Do-it yourself software has undoubtedly shortened the time it takes to prepare a tax return and cut down on the amount of mathematical errors. However, computers can’t catch what they don’t know.
At Visor, we see lots of clients’ past tax returns with mistakes, unfortunately often times following the receipt of an IRS audit letter. But not all mistakes are simply made at time of filing. Many are due to missing out on certain tax deductions and strategies during the year, because the client simply didn’t know any better at the time.
So we summarized below the most common tax filing mistakes that we see do-it-yourself taxpayers make. And, remember, you have up to three years later to correct a mistake, so take advantage of our free Second Check program and have your tax return reviewed by one of our tax professionals to be sure you didn’t miss out on a refund.
The tax law has several very beneficial carve outs for homeowners. Three of them are often overlooked when taxpayers self-prepare.
1. Forgetting to deduct property taxes
Real property taxes are deductible for US taxes in the year that they are paid. In most cases, counties collect tax payments twice a year. Too often, taxpayers will leave one or both payments off their tax return. The impact can result in losing out on thousands of savings.
Don’t forget, taxpayers are also eligible to deduct taxes paid on a second home or a timeshare.
2. Paying more tax than you should on the sale of your house
One of the biggest tax breaks available for homeowners is the section 121 exclusion. The first $500,000 (for married couples) or $250,000 (for single filers) of the gain from the sale of your home can be excluded from taxes. With most taxpayers facing capital gains rates of 15-20%, a $500k exclusion can result in up to $100k in savings.
The eligibility rules are a little sticky though. For instance, there are rules about having lived in and owned the home for a certain period of time. Working with a Visor tax advisor can ensure you get the biggest refund possible.
3. Leaving off the deduction for loan origination fees
Most homeowners know that their mortgage interest can be tax deductible. However, they often forget about fees paid in connection with their new home loan. This information can be a little tricky to find as it is usually buried on your mortgage statement. It can also be called by another name depending on what geographic location you are located in (i.e. in the Midwest they are referred to as points.) The calculation is also not super straightforward, because not all the fee is immediately deductible, amortization might be necessary. The end result is these fees often get left off homeowners’ tax returns.
Think the US federal tax law is complicated? Well, each state also has its own tax code. So, things get really fun when you move states or must travel to another state for work. If you need a primer, check out our guide to multi-state income taxes, or read on for the most common mistakes we see as a result.
4. Overpaying out-of-state taxes
When you work in multiple states your employer is required to withhold taxes and pay them to the state where you worked. This can get tricky because each state has different tax withholding and reporting rules. For instance, some states require that the employer report the full wages in box 1 of your W-2 to the state.
When you work out of state you should only pay taxes on the wages earned for the time period that you were working in that state. This means you may need to calculate the state wages yourself instead of relying on the W-2 sent to you by your payroll provider. The average state income tax rate is 4% so even misstating the wages by $20,000 can result in $800 in overpaid taxes.
5. Missing the credit for taxes paid to other states
If you work in one state and live in another then you file taxes in both states. It’s up to you to make sure you not double pay your state taxes.
When you go to file your taxes, you will need to file two tax returns. For the state that you worked in but do not live, you typically file a ‘non-resident return’. Then, on your home state’s resident tax return, you’ll report the income earned in the other state.
Confused yet? What you have to do on your home state return is claim a credit for the taxes paid to that other state. Too often, when we look at new client’s prior year tax returns, we see they missed the credit for taxes paid to another state. Depending on how much you earn out of state the tax implications could be very large.
6. Selecting the wrong filing status (MFJ vs. MFS)
The old school adage when it comes to married taxpayers is that married filing jointly is the best option. However, this is not always the case. The tax code is riddled with different provisions that are more favorable if you file as married filing separately. Any time you or your spouse have different types of income (think wages versus capital gains) or one makes significantly more or less than the other, there might be an opportunity to do planning.
For some people, it’s the legal liability that comes with filing jointly that they want to avoid. Remember, when you file jointly, you are both attesting that everything reported on the return is accurate and that both spouses individually are on the hooks for any combined tax liabilities. In these examples it is important to consult with a tax advisor who can calculate the tax impact under both filing statuses.
7. International students and other non-US citizens filing as residents
Taxes for non-US citizens have all sorts of added complexity. We even wrote a separate article with the top five mistakes for these non-US citizen taxpayers.
The top mistake made by those using do-it-yourself tax platforms? Filing as a resident when you should have filed as a non-resident.
The implications for this mistake can be harsh. For instance, certain non-residents are exempt from FICA payroll taxes (7.65% of earned income). The sad part is international students make this mistake the most, and we all know they could use those tax savings for tuition.
Saving for Retirement
8. Penalties for Roth IRA contributions
We find many of our new clients have underutilized their retirement saving accounts. From not understanding the differences between Traditional and Roth, to missing out on employer matches, mistakes can run the gamut. But the most easily avoided mistake that happens most often, getting penalized for a direct contribution to a Roth IRA when over the income limitations.
It’s great that you want to save an additional $5,500 in an IRA, beyond the $18,500 that you can put in a 401(k). But, there are income limitations for contributing directly to a Roth IRA, which for 2018 is $133,000 if single and $189,000 married. There’s a 10% penalty if in violation. But this can easily be avoided by simply using the Backdoor Roth IRA strategy, which entails first putting the funds in a non-deductible traditional IRA then converting it to Roth. It’s simple to do and avoids any chance of being penalized for exceeding the the income limits.
To see how you can still contribute to a Roth IRA if you are over the limit, read more about the Backdoor Roth IRA strategy.
9. Paying taxes on a 401(k) rollover
When switching jobs, often you will want to move funds from your old 401(k) to your new employer’s 401(k) plan. If the funds are simply going from one pre-tax plan to another, there is no tax associated with the rollover. However, you will receive a Form 1099-R from your previous employer to report the rollover amount. As a result, we see a couple different mistakes when clients come to us:
- They fail to report the 1099-R on their tax return. You may know a qualified rollover is not subject to tax but, if you forget to put the “gross distribution” on your tax return, the IRS will send you a nasty letter. Those are always fun to respond to as a novice…
- They overpay taxes because the 1099-R might not show the correct amount in box 2a, especially if your account has a mixture of pre and post-tax contributions. If you simply report the numbers in the boxes, then the do-it-yourself software could result in an overpayment.
Business Deductions for Self-Employed and Landlords
10. Double counting Rental/Business Income and/or leaving off certain deductions
Working for yourself can be very rewarding. However, going at it alone on your tax filings if you have rental property or your own business can be quite a hassle.
Each business trade has commonly accepted deductions. For instance, a landlord will have repairs/maintenance and trips to check on the property. An Uber driver will have gas, mileage, cell phone plans, and maybe health insurance. Too often, we see these get left off the tax return. Plus, they might be eligible for additional deductions depending on their specific circumstances, such as a home office deduction.
Solopreneurs and landlords have very time consuming tax reporting, as they must essentially report most of their P&L and determine which portions are deductible. There’s a reason why these folks will typically work with a tax advisor.
Bonus: Failing to File At All
11. Falling behind on filing tax returns
Maybe it was due to fear of making one of the mistakes listed above, but failing to file is much more common than one might think. And it can be difficult to get back into the annual routine after falling behind one year.
A tax advisor can be especially helpful in that case, in figuring out the best path to getting caught up. We see this a lot with Americans living overseas, as they don’t realize that they must file a return as a US citizen even if they did not earn any US-sourced income. For these expats, the IRS’s Streamlined Program is often a great solution for getting back on track.
Visor was founded on two key principles:
- Everyone deserves professional tax support, and
- Saving the most on taxes requires year-round planning.
Our view is that the combination of technology and tax experts is the best way to avoid all these mistakes outlined above. Join us as a client by signing up today and ask for a free Second Check of your past year’s tax return.
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