Top 5 Most Common Tax Mistakes
1. Not Paying Estimated Taxes – I see this very often since most self-employed individuals do not understand their filing requirements relative to self-employment taxes. Consequently, they do not pay them and are hit with a hefty tax bill at the end of the year and/or underpayment penalties for not paying them in the first place. Income tax is a pay as you go system and everyone who works for themselves and do not pay federal taxes via standard payroll wage deductions are required to pay into the tax system via estimated taxes quarterly throughout the year. It is also important to note that the self-employment taxes paid through estimated tax payments is the method by which self-employed individuals pay into the social security system. So it is very important for a variety of reasons that self-employed individuals understand their estimated tax filing requirements and be diligent about paying them to avoid costly tax bills down the line.
2. Being Happy About Big Refunds – Each year I see people come into have their taxes one so they can find out how much of a refund they are going to get. Generally any check from the government is a good thing but in the majority of taxpayers circumstances, the check they may receive represents their hard earned money they have worked for during the year and let the government hold, interest free, for the year. The only GOOD refund to get from the government comes in the form of refundable credits such as the earned income credit or additional child tax credit. Most credits the government allows are non-refundable which mean that they only serve to reduce you liability to a maximum of zero. Any excess credit remaining is not refunded. However, in the case of refundable credits, the government allows you to use the credit to reduce your liability to zero and then keep whatever is left over after the credit. I teach my clients in their tax planning that we only want to give the IRS their due, nothing more. So with proactive planning and management of their payroll withholdings throughout the year, we are able to keep a handle of any possible excess withholdings and make adjustments as necessary so they can keep as much of their salary in their pockets as possible.
3. Making Early Withdrawals from Retirement Plans – With the economy the way it is, I have seen it more and more frequently that tax payers are cashing out their retirement plans to make ends meet not realizing they have created a taxable event that can cost them big at the end of the year. Any withdrawal made from a retirement plan by a taxpayer who is younger than 59 ½ is subject to an early withdrawal penalty that is figured on the tax return at the end o the year, not at the time the withdrawal is made. There are, however, specific exceptions to this rule and taxpayers need to understand them to see if they fall under one of those exceptions. Generally, taxpayers think by paying the withholding they are covered in terms of the tax they need to pay and forget or are unaware of the penalty associated with the distribution. Understanding that sometime you have to do what you have to do to survive in these economic times, my suggestion to my clients is always BEFORE you cash out your plan come in and see me so we can discuss the repercussions of doing that and what other avenues they have in their current life situation that can alleviate that sting of the impending tax bill to come. GOOD, PROACTIVE tax planning is key in these situations.
4. Thinking That a Tax Return is a PRODUCT rather than a SERVICE – Tax preparation is a service and the tax return is consequent to that service. Each year I always get the tire-kickers wanting the cheapest price on their tax preparation fees. This is exactly the opposite of the approach tax payers should take in their area of their financial lives. Tax payers should think of their tax professional in the same regard as their physician. The tax professional should take a proactive stance in helping that client maintain the most beneficial tax position they can throughout the year. Should things go bad (i.e. large tax liability) the client should consult with the tax professional to diagnose the problem and take steps to keep that problem form happening in the future. There is no substitute for the knowledge of a professional tax preparer.
5. Not Asking Questions – I would suspect that had Wesley Snipes asked a few questions he would not be in half of the trouble he is in right now. That is why it is crucial that taxpayers understand the number presented on their tax return as the IRS will hold the taxpayer responsible for the return once it ii filed. If you do not understand the number son your return ask what they mean. A professional tax prepare will welcome the question and take time to explain rather than push papers in your face and tell you to sign. If it still doesn’t make sense after it is explained or you are not comfortable with the return you can ALWAYS get a second opinion. Two prepares presented with the same tax information from a client should have identical if not similar (some tax laws allow for slight interpretations within reason) returns. If they do not, there is a problem.