I have been a Certified Public Accountant and an expert tax preparer for over 30 years and have seen that many individuals create problems for themselves by repeating many of the same common mistakes. Here are seven of the most common mistakes and some easy ways to prevent making them yourself.
1. Poor Handling of Life Changing Event
Many life changing events can have a profound effect on your tax situation. It may seem counter intuitive to pause and consider the impact at the time but it can be vitally important. Events such as marriage, divorce, new job, a raise or large bonus, starting a small business, and many others need to be evaluated and may require a change in your withholdings (forms W-4).
2. Miscalculating Exemptions
If income from employment is a significant portion of your income and you had a balance due with your last tax return revise your form W-4. Federal form W-4 has worksheets on pages 2 and following for calculating the effect on number of exemptions claimed for working spouses, personal deductions, and more.
3. Forgetting Bonuses
If you receive a bonus from your employer any time during the year inquire how your employer will calculate federal taxes. IRS allows for two methods to calculate withholding on any payroll checks outside the normal frequency (one-time) and one of those methods is far more accurate than the method usually used by employers.
4. Not Considering Outside Income
If you have significant income from other than employment pay estimated vouchers. Many taxpayers do not realize that 90% of their annual tax liability must be paid by January 15 of the following year and also must be paid evenly throughout the year each “quarter” ( actually 90% of tax owed for the three, five, eight, and twelve month periods commencing January 1 of the current year, less taxes previously paid, must be paid by the 15th day of month following the end of each period). Alternatively, if this year’s tax will be more than your prior year’s taxes, then a taxpayer can pay a “safe harbor” amount during the year equal to 100% or 110% of your prior year taxes with the balance payable on or before the due date for your return. You may be subject to substantial penalties if you do not pay 90% of your tax or the safe harbor amount evenly throughout the year.
5. Ignoring “One Time” Income
Similar to the previous point, taxes owed due to a major sale or one-time income receipt are payable on the due dates for “quarterly” estimate vouchers. If you sell a piece of property, receive an income distribution from a trust, etc. remember to “save” a portion for Uncle Sam but don’t wait too long to pay because you cannot unless you pay the “safe harbor” amounts discussed above.
6. Waiting Too Long
Calculate your income tax liability well before December 31 but no later than early December. If you have a significant balance due you will have a minimum of three weeks to lower that balance if you prepare an early tax return. if you wait until your return is prepared after December 31 there is likely little if anything that can be done to reduce taxes owed.
7. Mishandling Your 401(k)
Explore 401k tax deferrals offered by your employer or if self-employed other qualified plan opportunities. In the case of employment and 401k withholdings, or self-employed plans such as an SEP, IRA, or Keogh, steps must be taken before if not well before December 31.
Internal Revenue Service Circular 230 Statement Applicable To Tax Advice, If Any, Contained In This Communication
New Treasury Regulations require us to inform you that neither you nor any other recipient may use any tax advice in this communication to avoid any penalty that may be imposed under federal tax law. To obtain penalty protection, the new Regulations require attorneys, accountants and other tax advisors to perform increased due diligence to verify all relevant facts and to format the written tax advice in a lengthy number of separately enumerated sections with numerous disclosures. If you would like us to prepare written tax advice designed to provide penalty protection, please contact us and we will be pleased to discuss the matter with you in more detail.