When you see a mistake, are you likely to correct it, or do you just
glance over it? If we’re talking about your taxes, hopefully you
would correct it. Chances are that the mistake you are catching
would have cost you money. There are a number of simple mistakes
that people make on their taxes that, if corrected, could help them
save money on taxes. Some of these mistakes are just silly errors
that are easily eliminated.
Withholding Too Much
Most people I know get refunds at the end of the tax year. However,
many of these people are receiving too much. I’m not saying that the
government is paying them more than they are entitled to, I’m saying
that these people have been withholding too much money from their
paychecks. Tax refunds are good, but the smaller they are the better.
Why is that? Because the more money you pay into the government
during the year from your paycheck, the less money you have to help
achieve your goals.
By lowering your withholding from your checks, you will
increase the amount of money that goes into your pocket. This is
money that can be used to help increase your investments or used as
cash to buy something that you might otherwise put on a charge card
and pay interest on later. Plus, when was the last time you received
your refund from the government plus interest on that amount? Probably
never. When you withhold too much from your paycheck you
are essentially giving the government an interest-free loan for the
year. Think about what you can be doing with that money, and then
think about what the government is probably doing with your money.
I’m sure you have better plans for it.
Compromising Wealth for Taxes
When trying to build wealth, most people focus on saving money in
taxes as their number-one priority, but is that really the way to go? It’s
important to do proper research before deciding that an investment
that will save you in taxes is more important than a taxable investment
that may perform better. Saving money in taxes is important,
but it’s not your ultimate goal. Make sure that you are making decisions
that are in the best interests of your long-term goals, not just so
you can save on taxes. Realistically, strategies that are employed
solely to save on taxes shouldn’t work for investment purposes
because that wasn’t why they were undertaken in the first place.
When deciding which road is the best to take for your investments,
consider why you are choosing to do anything. Is it because you want
to save on taxes? Or is it the best decision based upon your risk tolerance
and financial objectives?
Real Estate Trade-Ups
Did you know that you don’t have to pay taxes on the gain of your
home if you purchase another, more expensive house? Section 1031 of
the Internal Revenue Code says that you can delay paying tax on the
gain of the sale of your home as long as you roll that money into the
purchase of a new, more expensive house. The only stipulation to this
is that you have to live in the house, or keep it as your primary residence,
for at least two years. The allowable appreciation for a taxpayer
filing as single is $250,000. For those who are married, the allowable
appreciation is $500,000. Therefore, as long as you continue to trade
up in value, you won’t have to pay any taxes on the appreciation. However,
once you liquidate (sell off your property and don’t purchase
another home), you will have to pay the tax on the gain.
Statements? What Statements?
Poor record keeping is a killer for many people. Make sure that you
keep track of all your investment statements, check registers, charitable
contributions, and all other pertinent financial data. Not having
these papers may result in paying your CPA and the IRS more money
than necessary because you may wind up missing deductions that
will help lower your taxes.
But there is also such a thing as too much record keeping. I have
a client whose father recently passed away. His father was a meticulous record-keeper. However, he also kept things that were of no
importance. Therefore, upon his father’s death, my client had to wade
through the quagmire of paper that his father had kept for years and
years. It’s very important to keep good records of your investments
and transactions, but that prospectus that’s eight years old? It’s all
right to throw that away.
Special note: I have quite a few clients who came to me from
other firms. When they first come to see me, they have many
different statements from multiple companies. I have found
that many people truly don’t know what their assets are
because they simply have too many accounts at too many
firms. It’s very easy to get swept up in the latest advertisement
from a bank or mutual fund company; then, before you know it,
you have a torrent of paper coming to your mailbox every
month from way too many investment companies. In order to
combat this, try to find a company that will allow you to hold
your existing mutual funds and other assets in one consolidated
account, like a brokerage account. There are many firms that
will allow this, and it will make keeping track of your investments
much easier. You don’t want to compromise your investment
strategy or results by limiting yourself to one or two
investment companies; however, you also don’t want to lose
track of your portfolio because you have too many accounts at
These are probably the easiest to fix, but the most difficult to find.
Many times the only mistake in a client’s taxes is that two numbers
are added incorrectly or aren’t entered correctly. The most common
mistake that I see happens when people use spreadsheets they have
formulated themselves to help them. If there is an error in the
spreadsheet, it will continue into perpetuity as long as you don’t
know the error is there. This is why it’s important to have someone
else double-check your work. If they find an error that you missed,
they may have just saved you some money. However, that’s not to
say that all errors result in your paying more taxes. There are times
when the errors that are made result in the government’s paying
more back to you. But, when the IRS goes over your return and
finds an error, if it’s in their favor they’ll let you know. If it’s not,
they’ll let it go.
Doing Your Own Taxes
If you are a trained tax specialist or a CPA, then doing your own taxes
makes sense. Even if your taxes are simple you don’t itemize, and
you use the 1040EZ form, then doing your taxes is alright. However,
if that’s not the case, then perhaps you should consider hiring a professional.
The advantages of hiring a professional outweigh the
potential cost of paying someone to prepare your taxes.
First, whomever you hire will be more objective about your tax
situation than you will be. Second, tax professionals are trained in
up-to-date tax codes. They know what they’re doing and what the
best way to do it is. They also know the best way to save you money
on your taxes and whether you should itemize or not. Third, hiring
someone will help stem the tendency to procrastinate. Are you one of
those people who stand in line at the post office at 11:30 p.m. on
April 15 to send in your taxes? Or perhaps, you’ve been so busy that
you had to file for an extension? If so, then hiring a CPA is probably
a good idea.
Plus, you know that little box on the bottom of the second page of
the tax forms, the one that says preparer’s signature? By hiring someone
to prepare your taxes for you, if there is a problem, it becomes
their problem, too. If you make a mistake, the IRS hunts you down,
right? But if your CPA makes a mistake, it’s his or her problem, too,
because it’s the CPA’s job to make sure that things are done correctly.
Therefore, the onus of doing the job right falls directly onto the CPA,
not you. This may result in fewer sleepless nights for you!
Not Using Qualified Plans
We talked about this earlier. Qualified plans are one of the best ways
to help lower your taxable income and shelter your money from current
taxes. Not utilizing these types of accounts is one of the surest
ways to cost you money, both currently and over time.
Investing in Bonds Needlessly
The tax advantages of muni bonds are for those with higher incomes.
While I’m not advocating that those in the lower tax brackets stay away
from municipal bonds, I am saying that there may be other investments
better suited to those investors. Evaluate your tax situation and make
your decision based on that. If you want to add some stability to your
portfolio by using bonds, there are different types of bonds that exist
that may give you higher returns. And, those after-tax returns may be
higher than those returns offered by nontaxable muni bonds.