almost cost me over $500 last year. I knew the medical deduction had a floor of 7.5 percent. (This year it is 10 percent.) I mentally calculated 7.5 percent of our income (our gross income) and assumed our expenses wouldn't cross that limit. In a desperate moment I decided to collect all the medical receipts and calculate the amount just to make sure. I earned over $500 in those few hours of effort. First, it is 7.5 percent of our AGI, not gross income; second, all the doctor co-payments, prescription drugs, eyeglasses, parking and travel costs added up to an amount I didn't think we had spent. So never assume you can't take a deduction. Always make sure.
- Don't choose a tax preparer based on his/her promises to get the maximum refund: I know a certain tax preparer in the area where I used to live who claims regular groceries and a whole range of regular living expenses as deductions for his clients. (Yes, I have reported him to the IRS, but nothing seems to have happened and he is still in business.) His business is booming because he promises the maximum return and charges a percentage of the return as his fee. It is an audit waiting to happen for the clients.
- Don't overestimate the value of your donations: Keep the receipts and use a standard guide for the value of your donations.
- Don't forget to claim all the deductions for which you are eligible: You don't have to fear an audit to claim the deductions for which you are legally entitled. Many audits are in the form of a mail requesting supporting documentation; so if you have your paperwork in order and fulfill the eligibility criteria, the fear of an audit shouldn't prevent you from taking a deduction.
- Don't wait too long to file your taxes: If you wait too long, you might be in a hurry to file before the deadline and forget to claim all your deductions. If you file with an accountant, he might not have time for a thorough review. Do your tax preparation throughout the year by organizing your receipts, and start your return as soon as the new software hits the market with the latest changes.
- Check auto-import numbers: Most major tax preparation software now have a feature to auto-import your W2 and/or investment tax forms. It is a very handy feature, but it is not always perfect — especially if you have a complicated W2 or 1099 forms. Check to make sure the numbers are in the right place and you are not double-paying your taxes.
- Check different filing status to see which will be best for your situation: If you had a major life change in the year like getting married or divorced, do the taxes using different filing status. One status might be better than another. For example, if you became a single parent, it might be beneficial to file as head of household instead of single.
- Keep all your supporting documents in order: We should be taking every single deduction if eligible, but that doesn't mean the IRS can't question the deduction. Make sure to collect all the supporting documents and file them. It might be best to scan them and store them in cloud storage to avoid losing the documentation.
- Report all your income, even if you didn't receive the documentation: I had one of my contractors ask that I not issue her a 1099 so that she doesn't have to pay taxes on it. It does not work like that. If you received income, you should report it no matter what documentation you receive. Make sure you keep the receipts for all the expenses you incurred for the job so that you don't have to overpay taxes.
- Check all your tax forms and income reports for errors: With ever-changing tax laws, sometimes companies make errors too. Make sure the numbers you receive in the tax forms tally with what you have on record.
- Start your tax planning for next year right now: Many tax deductions will work only if you take advantage of it in the calendar year. By the time you are ready to file your taxes, it will be too late.
Have you made any mistakes in your taxes that cost you money? How do you make sure you have the maximum return that you can legally get? Do you use software, an accountant, or do it by hand?
The original article: Expensive tax mistakes to avoid appeared on FiveCentNickel.com.
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