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The process of filing tax returns is fraught with uncertainties and mistakes, but any of the following three major mistakes risk creating a severe negative impact that can be very costly. Read on as we discuss the top 3 mistakes most people make when filing their taxes.
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Failure of capitalizing on tax-saving opportunities
There are very limited ways that taxpayers can influence their 2016 tax liability as a majority of the determining factors are out of their control. Still, there exists a number of tax-saving opportunities that can be legally used to reduce the tax liability. The most outstanding tax-saving opportunity is presented by the IRA (Individual Retirement Account). The most common IRAs that are used to trim down tax liabilities are the traditional IRA and the Roth IRA.
The traditional IRA allows taxpayers to make a maximum contribution of $5,500 (if they were 49 years old or younger in 2016) or $6,500 (if they were aged 50 years or above in 2016) to their IRA accounts. A traditional IRA operates as a tax-deferred account, which means that your 2016 contributions are not taxed. Therefore, when filing tax returns, you need to deduct the 2016 contributions from your taxable income, and then pay taxes on the remaining income. Another advantage offered by traditional IRA is that your contributions can gain compound interests and dividends without any of your capital gains being subjected to tax. Thus, the growth of a traditional IRA account is faster than that of an ordinary taxable account. Nevertheless, you will be taxed when making any withdrawals. Even so, you will be subjected to a 10 percent penalty on any withdrawal you make from the traditional IRA before you reach the age of 59.5 years, but there are special circumstances that allow for a waiver of this penalty.
The Roth IRA allows your contributions to benefit from tax-free capital gains. However, unlike a traditional IRA, only after-tax cash can be used to fund your Roth IRA. This means that you have to pay taxes on taxable income, and afterward designated a certain proportion of the remaining amount to go into your Roth IRA. Hence, you pay taxes for your Roth contributions. Even so, Roth IRA offers a major tax benefit as the account will never be subjected to any tax after you reach the age of 59.5 years, and thus your Roth account can grow tax-free after this period.
A health savings account (HSA) can help you trim down your 2016 tax liabilities. Contributions made to HSAs are tax-free so long as they do not exceed $3,350 for individual and $6,750 for families, but people aged 55 years or older in 2016 are expected to add another $1,000 to their HSAs. Like a traditional IRA, these contributions benefit from tax-free capital gains, and you are only taxed when making withdrawals for health-care expenses. On the downside, you will be subjected to a 20 percent penalty on any withdrawal you make for non-medical expenses before you reach the age of 65.
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Last-minute tax filing
It is recommended that taxpayers start processing their tax returns early. However, some taxpayers begin the process when the deadline is quite near and this poses some problems, especially if the process turns out to be more complicated than expected. This risks causing the taxpayer to miss the deadline, and then be subjected to legal penalties and interests.
Another problem posed by last-minute tax filing is that taxpayers can find out that they do not have the cash for the tax payment. This makes them miss the deadline, and then be burdened further by additional legal penalties and interests.
Another advantage of filing your tax returns early is that you can get your refunds early. Also, it preempts identity theft as no one else can claim your tax refunds. On the other hand, late tax filing delays your tax refund and also exposes you to tax fraud through identity theft.
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Hiring the wrong individual for tax preparation
Tax laws and state codes regulate the process of tax preparation and filing of returns, and they also stipulate penalties and other punishments for any illegalities. This means it is usually beneficial for taxpayers to hire professional tax preparers. All the same, if your adjusted gross taxable income is less than $6,4000, then you can take advantage of the free software and fillable tax forms provided by the IRS.
Some taxpayers did work in different states in 2016 or ran businesses that spanned several states during the same period. These taxpayers need to hire the right tax professionals so as to file the correct tax returns. Yet, sometimes they hire the wrong people and they end up filing inaccurate tax returns. This jeopardizes their finances as they can be penalized heavily by the IRS and other relevant state agencies.
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