Top Taxpayer Mistakes
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the Unlucky 7
Top Taxpayer
Mistakes
Here's the lineup of the
biggest mistakes taxpayers make and what you can do to avoid them.
1.
Bad math
According to the Internal Revenue Service, errors in addition and subtraction
are the No. 1 mistake taxpayers make. All returns are examined for mathematical
errors. Mistakes in arithmetic or in transferring figures from one schedule to
another result in an immediate correction notice. If the error leads to a tax
deficiency, you automatically receive a bill for that amount. If you overpaid,
the excess is applied to future taxes, credited or refunded at your request. You
can’t appeal such corrections, but you can ask in writing that they be reviewed
if you think the Internal Revenue Service made a mistake.
Check
the figures on the Internal Revenue Service correction notice. They have been known to make mistakes.
Arithmetic mistakes alone rarely lead to a full audit.
2.
Forgetting about interest and dividends
Interest and dividend payments are reported to the
Internal Revenue Service by banks, brokerage
houses and other financial institutions, and they are cross-checked in about 96%
of the cases. The Internal Revenue Service attempts to match almost 100% of the returns that they
receive electronically or on computer tape and more than 50% of those that are
on paper. As a result of this cross-checking, the Internal Revenue Service sends out notices for
taxes and interest on overdue taxes for income and other payments that were not
reported. Unfortunately, according to the General Accounting Office, the
government agency that audits the Internal Revenue Service, about half the 10 million correction
notices the Internal Revenue Service issues each year are "incorrect, unresponsive, unclear, or
incomplete."
If you
get an incorrect notice, follow the appropriate procedures to contest it, or
contact your local problem resolution office.
3.
Not properly tracking investment 'basis'
A basis
is the original value of your investments. If you have mutual funds, for
example, each year those funds will report to you the dividends and capital
gains you earned. These dividends and gains will be taxable to you in the year
reported.
When
you sell these funds, your gain will be the difference between what you receive
on the sale and your "basis" (technically your amount realized less your
adjusted initial investment basis). The basis actually increases once any
financial gains you reinvested are taxed. If you reinvested taxable gains from
these funds, those gains (all of the dividends and capital gains reported) are
added to your basis to reduce your gain (or increase your loss). For example, if
I bought a fund for $1,000 and reinvested $200 in dividends and $50 in capital
gains, my basis is now $1,250. If I sell the fund for $1,500, I only have to
recognize $250 in gain on that sale. That’s much better than reporting a $500
profit for tax purposes. To make sure you have the right basis, check with your
fund company or broker. If you can’t get the data by the April 15 filing
deadline, you can either file for an extension or file an amended return later.
4.
Getting married
I’m not
saying don’t get married. What I am suggesting is that you postpone a Christmas
wedding until after the fInternal Revenue Servicet of the year. The tax savings could pay for a
sizeable chunk of the honeymoon.
Although the new 2003 tax law attacked some problems of married couples and
their taxes, there remains a marriage penalty if both married partners work. For
example, in 2004, two individuals who each earned $68,800 in taxable income
would pay $13,944 each in taxes for a total outlay of $28,020, according to the
2004 Internal Revenue Service tax tables. As a married couple, their taxable income would be
$137,600. They would have to file either a joint return or a return as married
filing separately. Either way, they would be required to pay $28,485.50 in taxes
-- $597.50 more than what they would have paid had they remained single. This is
because we have a progressive tax system where incremental dollars are taxed at
higher marginal rates. The second $68,800 therefore would be taxed at a higher
marginal rate than the fInternal Revenue Servicet $68,800.
This
tax penalty on marriage is no longer compounded by the standard deduction,
thanks to the 2003 tax law. A married couple is allowed $9,700 in nontaxable
income in 2004. Two single workers get $4,850 each for a total of $9,700.
In
2005, the standard deduction rises to $10,000 for married couples filing jointly
and $5,000 for single taxpayers.
However, high-income earners who marry will lose write-offs for personal
exemptions faster than their single counterparts. Marriage may also wipe out
potential IRA deductions. Of course, if only one partner is employed, marriage
would provide a tax savings. They could file jointly, at rates lower than for
single taxpayers.
5.
Losing track of receipts
In the
real world, you either have proof of your deductions or you lose them. Always
keep your receipts and checks if you want to deduct them. Deductible receipts
and checks should always be kept for at least three years from the due date of
the year filed, or the actual date filed, if later. Unless the Internal Revenue
Service can prove
fraud, the statute of limitations to disallow deductions is three years. Once
this three-year period has elapsed, the Internal Revenue Service is prohibited from even questioning
these deductions. Receipts for expenses that may be deducted in later years,
such as improvements to your house, should be kept for three years after the
return on which they are claimed.
Remember, the Internal Revenue Service is a paper-based bureaucracy. Separate your receipts and
checks by deductible category and make any audit easier for the auditor. The
easier you make it for them, the more they believe and accept that you know what
you are doing, and the easier they will make it on you.
6.
Failing to bunch deductions
There
are a number of deductions that are allowed only after you exceed a minimum
amount. For example, only those medical expenses that exceed 7.5% of your
adjusted gross income are allowed. Alternatively, miscellaneous deductions are
allowed only to the extent that they exceed 2% of your adjusted gross income.
Your
best planning strategy here is to bunch your deductions into a single year to
exceed these minimum requirements. For example, if you have an adjusted gross
income of $100,000, only those medical expenses in excess of $7,500 can be
deducted. In order to exceed this "floor" amount, you might prepay your
orthodontia bill or pay your Jan. 1 medical insurance on Dec. 31. With
miscellaneous itemized deductions, and the same adjusted gross income, you need
to exceed $2,000 in expenses. Prepay your tax preparer on Dec. 31 for that
year’s taxes or bunch order your investment subscriptions and expenses to exceed
that amount.
7.
Forgetting to donate unwanted items to charity before Dec. 31
Give
your old clothes, furniture, appliances and other items away to your favorite
charity. The wholesale value of those contributions is allowable as a charitable
deduction. Make sure that you get a receipt. No receipt, no deduction. The
receipt doesn’t have to list what you gave or what the items were worth, but it
must be dated. You can fill in the details yourself. Remember, too, that you can
deduct 14 cents a mile for any charitable work, including the trips to bring the
old clothes to the charity.
Copyright © 2001-2018 Gary W. Lundgren, EA All rights reserved.