And now for the third installment of the Top 10 tax filing mistakes to look out for…
Since this began as a Top 10 list, and I quickly realized 10 wouldn’t be enough to capture the common errors I frequently see, this third installment is the Bonus 5. These 5 aren’t the result of misunderstanding the tax code, but misunderstanding tax software.
[Bonus #1] Duplicating/missing expenses from 1099’s or W-2’s. Numerous deductible expenses are reported on a taxpayer’s W-2 or 1099 Forms. Sometimes software is clever enough to pick up these items, but then the taxpayer duplicates the item later in the program resulting in an overly large deduction that results in penalties when caught. Other times taxpayers assume the software picked up a deduction when entered through a W-2 or 1099 and doesn’t enter the information later. But if the software didn’t pick up the deduction, the taxpayer winds up missing out on it entirely.
[Bonus #2] Not entering 2a from 1099-R in tax software, or entering $0 instead of leaving it blank. I’ve done a lot of work reviewing returns for people who believe their tax software made an error because something they thought was entered didn’t wind up on the final return, resulting in re-assessments and penalties from the IRS or state tax authorities. By far the most common source of this error is when people enter payments reported on Form 1099-R, but don’t complete Box 2a, Taxable Amount. Sometimes, this box is left blank on purpose to indicate the taxable amount is not known but must be calculated, so people enter $0. A blank in 2a is not the same as $0! And occasionally the bank issuing the 1099-R completes box 2a incorrectly (entering $0 when it should be blank)…but that doesn’t mean the IRS will let you off the hook.
[Bonus #3] Missing carryover items. If you use the same tax software from year to year, this usually isn’t a problem. But if you use new tax software, or if you don’t import your information from the previous year, you might miss very valuable tax breaks that should be carried forward from the previous year. Many very valuable tax breaks aren’t taken all in one year, but instead are taken over a period of years.
[Bonus #4] Self-Employment expenses as employee expenses. One of the advantages to being self-employed as an independent contractor versus being an employee is the tax break for work expenses is much more generous. As an employee, you can only deduct work-related expenses that exceed 2% of your Adjusted Gross Income (AGI), and then only if you itemize deductions. Plus these deductions have no impact on your AGI, so you might miss out on a credit based on a high AGI even though after deductions your income isn’t that high. Independent contractors can take these expenses directly off their income, which reduces AGI, and doesn’t require itemizing. However, some people when using tax software will put their expenses under “job-related” or “work-related” expenses instead of “business expenses” because they don’t realize they are considered a business when self-employed.
[Bonus #5] HSA issues. Frankly, it’s too difficult to describe some of the ways HSA accounts get mangled by people using tax software. But the results are commonly things like being penalized for excess contributions when no excess contributions were made, being penalized for ineligible contributions even though you were covered by a qualifying plan and only made eligible contributions, not getting credit for contributions, and having distributions treated as taxable even though they were for qualifying expenses. My best advice is simply check your completed return from tax software before submitting it, and if you see additions to income, or penalty taxes, that you don’t understand, then get a professional review.
In fact, for all of the common items listed in this series of posts, your best protection is to take advantage of the services of a professional who can offer advice and guidance, along with the peace of mind of having a professional guarantee you’re not making foolish mistakes.