Tax law is complicated. There’s no doubt about it. But oddly enough, a lot of the tax mistakes people make are for shockingly simple things that could easily be avoided. (Some examples include missing the tax deadline, failing to report all your income, and not taking the right tax breaks, just to name a few).
Understanding these mistakes can help you avoid them in the future, since none of us really want to deal with the IRS more than we have to.
What’s Ahead:
1. Not paying required estimated taxes
If you’re a freelancer, small business owner, side hustler, or anyone else earning income where taxes aren’t withheld, you’re required to make quarterly estimated tax payments to the Internal Revenue Service (IRS).
Not paying required estimated taxes or paying them late has two major outcomes:
- Your tax bill will be a lot larger than anticipated.
- You’ll pay penalties and interest charges on your unpaid tax liability.
Either way you dice it, it’s not good. Work those quarterly payments into your schedule so you can breeze into tax season knowing you won’t be in trouble with Uncle Sam.
Read more: 7 Side Hustle Accounting Mistakes To Avoid
Who has to pay quarterly estimated taxes?
Generally speaking, if you owe $1,000 or more in federal taxes for the year, then you’ll need to pay quarterly estimated tax payments. This could include any income earned through:
- Self-employment
- Interest
- Dividends
- Alimony
- Capital gains
- Prizes and awards
Read more: Quarterly Estimated Tax Payments: Who Needs to Pay Them, When, and Why
2. Failing to keep necessary tax records
No matter how simple or complex your tax situation is, you’re going to need to collect receipts, income statements, and other things throughout the year to make sure you have everything you need to file your return.
So, what documents do tax preparers need to keep? In general, you should hang onto:
- Income statements such as W2s and 1099s.
- Bank statements.
- Any tax forms you receive electronically or by snail mail.
- Receipts for purchases and charitable donations you plan on writing off.
- Copies of your signed return and all supporting documents, so you have proof if you’re audited or need to file an amended return.
If this sounds like a lot, don’t panic. You can use our tax document checklist to keep it all organized.
3. Failing to report all of your income
The IRS knows how much money you make each year — and they also know when you fail to report it all. (They’re kind of like that parent who knows their kid broke their favorite vase but they ask them about it anyway just to give them a chance to come clean and tell the truth).
If you accidentally or purposefully leave something off your return, the IRS will know about it, and there will be consequences to pay. It could be as simple as paying a penalty fee or as extreme as being audited or facing tax fraud charges. Either way, it’s best to avoid it all together.
The easiest way to make sure you’re reporting all your income for the year is to hang onto all your W2s and 1099s. This will help you make sure nothing falls through the cracks when you sit down to prepare your return.
MU30 Tip: If you file your taxes and later realize you forgot to report something, file an amended return as soon as you can to fix it. Learn how in our piece – Tax Return Error? Here’s How To Amend Your Return.
4. Not using accounts that have tax advantages
One of the easiest ways to lower your tax bill is by maxing out any tax-advantaged accounts you have at your disposal. This includes:
- Employer-sponsored retirement accounts, such as a 401(k), 403(b), 457 plan, or a federal Thrift Savings Plan (TSP).
- Traditional IRAs.
- Health savings accounts (HSAs), which you qualify for if you have a high deductible healthcare plan (HDHP).
So, why should use tax-advantaged accounts to lower your taxes? Here’s a scenario to show you why. (It involves some math, so put your nerdy glasses on with me for a second).
A real-life example of why you should use tax-advantaged accounts
Meet Cleo. She’s a single, 28-year-old financial analyst who made $80,000 in 2022. Cleo’s big into saving, so she maxed out her company’s 401(k) ($20,500), her traditional IRA ($6,000), and her HSA ($3,650). This brings her taxable income down to $50,900.
Based on current marginal tax rates, her federal tax liability comes out to $3,650 for the year. Without the tax-advantaged accounts, Cleo would’ve been on the hook for $10,368 — A LOT more money.
Note that this is a simplified scenario that uses the standard deduction but doesn’t take into account other credits or expenses.
5. Filing with incorrect information
Another common tax mistake is filing a return that’s incomplete or inaccurate. This can result in delays in getting your refund, as well as additional penalties and interest charges from the IRS.
To avoid this, be sure to:
- Double-check your bank account and routing numbers if you’re getting a tax refund via direct deposit.
- Review your name, Social Security number, address, and other personal information.
- Make sure your filing status is correct.
- Confirm that your income matches the W2s and other income statements you have on hand.
- Review your deductions and credits to see if they make sense for your situation.
6. Filing under the wrong status
Your filing status can have a huge impact on how much you owe in taxes for the year. It can also determine if you even need to file a return in the first place.
So, what happens if you file under the wrong tax status?
The most common downside is that it could result in a larger tax bill than necessary. And if the IRS suspects you were intentionally deceptive, you could be audited or hit with a tax fraud penalty.
What are your tax status filing options?
Tax filers have five filing statuses to choose from:
- Single – Applies to anyone who isn’t married, including those who are divorced or legally separated.
- Married filing jointly – Applies to anyone who’s married and wants to file taxes together.
- Married filing separately – Applies to married couples who want to file taxes separately. This could be advantageous if you only want to be responsible for your own taxes. Or, if filing under this status will save you more money.
- Head of household – Mostly for those who are single, but it can also be used if you pay for more than 50% of the costs for you and a qualifying person.
- Qualifying widow(er) with dependent child – For anyone whose spouse has recently died and has at least one child dependent. Special rules apply, though.
If you’re stuck between two filing statuses, the IRS recommends preparing your return both ways to see which saves you the most money.
Read more: How To Know When You Should File Your Taxes Jointly or Separately
7. Not taking the right tax breaks
There are HUNDREDS of tax deductions and credits out there. Some are quite common — like the earned income tax credit, child tax credit, and property tax deduction.
Others are super obscure — like how you can write off student loan interest paid by your parents. Or, how you can write off taxes paid to the Social Security Administration if you’re self-employed.
Read more: Tax Benefits For College Students: How To Pay Less And Get More Back
One of the best ways to reduce your taxes is to take advantage of every tax break you qualify for. The good news is, if you file your taxes online, the tax software you use will automatically maximize these deductions and credits for you.
Check out a few of our recommended tax software options here: Best Tax Software Compared
8. Missing the tax deadline
The tax filing deadline is April 15 (almost) every year (or October 15 if you file an extension). But in 2023, it’s April 18 due to a state holiday. One of the most common tax mistakes people make is missing this deadline.
So, what happens if you miss a tax deadline?
- If you’re set to receive a refund: the short answer is nothing. You can file your tax return at any time and get your money. You won’t pay any penalties or fees.
- If you owe the IRS money: you’ll pay a penalty for filing a late return and for not paying your taxes on time. This penalty gets larger the longer you wait, so file your return ASAP if you can.
The IRS’ Failure to File Penalty is 5% each month for any unpaid taxes owed. This fee maxes out after five months for a total of 25%. There’s also a Failure to Pay Penalty that keeps accruing each month even after the Failure To File Penalty stops. It can all add up in a hurry.
MU30 Tip: A tax extension gives you more time to file your return, but it does not give you more time to pay any taxes you owe. So, if you have a bill this tax year, set up a payment plan by the deadline even if you haven’t filed a return yet.
9. Filing your tax return too early
If you’re anything like me, you may be in a hurry to file your taxes as soon as possible each year. Especially if you’re set to get a refund.
Side story: I remember so many times in college when I treated the first day of tax season like my birthday or Christmas. I’d wake up and file my return as quickly as I could because I was so excited to see what my return would be. Weird, I know.
But here’s the catch — another easy tax mistake people make is filing their return too soon. Sounds odd, right?
When you file your return too soon, you run the risk of not having all the proper tax documents you need to file a complete and accurate return. You could also miss out on valuable deductions and credits and that could maximize your refund even more.
What you should do if you make a mistake on your tax return
Okay, so what happens if you file your return and then realize, “Crap! I’ve made a mistake!”? Calm down and take a deep breath. We’re gonna get through this.
In most cases, all you need to do is file Form 1040X, which is an amended tax return, to correct any mistakes you made.
You can typically amend your return using the same tax software or company you used to file it the first time. Or, you can download this form from the IRS and fill it out by hand (although this is a lot more tedious).
Summary
These are just a few of the most common tax mistakes people make each year. The IRS doesn’t always make things easy for us, so there are some things that are just honest mistakes.
One easy way to minimize these mistakes is to file electronically using tax software or a tax professional.
Read more:
Source: moneyunder30.com