This post and the two that follow will address the most common mistakes made by people who prepare their own returns. The IRS has published a similar list that is widely published. However, this list is specifically geared toward people who use tax software…so some common mistakes on the IRS list like using the wrong mailing address or forms are not relevant. I’ve focused on the mistakes we most commonly see when reviewing returns for people who have used popular tax software programs.
The result is a Top 10 list of most common tax mistakes that can affect all taxpayers, plus 5 bonus items that specifically affect people using tax software. If you’re doing your own taxes, you do yourself a big favor by looking out for these common mistakes.
10) Failing to get the maximum Homebuyer Credits. This one is surprisingly common for a situation that only affects certain taxpayers who bought homes in a relatively short period of time. These mistakes are especially troubling because the amounts involved are quite large, typically several thousand dollars. Two common mistakes are often made. One, taxpayers think they can’t claim a homebuyer credit based on income, even though their income qualified in the previous year. One of the provisions of the credit is you can actually claim the credit on the previous year’s return by amending that year’s return. The second common mistake is many non-married individuals often don’t realize that if they purchase a home together, they can split the credit however they want. So if only one person qualifies for the credit, the other person can claim the full $8,000, not just half of the amount.
9) Not using insolvency exclusions for canceled debt. Beginning in 2008, we’ve been seeing a lot of 1099-C’s from people who’ve had debt canceled. Often they’re unaware of all the different ways they can exclude the amount on the 1099-C from being treated as income. This is another one that can easily cost thousands.
8 ) Not using retirement account penalty exceptions. People who’ve had to take an early withdrawal from a retirement account often qualify for one or more of the penalty exceptions to avoid the 10% non-qualified distribution penalty. Often taxpayers aren’t made aware of the possibility they may qualify when they take the distribution so they don’t even investigate whether or not they qualify.
7) Filing separately when married. While there are a few (very rare) instances when filing separately can be advantageous, many couples, particularly newly married couples, file separately simply because it’s more convenient. In most cases, this will be a costly mistake worth far more than the inconvenience of both spouses getting their tax information together at one time.
6) No basis/wrong basis used for employee stock sales. Usually when stock is sold from an employee stock plan, the gain from the transaction is treated as ordinary income and included in your W-2. However, many people report the gain a second time as part of the stock sale associated with the transaction. Because the gain was recognized as ordinary income, the basis will nearly always be equal to or greater than the proceeds, resulting in no gain. Instead, many people pay tax twice on the same income.