The easiest way to keep auditors at bay is to file tax returns that are accurate and free of red-flag deductions. "A good tax preparer's job is to make sure you pay the least amount as required by the law," says tax attorney Adam Fayne, but he adds that it's also to make sure you're not paying too little either, because if you're caught "you'll have to pay that money plus potential interest and penalties."
Years ago, math errors made up the majority of tax mistakes, but computing software has all but made this problem obsolete, says Steve Warren, a Minneapolis-based CPA with the firm Lehrman, Flom & Co., P.L.L.P. Still, Americans find other places to screw up their returns. Here are eight of the most common tax mistakes — and how to avoid them.
Doing Math by Hand
Okay, we just said that math errors rarely happen, but they still do. According to the IRS, if you do your return by hand, you're more than 20 times more likely to make a mistake. And while software is mostly perfect, humans are not. Warren says he still sees math errors on returns, mainly from people transposing numbers while typing. Also, double check that you're entering the correct numbers into the correct boxes. It sounds dumb, but Warren says he sees it with surprising frequency. And since we're talking about dumb mistakes, don't forget to sign your return and double check your social security number — these two mistakes happen more than you'd think.
Not Considering The Alternative Minimum Tax
In the late 1960s, a few of America's wealthiest citizens were using loopholes in the tax code to essentially duck out of paying any taxes at all. So congress passed the Alternative Minimum Tax, which ensured that those earning large sums of money — even if it was held offshore — would still have to pay something.
The Alternative Minimum Tax offers a different method to calculate the tax you owe, and ideally a tax preparer should work your return through both the traditional and Alternative Minimum Tax scenarios. If you owe more under the alternative preparation, you need to pay that difference. "Too many people, including tax preparers, are not aware of this," says Warren. Most Americans don't need to worry too much about the Alternative Minimum Tax, unless they make more than $150,000 a year.
Claiming a Dependent Incorrectly
If you have a child, but are single, or are filing separately from your spouse, only one of you can claim the dependent. Even though it seems like the custodial parent would be the person to claim the dependent, that's not necessarily the case. In certain instances (which are all fairly complex), the other parent may be able to claim the child. If you have questions about whether you can claim your child or not, it's probably best to ask a tax professional.
Also, Warren says that he does see problems where a vindictive ex rushes to file his or her return claiming a child as the dependent. Since only one parent can claim the dependent, the other parent's return will be rejected when they (perhaps rightfully) claim the child. There are recourse options if you think your ex has tried to pull a fast one on the IRS, but you're going to have to jump through some hoops. Warren says the best thing to do is communicate with your ex and formulate a plan that seems fair (many couples work this out in the divorce process).
Not Reporting Gambling Winnings
Yes, you have to disclose everything, even if it seems silly. If you won a $5 scratch-off ticket, technically you're supposed to report that income. And if you won big in Vegas, you really have to report that. In fact, casinos are required to give you a W-2G form if you win above a certain threshold in their facility. However, the thresholds are different for keno, slots, and wagering card games.
Throwing Things Away
Chicago-based attorney Adam Fayne says that the statute of limitations for most tax issues is three years, but he has all his clients keep things for six. If the IRS thinks you may have underreported your income by 25 percent or more, it can ask for six year's worth of records.
One thing that people often don't keep — but should — are documents showing proof of charity deductions. Whether you gave a t-shirt to Goodwill, a monthly sum to your local NPR station, or built a new wing for the local museum, if you claim it on your return, you must have proof of the donation.
Not Counting Services as Income
In the gig-economy, more and more independent contractors are trading services. And while it's awesome to have your photographer friend shoot your headshots in return for you copyediting his website, both of those favors technically count as income. You should include the value that his time would have cost you in your total income for the year.
Now, to be clear, there's a difference between bartering professional services and giving gifts. Warren says that if your friend buys you pizza in exchange for helping him move, you need not report that. Helping a friend move is an act of friendship, and buying pizza is simply a nice gesture. However, if you were a professional mover, you would need to report that pizza as income.
Hiring a Shady Tax Preparer
"Anyone promising you anything too good to be true probably is," says Fayne. He adds that, "The IRS has done a good job shutting down many of the shady tax preparers out there," but it's impossible to get them all. Worst of all, it's your signature on the forms: You're ultimately the one liable if your tax return was prepared the wrong way — and you'll end up owing that money (usually with interest) if the IRS catches you.
Not Choosing the Correct Filing Status
Warren says that filing jointly is most married couples' best bet. But in a few very specific instances — like when one partner makes much less money and has very high medical bills — it may make sense to file separately. Ideally you should have your tax preparer run both scenarios. Also, "sometimes a single person with a child does not realize that they can use the head of household filing status, which produces a lower tax bill than the single filing status," says Warren.
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