Yes, it's really happening again. As surely as spring follows winter and indigestion follows lunch at Long John Silver's, Tax Day will soon be upon us. File all the extensions you want, my procrastinating friend, but that blank 1040 isn't going anywhere. If there is a silver lining on the charcoal-black tax cloud that will soon engulf us, it's that you can avoid the very worst fate — an (IRS) audit — by dodging the 10 worst mistakes you can make on your taxes.
Should you prepare your tax return yourself or hire a tax pro? Do you really need to keep old business receipts for years and years, or can you throw a shredding party? Is itemizing deductions worth the headache? Keep reading for tips from tax experts and the big bad IRS itself for making the U.S. tax season as painless as possible (warning: still quite painful).
The IRS is an oddly trusting institution. Filing a tax return is "voluntary," meaning that every taxpayer is responsible for filling out the right forms, and accurately and honestly reporting all income, expenses, deductions and exemptions. If you're lucky, that's the end of it. But if you're one of the roughly 1.5 million Americans who receives an IRS audit each year, it's only the beginning [source: McCoy].
When you file a tax return, the IRS doesn't ask you to staple receipts, bank statements or other paperwork to the back of the return. It's tempting, then, to think that you should feed these documents to the shredder. Bad idea!
True, the odds are in your favor that you will never have to show those investment account statements and Lowe's receipts to anyone. But if you are unlucky enough to trigger a red flag with the IRS computer, you will need to back up every number with a piece of paper.
- W-2 and 1099 income statements
- Confirmation from IRS that you filed your tax return
- Medical bills
- Receipts for charitable donations
- Receipts for improvements and expenses related to rental property
- Investment account statements
- If you own your own business: business expenses, employee wage statements (W-2s and 1099s), all payroll taxes paid (FICA and FUTA), etc. Businesses should save documents for at least four years.
Most of us filed our first tax return when we were teenagers and the entire operation — copying a single number from a W-2 and entering it into the right box on the 1040EZ — took 23 minutes and a sharp No. 2 pencil. But there comes a time in every taxpayer's life we ask the anxiety-ridden question: "Am I making a huge mistake by doing my own taxes?"
As life grows more complicated, so do our finances. You get married, have a kid, buy a house, take on a side job, invest for retirement — all of these life events have tax implications, and overlooking them could be very costly.
- Pro: Increases your odds of getting a refund
- Con: It costs more money — around $270 for a standard 1040; $420 for business schedules E or C
- Pro: Decreases your chance of an IRS audit and penalties
- Con: It puts your financial fate in the hands of a stranger
- Pro: A tax pro can offer advice on how to lower your tax exposure for next year
- Con: Not all tax advisers are created equal. Can you afford a good one?
The IRS offers different tax breaks, deduction limits and exemptions for taxpayers in different life situations. It makes sense that a married couple should be able to claim twice the standard deduction as a single person, or that a widow with a child shouldn't have to pay a higher tax rate just because she's technically single. As a taxpayer, you need to choose a filing status that accurately reflects your life status as of Dec. 31 of the tax year [source: IRS]:
- Married filing jointly
- Married filing separately
- Head of household
- Qualifying widow(er) with dependent child
For newly married couples, tax season is a useful exercise in spousal communication. Both parties need to be on the same page. If the husband files his return under "married filing jointly," but the wife files her own return as "married filing separately," they will have plenty of time to talk it over on the drive to their audit. The same is true for a married couple that files separately with one spouse itemizing deductions and the other claiming the standard deduction [source: IRS]. That's another IRS no-no.
For the record, legally married same-sex couples can claim married status on their federal tax returns even if they are not living in a state that recognizes their union [source: IRS]. Also note that you can only claim head of household status if you are "considered unmarried" by the IRS and you have dependents [source: Schnepper].
Most taxpayers view the standard deduction as nothing short of a gift from the IRS gods. The standard deduction was adopted in 1944 to give taxpayers a simplified way to deduct personal nonbusiness expenses from their taxable income. The original standard deduction was a flat 10 percent of income up to a maximum of $1,000, but the IRS began setting a figure for the standard deduction in 1970 [source: Tax Policy Center]. Here are the standard deductions for 2013 [source: IRS]:
- Single = $6,100
- Married filing separately = $6,100
- Married filing jointly = $12,200 (more if you or your spouse are 65 or older)
- Head of household = $8,950
- Qualifying widow(er) = $12,200 (more if you are 65 or older)
If you earn a modest income, those standard deduction figures are a huge help. But it's a big mistake to assume that the standard deduction is right for every tax situation. In some cases, the extra work of itemizing can save you a lot more money. Some examples [sources: IRS, IRS and IRS]:
- If you buy a house, you can deduct all mortgage interest on your primary residence.
- If you have significant medical expenses that aren't covered by insurance, you can deduct any amount that exceeds 10 percent of your adjusted gross income (7.5 percent if you or your spouse are 65 or older).
- If you give a substantial amount of money to charitable organizations, itemizing might be a better deal for you. Make sure to have receipts to back it up, though.
On a good year, American taxpayers make between 3 and 5 million mathematical errors on their federal tax returns. On bad years — such as 2001 and 2008, when stimulus credits messed with our math — those errors can skyrocket to more than 16 million [source: Rampell]. The good news is that a math mistake, even a big one, is not necessarily going to get you on the IRS's "naughty" list. In fact, the IRS computers are so skilled at correcting miscalculations that the agency doesn't require you to file an amended return [source: IRS].
Other number blunders could cost you, though. Accidentally claiming $9,100 in charitable contributions when you only made $1,900 is a matter you'll probably need to discuss with your friendly neighborhood IRS agent.
If you are claiming dependents on your tax return, pay particularly close attention to their Social Security numbers. Double-check them. Triple-check them. Make sure that their names are spelled exactly as they're written on their Social Security cards. If the IRS computers catch a discrepancy between a dependent's name and Social Security number, that will trigger an automatic rejection of any credits or benefits tied to that dependent [source: Schnepper].
The IRS recognizes that raising kids is insanely expensive. Not to mention raising kids while supporting an elderly parent or a wayward nephew. That's why it offers tax credits to families with dependent children or relatives. But if you try to claim someone as a dependent who isn't a dependent, it will send your tax return straight to the trouble pile.
The IRS has established a long set of criteria for who qualifies as a "child." Here are the highlights [source: IRS]:
- Relationship: A "child" can either be a biological child of the taxpayer, a stepchild, an adopted or foster child, or even a sibling or stepsibling of the child. Descendants of any of these folks are also OK.
- Residence: The child must live with the taxpayer for more than half of the tax year.
- Age: The child must be under 19 on Dec. 31 of the tax year, or under 24 if a full-time student.
- Support: The taxpayer must provide more than half of the child's financial support for the year.
- Relationship: Parents, great aunts, cousins, step-brothers all qualify -- in fact, you don't have to be related to the person at all, provided they meet the other requirements.
- Residence: An actual relative does not have to live with the taxpayer, but nonrelatives like roommates or friends have to live with the taxpayer full-time.
- Age: A qualifying relative can be any age.
- Support: The taxpayer needs to provide more than half of the dependent's financial support during the tax year and the dependent's gross income must be less than the personal exemption of $3,900 in 2013. Also, the dependent cannot take the personal exemption on his or her tax return at the same time.
It's easy to get carried away when you start itemizing deductions, especially if you own your own business. The more receipts you add to the expense pile, the lower your taxable income. Suddenly every Office Depot purchase and Panera breakfast starts to look like a legitimate business expense. Be super careful, though. The IRS might start to wonder how a taxpayer whose business routinely loses money can afford a $3,000 mortgage payment and four dependent kids.
- Home office: The IRS greatly simplified the home office deduction in 2013 — a flat $5 per square foot — but there are still strict rules for what qualifies as an office. The space needs to be used "regularly and exclusively" for business and it must be your "principal place of business." A laptop on your kitchen table is not a home office.
- Medical expenses: You can deduct medical expenses not covered by insurance, but only the amount that exceeds 10 percent of your adjusted gross income (7.5 percent if you're 65 or older).
- Charitable donations: Make sure the organization qualifies as tax exempt. Also, all donated items must be in "good or better" condition, so your worn sweaters may not count.
The IRS is nothing if not exhaustive (and exhausting). It wants to know about every red cent you earned during the tax year, whether it was through a full-time office job, a home-based cupcake business or part-time waitressing gig for tips. If you are paid by direct deposit, check, cash or rolls of pennies, it all counts as earned income.
The IRS receives copies of all W-2s and 1099s sent by your employer or clients, so there's no getting around that income. But don't be fooled into thinking that cash income, payments from foreign companies, and other types of income that don't generate a W-2 or 1099 are somehow immune to taxation.
This is the "voluntary" part again. It's up to the taxpayer to honestly and accurately declare all earned income. If you are audited, the IRS is going to ask for copies of your bank statements. If you can't explain where all of these mystery deposits came from, you will be in deep doo-doo.
A tax refund check is a beautiful thing. The IRS says that it issues 90 percent of them within 21 days of receiving a tax return [source: IRS]. But what if you can't wait that long? Aren't there ways to get that fat refund check sooner?
Technically, yes, but you'll pay dearly for it. The first method is called a refund anticipation loan or RAL. Here's how RALs work:
- A tax preparation service, bank, or cash-checking operation gives you a loan for the amount of your tax refund minus their fees.
- When your actual refund check arrives from the IRS, you pay back the loan.
- The lender charges crazy high interest on the loan. In one example, a $1,500 loan carried an interest payment of $61.22, or an APR of 149 percent [source: National Consumer Law Center].
Thankfully there's been a crackdown on RALs, which were marketed mainly to low-income and elderly taxpayers. In their place, some lenders are peddling refund anticipation checks (RACs). These are designed for folks who are getting a refund but don't have a bank account. The lender opens a temporary bank account to deposit the refund and charges steep fees (somewhat less than RALs) to withdraw the cash. Since the money doesn't come to you any faster, the main "benefit" is that the RAC allows the taxpayer to avoid paying the tax prep fees up front [source: NCLC].
Avoid the fat fees by setting up your own bank account to have the check directly deposited there. Then get free help with your taxes from the Volunteer Income Tax Assistance program.
The IRS takes its deadlines seriously. That means that all tax returns, plus checks for any taxes owed, must be stamped or filed electronically by April 15 or bring on the penalties! But what if you don't have enough money to cover the taxes you owe? Should you postpone filing until you have the cash to cover your bill?
Here's what the IRS says:
- Always file on time, even if you can't pay the full amount that you owe. If you don't, you are charged a failure-to-file penalty of 5 percent of unpaid taxes for each month you are late, up to 25 percent of unpaid taxes.
- Pay what you can and contact the IRS to explore payment options.
- You will only be charged 1/2 of 1 percent of the balance you owe on your unpaid taxes each month. That's much better than the failure-to-file penalty.
The IRS does offer "automatic" filing extensions of up to six months, but you still have to file for an extension by April 15. Plus — and this is the most important detail — a filing extension is not a payment extension! You still have to pay any owed taxes — or your best estimation thereof — by April 15 [source: IRS]. You will be charged interest on any unpaid taxes after that date.
For lots more tax preparation tips and mind-blowing top 10 lists from HowStuffWorks, check out the links on the next page.
The most sweeping tax overhaul in decades became law in December 2017. HowStuffWorks explains what taxpayers can do to benefit from the tax changes.
Author's Note: 10 Worst Mistakes to Make On Your Taxes
Nobody hates Tax Day quite as much as the self-employed. As a freelance writer, I don't have a "boss," which is awesome 364 days of the year. The one benefit of having a boss is that your income taxes are subtly skimmed from each paycheck. In fact, it's easy to forget that you're paying taxes at all until April 15 rolls around and Uncle Sam owes you a big fat refund check. For us freelancers, the exact opposite is true. When we get paid, no taxes are withheld. Once the money is in the bank, we pay the mortgage and buy the groceries and think that everything is super-duper until Tax Day rolls around and — BAM! — we have to pay the entire year's taxes all at once. To be honest, that's the not the way it's supposed to work. In fact, the IRS insists that freelancers, contractors and other self-employed folks file quarterly estimated taxes. There's a small penalty if you don't, but the bigger punishment is writing a huge check in April for money that may or may not be in the bank. After years of April agony, we've finally boarded the estimated taxes train. Now our tax pain is spread out in four equally irritating installments. Thank you, IRS.
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