6 Tax Filing Mistakes That Can Cost You Money
Are you taking a deduction for retirement account contributions? What about investment management fees? Remember, you can always amend your return.
As a money manager that specializes in managing my client's money tax-efficiently, I have reviewed countless tax returns during my career. In this article, I am going to review six common, yet simple, tax return errors that may be costing you money. By reviewing your own returns for these common mistakes, you can help to ensure that that you aren't paying more in taxes than you should be.
Throughout this article, I will direct you to specific lines on your IRS Form 1040 for you to review. This is the most common form of tax return. If you are lucky enough to file one of the simpler versions of this form (1040-EZ or 1040A), then some of these issues may not apply to you, or they may be reported on a different line on your tax return.
Mistake #1: Not Taking a Deduction for IRA Contributions Made
If you contribute to a traditional (not a Roth) Individual Retirement Account (IRA), then you may be eligible to deduct that contribution on your tax return. There are rules that determine your eligibility to deduct these contributions which can be found in the handy IRS publication 590.
If you are eligible to take a deduction for your IRA contribution, that deduction should show on line 32 of your IRS Form 1040. If you are not eligible to deduct your IRA contributions, I strongly suggest you reconsider whether you should be making them. A better approach may be to contribute to a Roth IRA or to your employer's retirement plan instead. I recommend speaking with a qualified financial adviser to learn about the best course of action.
Mistake #2: Not Accounting for Estimated Tax Payments Made Throughout the Year
If your income tax situation requires it, you may be making tax payments to the IRS on a quarterly basis. These payments are known as "estimated tax payments" and are reported on Line 65 of IRS form 1040. Because Line 65 also may include last year's refund if you chose to apply it this year, you may need to do some quick math to make sure the numbers are correct.
Mistake #3: Not Taking a Deduction for Investment Management Fees Paid
You have a choice between taking a "standard deduction" or "itemizing" your deductions (reported on Schedule A), depending upon which would provide you with the largest deduction amount. If you itemize your deductions on Schedule A, and you pay a professional to manage your investments, you may be eligible to deduct these expenses on your tax return. These fees should be reported on line 23 of Schedule A.
If you do not see a Schedule A on your tax return, it is possible that you are not "itemizing" your deductions, and you are instead taking the standard deduction. This is most likely if you do not own a home or live in a state without income taxes since these are two of the largest and most common itemized deductions.
Mistake #4: Reporting Tax-Free 401(k) or IRA Rollovers as Taxable Income
This is by far the costliest mistake I see made on tax returns. Typically, "rollovers" are tax-free, and the accidental misreporting of these rollovers can result in your paying thousands of dollars more in taxes than you should have paid.
A "rollover" is a distribution of money from one tax-advantaged retirement account which is then deposited into another similar tax-advantaged account, through a process that meets certain requirements. For example, a common form of rollover occurs when an employee leaves his or her employer and chooses to move the money directly from his/her 401(k) or 403(b) account into their Individual Retirement Account (IRA).
If done properly, rollovers are tax free and are reported as such on tax forms prepared by the financial institution that distributed the money, on a form called a 1099-R. Don't be confused though, if all distributions from retirement accounts are reported on this form, not just tax-free rollovers. The financial institution's understanding of the taxability of the distribution is reflected on form 1099-R in two amounts; the "gross distribution" amount in box 1 and the "taxable distribution" amount in box 2. The "gross distribution" represents the money that left the account, and the taxable distribution is the amount of the distribution that the financial institution believes to be taxable.
You should check your tax return to confirm that the numbers shown on the 1099-R form are reflected on Form 1040 of your tax return. The amount of the rollover should be reported on line 15a or 16a and the amount of the rollover that is taxable should be reported on line 15b or 16b.
It is important to note that for various reasons, financial institutions will sometimes report a tax-free rollover as being taxable, when it is in fact not. If you performed what you believe to be a tax-free rollover that is being reported as taxable by the financial institution on the 1099-R, it is advisable to speak with a qualified tax professional.
Mistake #5: Failure to Report Basis on the Sale of Stocks, Etc.
In simple terms, income from the sale of financial assets such as stocks, bonds, mutual funds, etc., is equal to the difference between what you originally paid for it, and what you sold it for. I commonly see tax returns that report the sales price of a financial asset but do not report the cost (a.k.a. "basis) thus reporting a great deal more income than was actually earned. This can have a tremendous impact on the amount of taxes you pay.
When you sell a financial asset such as a stock, bond, mutual fund, etc., that sale is reported on form Schedule D. Schedule D will show the sales price, and the cost (what you originally paid for the asset, also referred to as basis), for all financial assets sold. If you sold more than one asset, your sales will usually be itemized on form 8949. It is important to review all of the sales of financial assets being reported on these forms in your tax return to ensure that the cost you originally paid for the asset is being accounted for. If the cost is being reported as 0, it is possible that it was left blank (for a variety of reasons) and should be reviewed.
Mistake #6: Entering the Wrong Social Security Number on Your Tax Return
Although not the costly mistake that #4 and #5 are, entering the wrong Social Security number on your tax return can turn into an administrative nightmare. Fixing this error requires working with the bureaucracy of the IRS which at the current time is extremely understaffed. Fixing this error could take anywhere from 1-8 hours of your time to resolve over a period of months. I cannot emphasize enough to make sure that the Social Security numbers being reported are correct!
Amending Your Tax Returns
In the event you have already filed your tax return and have discovered an error, you have the ability to amend your tax return. Amending your tax return allows you to fix the error and re-report your tax return with the IRS. This is done by filing form 1040X and it is usually best to have this done by a professional tax return preparer.
Michael Rose, CFP is president of Forthright Investments, LLC. He holds a B.S. in Finance and a M.S. in Taxation from Bentley University.
About the Author
President, Forthright Investments, LLC
Michael is president of Forthright Investments, LLC, a money management firm located outside of Boston, Massachusetts. He spends his time providing investment management, tax planning, and personalized financial advice to individuals and families. Michael holds a B.S. in Finance and a M.S. in Taxation from Bentley University. He is a Certified Financial Planning (CFP®) professional.