This post is the second in a three part series of most common tax mistakes made by people using tax software. Part 1 included the first five common mistakes. Unlike most lists of common mistakes, this list is specifically geared to people using tax software, so you won’t find mistakes that software prevents you from making, but you will find mistakes unique to users of tax software.
5) Not recognizing when tax benefits can give a “domino effect.” Many tax benefits both depend on, and effect, your Adjusted Gross Income. A common example is IRA deductions, where making a contribution can not only reduce your taxable income, but also make you eligible for an additional credit for making the IRA contribution. By not fully appreciating how taking a particular deduction or credit can affect other deductions and credits, taxpayers often miss out on tax breaks because they only considered the first effect (first “domino”) of a particular decision.
4) Not deducting real estate taxes or car sales tax. Many people with a small mortgage (or none) realize they don’t have enough deductions to itemize, so they’re better off just taking the standard deduction instead of listing individual deductions. However, beginning in 2008, taxpayers have been able to increase their standard deduction by adding in the amount of real estate taxes paid and (in 2009) the amount of sales tax paid on a car.
3) Not maximizing tax benefits from education expenses. Since there are literally over a dozen ways to receive tax benefits from education expenses, it’s not surprising that many people with education expenses fail to find the optimal way to use these benefits. Most software does a pretty good job of comparing the most common benefits, but there are additional strategies too complex for tax software that can save you hundreds, and sometimes thousands, of dollars.
2) Not filing because you can’t pay. Many people don’t file because they don’t think they can pay the tax due. But the penalties for not filing on time can be as much as ten times greater than the penalties for not paying on time. Submit your taxes on time. File an extension to get them done if you have to. The penalties and interest can be over 5% of the amount due per MONTH if you don’t file, but if you file you have numerous options to pay off the balance over time with much lower penalties.
1) Paying tax on state refunds. State refunds are only taxable if you received benefit from deducting state taxes in an earlier year. For most simple returns, your tax software can determine this for you if you use the same software year after year. But often taxpayers don’t know how to figure out whether or not a state refund is taxable, so they just report it as income and pay tax on it…often unnecessarily.
That’s it for the top ten tax mistakes. The next post is five additional errors specifically related to the way people use tax software. In my work supporting tax software users, I’ve seen certain mistakes in the way people use tax software are quite common, and the next post will cover them. Continue…