As financial advisors, we love it when clients ask for tax guidance because it is an excellent opportunity to strategize. With some foresight, you can steer clear of situations that lead to excessive taxes, penalties, or interest. Yet many people hesitate to reach out until it is too late. To encourage you to be more proactive about addressing your questions, allow me to share seven common tax mistakes that are entirely avoidable.
1. Failing to Plan Ahead
The most common error is poor planning. For example, certain things must occur by the end of the year, while others can wait as long as they happen by April 15th. We see people thinking about taxes some in November or December, then in earnest around March while gathering documents for the tax preparer or entering data into tax preparation software. The rush to get the return filed often comes at the cost of overlooking potential planning opportunities.
Aim to get ahead of this cycle by reviewing your tax situation in April and then again in September. At the end of April, examine your tax forms from the prior year in search of things you can do differently moving forward. Then, check how your financial situation has evolved (compared to expectations) and make any necessary adjustments in September. This rhythm will be much more relaxed as it allows you to review your tax data in April (when it is still fresh) and tackle year-end tasks before the holidays hit.
So, what should you look for? Of course, there is a mix of things, and performing this exercise with a financial professional would be best. But here are a few questions to explore.
- Are you choosing the most tax-advantaged ways to save for retirement?
You can’t avoid taxes, but the timing of when you pay them can matter. Delaying payment today isn’t always best for your long-term financial outcomes.
So consider your current and projected cash positions and take advantage of relevant opportunities, such as investing in the Roth deferral option in your company 401k or converting to a Roth IRA, where your money can grow tax-free. In addition, if you are a business owner, you may have the opportunity to add a 401k plan to your company, potentially tripling the retirement money you can put away. - Would it be beneficial to harvest capital gains or losses from your investment accounts?
If you have significant losses in your investment accounts, consider realizing those losses and reinvesting in the appropriate replacement securities. A loss can help offset future capital gains from selling a home, business, or other securities. That could save a significant amount of taxes in the future. But the devil is in the details, so please consult a professional. - Can you make strategic charitable donations or gifts to reduce your tax burden?
Giving to charity is great, but doing so in a way that minimizes your taxes is even better. Check out our blog post about six charitable giving strategies for the details if you are charitably minded. - Are you withholding appropriately for your situation?
To avoid an unpleasant tax surprise, don’t forget to adjust your withholdings if your marital or dependent status changes. Conversely, do not over-withhold and give the US Treasury an interest-free loan. - Did you miss any distributions or tax-deductible contributions?
Many people set up automatic RMDs (required minimum distributions) or contributions to their tax-advantaged accounts, such as Health Savings Accounts (HSA), 401ks, or IRAs, while others plan to handle them all at once. Whatever your situation, check in as you reach the end of the year to ensure you don’t forget anything. *You have until April 15th to fund HSA contributions for the prior year.
- What do you plan to do with compensation received in the form of company stock?
The default position for most company plans is to leave earned stock where it is, but depending on your situation, there might be a cost to doing nothing. Therefore, we recommend you proactively develop a plan to maximize these funds. - When was the last time you analyzed your business structure?
If you own a business, don’t leave your tax situation on autopilot. Instead, evaluate your setup periodically to confirm that you have the most tax-advantaged and risk-protected business structure for your situation. For example, there might be tax advantages to incorporating your sole proprietorship.
For a more detailed checklist, download the guide below.
2. Missing Important Deadlines
The Internal Revenue Service (IRS) is serious about deadlines. So, to avoid unnecessary penalties and interest, develop a system for filing your tax returns and making timely payments. The most important dates to remember are as follows.
- March 15th is the tax filing deadline for business returns.
- April 15th is the tax filing deadline for personal returns.
- Estimated tax payment deadlines occur in April, June, September, and January of the following year.
Although that may sound pretty straightforward, it is a common tax mistake that young adults with their first jobs, newly divorced people, and older people often fall prey to due to a lack of awareness. And, occasionally, people skip paying their taxes altogether because they don’t have the funds, but that is a serious blunder. It is better to file a return anyway, pay as much as possible, and then work with the IRS on a payment plan to avoid owing even more.
3. Neglecting to Perform Quality Control
One of the most common tax mistakes people make is hurrying through the process to the point where foolish errors occur. Some of us procrastinate and run out of time, while others find taxes so dull that they cannot focus on the details. But, sadly, the IRS doesn’t care about our excuses, so it can help to develop some rigor.
We recommend setting aside some time in February to check and double-check that you have all the required information. Below is a list to get you started, but it is not exhaustive, and everyone’s situation is different, so please customize it to your needs and save it so you don’t have to recreate it every year.
- W-2 forms from all employers
- 1099 forms for any significant contract work
- Statements from any bank or investment accounts that pay interest, dividends, or have realized capital gains or losses
- Income from unemployment, social security, required minimum distributions (RMDs), rental properties, etc.
- Contribution records for tax-deferred retirement accounts or healthcare savings accounts
- Receipts from deductible expenses (childcare, education, mortgage interest, medical care, unreimbursed business expenses, etc.)
- Donation records
- Dependent information
Then, when it is time to review your tax forms, check them carefully for errors. If you use tax software, much of this information carries over from one year to the next, but watch for common tax filing mistakes such as the following.
- Mistyped names
- Inaccurate social security numbers or tax ID numbers
- Math errors
- An incorrect filing status, such as “married filing jointly” or “head of household” when you are newly single
- Missing signatures (if you are filing by mail)
- Erroneous routing and account numbers (if you are filing electronically) or missing checks (if you file paper returns)
These mistakes can delay tax refunds or result in penalties for people who owe money.
4. Missing Credits or Deductions
If you don’t stay current with tax law changes, it is easy to overlook valuable credit or deduction opportunities. For instance, most people know about Child Tax Credits and Earned Income Tax Credits. But, if you spend money on college or continuing education courses, you may be eligible for the Lifetime Learning Tax Credit or the American Opportunity Tax Credit. And it’s not just tuition; books, fees, supplies, and equipment expenses also count.
5. Itemizing When the Standard Deduction Might Be More Beneficial
In 2018, the Tax Cuts and Jobs Act (TCJA) took effect and nearly doubled the standard deduction for household taxpayers while reducing opportunities for itemized deductions. Since the entire point of itemizing deductions was to claim the eligible expenses that exceeded the standard deduction, the net effect of this change is that itemizing no longer makes sense for many people.
That was a rough shift for many who can no longer deduct charitable donations or state taxes that exceed the new thresholds. If this is the case for you, please contact us or your Certified Public Accountant (CPA) to explore alternatives.
6. Keeping Inadequate Records
Most of the time, you file your taxes yearly and then go about your business. But be sure to keep detailed records of your decisions and backup documentation, such as copies of receipts, to protect yourself in the event of an audit. Three to seven years of documentation is the standard rule of thumb, but since most of us keep electronic records now, there is little need to discard them.
7. Overlooking or Ignoring IRS Notices
We have talked to some taxpayers who simply ignored or “forgot” about notices from the IRS about late payments, penalties, missed deadlines, inadequate or underpaid taxes, or other infractions, hoping the issue would resolve itself. Please hear no judgment. I understand the temptation and taxes are not fun, but this strategy never works. Ignoring mistakes or mishaps will only make the situation worse. You could incur additional penalties, rack up interest, or, in the case of illegal behavior, wind up in prison.
If you committed one (or several) of the common tax mistakes above, I recommend owning up to them as quickly as possible. You can fix tax mistakes by filing an amended return for up to 3 years.
Common Tax Mistakes: The Bottom Line
No one enjoys thinking about taxes, but failing to think ahead or to pay attention to the details can cost you in the long run. If you have a relationship with a financial advisor, especially one with the CFPⓇ designation, which requires training in this area, put them to work. Set up a meeting today to explore your options.
