Tax laws are complex. There is no doubt about this. But strangely enough, many tax mistakes people make are due to shockingly simple things that can be easily avoided. (Some examples include failure to meet a tax deadline, failure to report all of your income, and failure to use the correct tax credits, just to name a few).
Understanding these mistakes can help you avoid them in the future, as none of us want to deal with the IRS more than necessary.
1. Failure to pay required estimated taxes
If you are a freelancer, small business owner, worker, or anyone else earning tax-free income, you must make quarterly estimated tax payments to the Internal Revenue Service (IRS).
Read more: Quarterly estimated tax payments: who should pay them, when and why
Failure to pay the required estimated taxes or their late payment entails two main consequences:
- Your tax bill will be much larger than expected.
- You will pay penalties and interest on unpaid tax liabilities.
No matter how you slice it, it’s not good. Incorporate these quarterly payments into your schedule so you can enter tax season with peace of mind knowing you won’t have any problems with Uncle Sam.
Read more: 7 accounting mistakes to avoid
Who has to pay quarterly estimated taxes?
Generally speaking, if you owe $1,000 or more in federal taxes per year, you will need to pay quarterly estimated tax payments. This may include any income derived from:
- Self-employment.
- Interest.
- Dividends.
- Alimony.
- Capital gain.
- Prizes and awards.
2. Lack of necessary tax accounting
No matter how simple or complex your tax situation is, you will need to collect receipts, income tax returns and other things throughout the year to make sure you have everything you need to file your return.
So, what documents should tax inspectors keep? In general, you should stick to:
- Earnings reports like W2s and 1099s.
- Bank statements.
- Any tax forms you receive electronically or by regular mail.
- Receipts for purchases and charitable donations you plan to write off.
- Copies of your signed return and all supporting documents so that you have proof that you have been audited or that you need to file an amended return.
If this sounds like a lot, don’t panic. You can use our Money Under 30 Tax Document Checklist to keep everything organized.
3. Not reporting all of your income
The IRS knows how much money you make each year, and they also know when you don’t report everything. (They are like those parents who know that their child broke their favorite vase, but still ask them about it, just to give them a chance to confess and tell the truth).
If you accidentally or intentionally leave something on your return, the IRS will know about it and you will have to pay the consequences. It can be as simple as paying a fine, as well as an extreme audit or a charge of tax fraud. In any case, it is best to avoid all of these together.
The easiest way to make sure you report all your earnings for the year is to keep all your W2s and 1099s. This will help you make sure nothing slips away when you sit down to prepare your return.
Tip MU30: If you file a tax return and later discover that you forgot to report something, file an amended return as soon as possible to correct it. Find out how to do this in our article – Error in tax return? Here’s how to change your return.
4. Not using tax credit accounts
One of the easiest ways to lower your tax bill is to make the most of all the tax credits available to you. It includes:
- Employer sponsored retirement accountssuch as a 401(k), 403(b), 457 plan, or a federal savings plan (TSP).
- Traditional IRA.
- Health Savings Accounts (HSA)to which you are eligible if you have a high deductible health plan (HDHP).
So, why should tax credit accounts be used to reduce taxes? Here’s a script to show you why. (This requires some math, so put on your nerd glasses for a second).
A real-life example of why you should use tax-advantage accounts
Meet Cleo. She is a 28-year-old single financial analyst who made $80,000 this year. Cleo loves to save money, so she makes the most of her company’s 401(k) ($19,500), her traditional IRA ($6,000), and HSA ($3,600). This reduces her taxable income to $50,900.
Based on current marginal tax rates (find out what that fancy phrase means here), her federal tax liability is $6,946.50 per year. No tax credit accounts Cleo would be on the hook for $13,348.50. – A LOT more money.
Please note that this is a simplified scenario and does not include itemized or standard deductions or other expenses.
5. Submission of incorrect information
Another common tax mistake is filing an incomplete or inaccurate return. This may result in delays in receiving your refund, as well as additional penalties and interest payments from the IRS.
To avoid this, be sure to:
- Double check your bank account and routing numbers if you receive a tax refund through direct deposit.
- Check your name, social security number, address, and other personal information.
- Make sure your submission status is correct.
- Verify that your income is W2s compliant and other income statements that you have.
- View your deductions and loans to see if they make sense for your situation.
6. Submission with wrong status
Your filing status can have a huge impact on how much you owe in taxes for the year. It can also determine if you need to file a return at all.
So what happens if you file with the wrong tax status?
The most common disadvantage is that this can result in a larger tax bill than necessary. And if the IRS suspects that you were intentionally misleading, you may be subject to review or fined for tax fraud.
What are your tax status filing options?
Taxpayers have five filing statuses to choose from:
- Lonely – Applies to anyone who is not married, including those who are divorced or living apart from each other.
- Joint registration in marriage – Applies to anyone who is married and wants to file taxes together.
- Married are served separately – Applies to married couples who wish to file taxes separately. This can be beneficial if you only want to be responsible for your own taxes. Or if filing under this status will save you more money.
- Head of family – Mainly for those who are not married, but it can also be used if you pay more than 50% of the costs for yourself and a suitable person.
- A qualified widow (widow) with a dependent child – For those whose spouse has recently died and has at least one dependent child. However, special rules apply.
If you’re stuck between two filing statuses, the IRS recommends filing both ways to see which one will save you the most money.
Read more: How to Know When You Should File Taxes Together or Separately
7. Wrong tax breaks
There are HUNDREDS of tax deductions and credits out there. Some of them are quite common – for example, the earned income tax credit, the children’s tax credit, and the property tax deduction.
Others are very vague – like how you can write off student loan interest paid by your parents. Or how you can write off Social Security taxes if you are self-employed.
Read more: Student Tax Benefits: How to Pay Less and Get More
One of the best ways to reduce taxes is to take advantage of each tax credits to which you are entitled. The good news is that if you file your taxes online, the tax software you use will automatically maximize those deductions and credits for you. (Check out some of our recommended tax software options here: The best tax software in comparison).
8. Missing the tax deadline
The tax filing deadline is April 15 (almost) every year (or October 15 if you are applying for an extension). One of the most common tax mistakes people make is missing this deadline.
So what happens if you miss your tax deadline?
- If you are eligible for a refund: the short answer is nothing. You can file a tax return at any time and get your money back. You will not pay any fines or commissions.
- If you owe money to the IRS: you will pay a penalty for late submission of the declaration and for late payment of taxes. This penalty increases the longer you wait, so file your tax return as soon as possible.
IRS’ Failure to comply with the penalty is 5% each month for any unpaid taxes. This fee peaks after five months at 25%. There is also a non-payment penalty that continues to accrue each month even after the non-payment penalty expires. All this can happen in a hurry.
Tip MU30: The tax extension gives you more time to file your return, but not give you more time to pay any taxes you owe. So, if you have an invoice for this tax year, set up a payment plan by April 15, even if you haven’t filed yet.
9. Filing Your Tax Return Too Early
If you’re anything like me, you might be in a rush to file your tax return as soon as possible each year. Especially if you’re in the mood for a refund.
Side story: I remember many times in college I treated the first day of tax season like my birthday or Christmas. I woke up and filled out the declaration as quickly as I could because I was so excited to see what it would be like. Strange, I know.
But here’s the catch – another simple tax mistake that people make is filing a tax return. too early. Sounds weird, right?
If you file your return too early, you risk not having all the proper tax documents needed to file a complete and accurate return. You may also be missing out on valuable deductions and credits, and this can further increase your return.
What to do if you make a mistake on your tax return
So what happens if you file your tax return and then realize “Shit! I made a mistake!”? Calm down, take a deep breath. We’re going to get through this.
In most cases, all you need to do is file Form 1040Xwhich is an amended tax return to correct any mistakes you made.
You can usually change your tax return using the same tax program or company that you used to file the first time. Or you can download this form from the IRS and fill it out manually (although this is much more tedious).
Summary
These are just some of the most common tax mistakes people make every year. The IRS doesn’t always make life easy for us, so some things are just honest mistakes.
One easy way to minimize these errors is to file electronically with tax software or contact a tax professional. (My favorite tax preparation software that I use faithfully every year is Turbotax).