Most Common Taxpayer Mistakes

TAXES

Jeff Schnepper

Decision Center

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Ask the Experts

veryone makes mistakes, but a mistake on your tax return can really cost you. The single biggest reason why people pay too much in taxes each year is because of mistakes they make in preparing their returns.

In 1997, the average household paid more in federal, state and local taxes than it spent on food and other necessities. According to the Tax Foundation, the average household in 1997 paid 26.7 percent of their income to taxes while only 12.9 percent was spent on food and clothing. Some of those families could have avoided paying the government so much if they had not made some easily avoided mistakes on their tax forms. Here are some typical tax-time oversights and mistakes:

1. Bad math

According to the Internal Revenue Service, errors in addition and subtraction are the number one mistake taxpayers make. All returns are examined for mathematical errors. Mistakes in arithmetic or in transferring figures from one schedule to another result in an immediate correction notice. If the error leads to a tax deficiency, you automatically receive a bill for that amount. If you overpaid, the excess is applied to future taxes, credited or refunded at your request. You can't appeal such corrections, but you can ask in writing that they be reviewed if you think the IRS made a mistake.

Check the figures on the IRS correction notice. They have been known to make their own mistakes. Arithmetic mistakes alone rarely lead to a full audit.

2. Forgetting about interest and dividends

Interest and dividend payments are reported to the IRS by banks, brokerage houses and other financial institutions, and are cross-checked in about 96 percent of the cases. The IRS attempts to match almost 100 percent of the returns that they receive on computer tape and more than 50 percent of those that are on paper. As a result of this cross-checking, the IRS sends out notices for taxes and interest on overdue taxes for income and other payments that were not reported. Unfortunately, according to the General Accounting Office, the government agency that audits the IRS, about half the 10 million correction notices the IRS issues each year are "incorrect, unresponsive, unclear or incomplete."

If you get an incorrect notice, follow the appropriate procedures to contest it, or contact your local Problem Resolution office.

3. Forgetting to bunch your deductions

There are a number of deductions that are allowed only after you exceed a minimum amount. For example, only those medical expenses that exceed 7.5 percent of your adjusted gross income are allowed. Alternatively, miscellaneous deductions are allowed only if they exceed 2 percent of your adjusted gross income.

Your best planning strategy here is to bunch your deductions into a single year to exceed these minimum requirements. For example, if you have an adjusted gross income of $100,000, only those medical expenses in excess of $7,500 can be deducted. In order to exceed this "floor" amount, you might prepay your orthodontia bill or pay your January 1 medical insurance on December 31. With miscellaneous itemized deductions, and the same adjusted gross income, you need to exceed $2,000 in expenses. Prepay your tax preparer on Dec. 31 for that year's taxes or bunch order your investment subscriptions and expenses to exceed that amount.

4. Not properly tracking your investment basis

A basis is the original value of your investments. If you have mutual funds, for example, each year those funds will report to you the dividends and capital gains you earned. These dividends and gains will be taxable to you in the year reported.

When you sell these funds, your gain will be the difference between what you receive on the sale and your basis (technically, your amount realized less your initial investment). The basis actually increases once any initial financial gains you received are taxed. If you received taxable gains from these funds, those gains (all of the dividends and capital gains reported) are added to your basis to reduce your gain (or increase your loss). For example, if I bought a fund for $1,000 and received $200 in dividends and $50 in capital gains, my basis is now $1,250. If I sell the fund for $1,500, I only have to recognize $250 in gain on that sale. That's much better than reporting a $500 profit for tax purposes.

5. Getting married without knowing its financial consequences

Marriage can be an expensive proposition from a tax point of view when both spouses are working.

There is a marriage penalty if both married partners work. For example, in 1997, two individuals who each earned $24,000 in taxable income would pay $3,600 each in taxes for a total outlay of $7,200. As a married couple, their income would be $48,000. They would have to file either a joint return or a return as married filing separately. Either way, they would be required to pay $8,227 in taxes, $1,027 more than what they would have paid had they remained single. This is because we have a progressive tax system where incremental dollars are taxed at higher marginal rates. The second $24,000 would therefore be taxed at a higher marginal rate than the first $24,000.

This tax penalty on marriage is compounded by the standard deduction. A married couple is allowed $6,900 in nontaxable income in 1997. Two single workers get $4,150 each for a total of $8,300. By getting married, an additional $1,400 becomes taxable and at the highest rate.

Moreover, high-income earners who marry will lose write-offs for personal exemptions faster than their single counterparts. Marriage may also wipe out potential IRA deductions. If two people with incomes of $25,000 get married and either one has an employer pension plan, neither one qualifies for an IRA deduction. They could lose $4,100 in deductions and pay as much as $1,200 in additional taxes.

I'm not saying don't get married. What I am suggesting is that you postpone a Christmas wedding until after the new year. The tax savings could pay for the honeymoon. Of course, if only one partner is employed, marriage would provide a tax savings. They could file jointly, at rates lower than for single taxpayers.

6. Forgetting to donate unwanted items to charity

Give your old clothes, furniture, appliances and other items away to your favorite charity. The wholesale value of those contributions is allowable as a charitable deduction. Make sure that you get a receipt. No receipt, no deduction. The receipt doesn't have to list what you gave or what the items were worth, but it must be dated. You can fill in the details yourself. Remember, too, that you can deduct 12 cents a mile for any charitable work, including the trips to bring the old clothes to the charity.

7. Losing your receipts

In the real world, you either have proof of your deductions or you lose them. Always keep your receipts and checks if you want to deduct them. Deductible receipts and checks should always be kept for at least three years from the due date of the year filed, or the actual date filed, if later. Unless the IRS can prove fraud, the statute of limitations to disallow deductions is three years. Once this three-year period has passed, the IRS is legally prohibited from even questioning these deductions. Receipts for expenses that may be deducted in later years, such as improvements to your house, should be kept for three years after the return on which they are claimed.

Remember, the IRS is a paper-based bureaucracy. They want documents, not numbers from a personal finance software package. At the same time, don't come in with an unorganized shopping bag of receipts either. It is not the job of the IRS to improve your organizational skills, and they will not even look at documents if they're not set up in a logical, orderly fashion. Separate your receipts and checks by deductible category and make any audit easier for the auditor. The easier you make it for them, the more they believe and accept that you know what you are doing, and the easier they will make it on you.

Your best planning strategy here is to bunch your deductions into a single year to exceed these minimum requirements.

I'm not saying don't get married. What I am suggesting is that you postpone a Christmas wedding until after the new year.

Remember, the IRS is a paper-based bureaucracy.

How can I avoid making costly mistakes?

Articles

The 10 Most Overlooked Deductions

Next Steps

Go to Money's Tax Estimator Worksheet

	TAXES

	Most Common Taxpayer Mistakes Jeff Schnepper Decision Center

.......................................... WEB LINK Ask the Experts	veryone makes mistakes, but a mistake on your tax return can really cost you. The single biggest reason why people pay too much in taxes each year is because of mistakes they make in preparing their returns. In 1997, the average household paid more in federal, state and local taxes than it spent on food and other necessities. According to the Tax Foundation, the average household in 1997 paid 26.7 percent of their income to taxes while only 12.9 percent was spent on food and clothing. Some of those families could have avoided paying the government so much if they had not made some easily avoided mistakes on their tax forms. Here are some typical tax-time oversights and mistakes: 1. Bad math According to the Internal Revenue Service, errors in addition and subtraction are the number one mistake taxpayers make. All returns are examined for mathematical errors. Mistakes in arithmetic or in transferring figures from one schedule to another result in an immediate correction notice. If the error leads to a tax deficiency, you automatically receive a bill for that amount. If you overpaid, the excess is applied to future taxes, credited or refunded at your request. You can't appeal such corrections, but you can ask in writing that they be reviewed if you think the IRS made a mistake. Check the figures on the IRS correction notice. They have been known to make their own mistakes. Arithmetic mistakes alone rarely lead to a full audit. 2. Forgetting about interest and dividends Interest and dividend payments are reported to the IRS by banks, brokerage houses and other financial institutions, and are cross-checked in about 96 percent of the cases. The IRS attempts to match almost 100 percent of the returns that they receive on computer tape and more than 50 percent of those that are on paper. As a result of this cross-checking, the IRS sends out notices for taxes and interest on overdue taxes for income and other payments that were not reported. Unfortunately, according to the General Accounting Office, the government agency that audits the IRS, about half the 10 million correction notices the IRS issues each year are "incorrect, unresponsive, unclear or incomplete." If you get an incorrect notice, follow the appropriate procedures to contest it, or contact your local Problem Resolution office. 3. Forgetting to bunch your deductions There are a number of deductions that are allowed only after you exceed a minimum amount. For example, only those medical expenses that exceed 7.5 percent of your adjusted gross income are allowed. Alternatively, miscellaneous deductions are allowed only if they exceed 2 percent of your adjusted gross income. Your best planning strategy here is to bunch your deductions into a single year to exceed these minimum requirements. For example, if you have an adjusted gross income of $100,000, only those medical expenses in excess of $7,500 can be deducted. In order to exceed this "floor" amount, you might prepay your orthodontia bill or pay your January 1 medical insurance on December 31. With miscellaneous itemized deductions, and the same adjusted gross income, you need to exceed $2,000 in expenses. Prepay your tax preparer on Dec. 31 for that year's taxes or bunch order your investment subscriptions and expenses to exceed that amount. 4. Not properly tracking your investment basis A basis is the original value of your investments. If you have mutual funds, for example, each year those funds will report to you the dividends and capital gains you earned. These dividends and gains will be taxable to you in the year reported. When you sell these funds, your gain will be the difference between what you receive on the sale and your basis (technically, your amount realized less your initial investment). The basis actually increases once any initial financial gains you received are taxed. If you received taxable gains from these funds, those gains (all of the dividends and capital gains reported) are added to your basis to reduce your gain (or increase your loss). For example, if I bought a fund for $1,000 and received $200 in dividends and $50 in capital gains, my basis is now $1,250. If I sell the fund for $1,500, I only have to recognize $250 in gain on that sale. That's much better than reporting a $500 profit for tax purposes. 5. Getting married without knowing its financial consequences Marriage can be an expensive proposition from a tax point of view when both spouses are working. There is a marriage penalty if both married partners work. For example, in 1997, two individuals who each earned $24,000 in taxable income would pay $3,600 each in taxes for a total outlay of $7,200. As a married couple, their income would be $48,000. They would have to file either a joint return or a return as married filing separately. Either way, they would be required to pay $8,227 in taxes, $1,027 more than what they would have paid had they remained single. This is because we have a progressive tax system where incremental dollars are taxed at higher marginal rates. The second $24,000 would therefore be taxed at a higher marginal rate than the first $24,000. This tax penalty on marriage is compounded by the standard deduction. A married couple is allowed $6,900 in nontaxable income in 1997. Two single workers get $4,150 each for a total of $8,300. By getting married, an additional $1,400 becomes taxable and at the highest rate. Moreover, high-income earners who marry will lose write-offs for personal exemptions faster than their single counterparts. Marriage may also wipe out potential IRA deductions. If two people with incomes of $25,000 get married and either one has an employer pension plan, neither one qualifies for an IRA deduction. They could lose $4,100 in deductions and pay as much as $1,200 in additional taxes. I'm not saying don't get married. What I am suggesting is that you postpone a Christmas wedding until after the new year. The tax savings could pay for the honeymoon. Of course, if only one partner is employed, marriage would provide a tax savings. They could file jointly, at rates lower than for single taxpayers. 6. Forgetting to donate unwanted items to charity Give your old clothes, furniture, appliances and other items away to your favorite charity. The wholesale value of those contributions is allowable as a charitable deduction. Make sure that you get a receipt. No receipt, no deduction. The receipt doesn't have to list what you gave or what the items were worth, but it must be dated. You can fill in the details yourself. Remember, too, that you can deduct 12 cents a mile for any charitable work, including the trips to bring the old clothes to the charity. 7. Losing your receipts In the real world, you either have proof of your deductions or you lose them. Always keep your receipts and checks if you want to deduct them. Deductible receipts and checks should always be kept for at least three years from the due date of the year filed, or the actual date filed, if later. Unless the IRS can prove fraud, the statute of limitations to disallow deductions is three years. Once this three-year period has passed, the IRS is legally prohibited from even questioning these deductions. Receipts for expenses that may be deducted in later years, such as improvements to your house, should be kept for three years after the return on which they are claimed. Remember, the IRS is a paper-based bureaucracy. They want documents, not numbers from a personal finance software package. At the same time, don't come in with an unorganized shopping bag of receipts either. It is not the job of the IRS to improve your organizational skills, and they will not even look at documents if they're not set up in a logical, orderly fashion. Separate your receipts and checks by deductible category and make any audit easier for the auditor. The easier you make it for them, the more they believe and accept that you know what you are doing, and the easier they will make it on you.	Your best planning strategy here is to bunch your deductions into a single year to exceed these minimum requirements. I'm not saying don't get married. What I am suggesting is that you postpone a Christmas wedding until after the new year. Remember, the IRS is a paper-based bureaucracy.
	How can I avoid making costly mistakes?
	Articles \|

	The 10 Most Overlooked Deductions

	Next Steps \|

	Go to Money's Tax Estimator Worksheet Illustration by Terry Allen Copyright 1998 Microsoft Corporation