Pinching pennies and investing are not the only sound strategies to build long-term wealth. Smart tax planning and avoiding dangerous tax mistakes play a big part in increasing your disposable income as well.
Learn a bit about the tax system and save yourself thousands of dollars. Here are the eight most dangerous tax mistakes you will face throughout your life.
1. College Students: Forgetting to File
Consumed with studies, parties and part-time work, college students might not think about taxes. But it is crucial to avoid mistakes by spending a few minutes to understand your tax situation.
If you are single and made more than $6,300 in wages last year or received at least $1,050 in unearned investment, interest or profits from selling — including those eBay sales — you must file a tax return, said tax expert Crystal Stranger, an enrolled agent and president of First Tax, which bills itself as the “first nationwide tax firm created exclusively for small businesses.”
If you had a side business, you are not off the hook. Did you earn more than $400 from self-employment income, or more than this amount on a 1099-MISC tax form? If so, you must file, even if you do not meet the gross income thresholds.
2. Young Professionals: Delaying Investing in a 401k
By investing in your employer’s retirement plan as early as possible, you can easily secure a large retirement nest egg. Wait a few years before participating, and you will end up paying more taxes today and having a smaller retirement account later.
Those who qualify can enjoy additional tax benefits, Stranger said. The saver’s credit and various education credits can put more money in your pocket by cutting your taxes. Many people can benefit from the latter, including parents paying for their chidren’s education and adults adding to their own skills.
3. Newlyweds: Choosing the Wrong Filing Status
When you begin married life, set a sound foundation for your financial future. Smart tax-planning can put more money in your joint bank account.
When completing tax returns as a married couple, compare the total amount of tax due between the two filing status options: married filing jointly and filing separately. Find out which status nets you the lowest tax bill.
This is easy to do with tax software. Or, ask your tax professional to do the calculations for you. Choose the wrong filing status, and you will end up costing your new family money unnecessarily.
4. New Homeowners: Failing to Keep Track of Everything
Buying a home is one of the most stressful ventures of adulthood. Forgetting the tax implications of a home purchase makes the situation even more trying. Remember, “not all closing costs are deductible,” said Bill Farmer, an enrolled agent with Lexington, Ky.-based HTI Tax Service.
Unlike business expenses, home improvements are generally not tax-deductible, Stranger said. However, if you use part of your home for a business, you might be able to deduct applicable repairs. Do not skimp on this one — maintain your records and check with the IRS to ensure you are in compliance with the law.
Finally, there is another reason to keep track of your home improvements. Ultimately, when you sell, you can add the cost of improvements to your original price, or basis, and save on capital gains taxes if you owe them. Keep the records where you can access them, because at sale time they are worth money to you in the form of tax savings.
5. New Parents: Not Applying for Junior’s Social Security Number
Having children is a joy — and a wonderful way to lower taxes. For every child and dependent, you receive a tax credit. For 2015, the personal exemption is $4,000.
However, if you forget to apply for Junior’s Social Security number, you will not be able to prove to the IRS that you are eligible to claim the juicy exemption, Stranger said.
There is a caveat to this important tax saver: If you are a high-income earner, you may not qualify for this tax break. Anyone married filing jointly with adjusted gross income in excess of $309,900 will experience a phase-out.
6. Self-Employed or Small-Business Owners: Keeping Poor Records
If you have a small business or just a side hustle on top of your 9-to-5, do not make the mistake of keeping poor records that fail to support deductions associated with business expenses.
Attorney Richard C. Watson III, founder of Santa Ana, Calif.-based Watson Tax Law Group, reminds business owners that if they cannot substantiate a declared business expense in an audit, the IRS might not allow it, thereby costing them additional taxes and penalties.
Watson urges business owners to claim every legal business deduction allowed. That means supplies, memberships and business use of a vehicle, to name a few.
7. Retirees: Thinking Tax Planning Stops When Work Ends
Just because you are retired does not mean you will not owe taxes. Stranger and Farmer both underscored the importance of tax planning and awareness of tax obligations in retirement. For all but very low-income taxpayers, Social Security is taxable. Stranger said that up to 85 percent of your Social Security income might be taxed.
The IRS has an easy method to estimate whether your Social Security is taxable on its website.
8. Throughout Your Life: Failing to Itemize Deductions If You Can
Many taxpayers start out claiming the standard deduction when they first begin paying taxes and might not realize that itemizing deductions instead can slash their tax payments. To help you decide whether to claim the standard deduction or itemize your deductions on Schedule A, IRS Publication 501 lays out the details:
For 2015, standard deductions are as follows:
- If you’re single or married filing separately, your standard deduction is: $6,300.
- If you’re married filing jointly or a qualifying widow(er) with a dependent child, your standard deduction is: $12,600.
- If you’re filing as head of household, your standard deduction is: $9,250.
For example, Maria has a new home and is making mortgage interest — not principal — payments totaling $18,000 per year. Her property taxes are $3,000 per year. Add up those two items and her itemized deductions are $21,000, well above the single standard deduction of $6,300.
Tax software — or a flesh-and-blood tax professional — can help you decide whether it makes more sense to itemize or to take the standard deduction.
Spend a few minutes at the IRS website every year, and investigate the annual changes and updates to the tax code. By avoiding common tax mistakes, you will increase your account balances and have more money to save and invest.