Few things can strike dread into the heart of the average American like tax season. Considering the complexity of filing taxes — and the potentially high stakes for making a mistake — it’s no wonder that anywhere from 20% to 25% of taxpayers wait until the two weeks before April 15 to prepare and file their taxes.
Unfortunately, there’s not a lot you can do to make tax season easier or more enjoyable — but you can avoid some of the mistakes that accountants and tax preparers see over and over again.
Here are the top four mistakes your tax preparer would love to help you avoid:
1. Don’t expect others to keep better records than you do
This often comes up for freelancers and other self-employed individuals. Since they’re technically working as contractors — and potentially have several employers — they’ll be receiving multiple 1099-MISC forms, rather than the single W-2 form that traditional employees receive.
However, since contract employers aren’t required to generate a 1099 form for a contractor who earned less than $600, you don’t necessarily see these tax forms from every one of your clients. But of course, you still owe taxes on your income — whether or not you received a 1099 form. That means you have to keep good records throughout the year.
2. Understand withholding before tax time
When it comes to taking an early withdrawal from a tax-deferred retirement account, misunderstanding withholding can be disastrous. According to Diana Isbell, an accountant in Lafayette, Indiana, “If you withdraw from an IRA/401(k) under the age of 59½ and the fund ‘withholds taxes,’ that DOES NOT mean the amount withheld is all that you owe.”
That’s because those mutual funds are only required to withhold the early withdrawal penalty amount of 10%, plus the lowest federal income tax rate of 10% — which may be much lower than your actual tax bracket. In addition, adding the amount withdrawn from the IRA or 401(k) into your earned income for the year will often push you into the next bracket, meaning you owe even more.
As Isbell puts it: “Always discuss the tax implications of an early withdrawal from a tax-deferred retirement account PRIOR to withdrawing the money. That kind of withdrawal should only be done as a last resort.”
3. Know which tax break you’re using
For both education and dependent-care costs, there are multiple ways to receive tax breaks — but you’re not permitted to use more than one tax break for each type of expense. This can get a little complicated, as it’s tough for the average taxpayer to know which benefit will be the best choice for their circumstances.
For instance, taxpayers may not claim the dependent-care tax credit if they used a dependent-care flexible spending account through their employer. So it pays to crunch the numbers at the beginning of the year to determine whether the FSA or the tax credit will save you more money.
When it comes to education credits, Melissa Labant, a tax specialist at the American Institute of CPAs says, “In general, the American Opportunity Credit provides the most benefit for taxpayers who qualify.”
4. Procrastination will cost you
You might be dreading tax season this year, because you know you don’t have enough cash to pay what you owe. You put off filing in the hopes that you can get enough money together, but then April 15 comes and goes.
Unfortunately, unlike missing your mother’s birthday, this is not something you can talk your way out of. The IRS is serious about deadlines, and it charges late filers a failure-to-file penalty of 5% of unpaid taxes for each month you’re late, up to 25% of the total amount owed.
If you don’t have enough to cover the full amount, pay whatever you can and talk to the IRS about payment options. By working with the IRS, you’ll only be charged ½ of 1% of the balance you owe each month.
In addition, you can also file for an extension of up to six months if you request it no later than April 15. However, it’s important to remember that filing an extension is NOT a payment extension — you still have to pay any taxes you owe, or at least your best estimate.
Have you made any of these mistakes in the past? How are you preparing for tax season?
{ read the comments below or add one }
I don’t do my own taxes but even preparing all the tax documents for my accountant is not a fun thing to do. By strictly limiting 1-2 credit cards to pay for all business expenses makes this preparation a little easier. Thankfully we only have to do this once a year!