It’s the beginning of every American’s favorite time of the year to hate: tax season. The IRS will begin accepting tax returns for the 2022 tax year on January 24th. Here are three of the biggest tax filing mistakes people make.
1) Missing last-minute tax-saving opportunities.
While it’s too late to influence most of the factors that will determine your 2022 tax liability, there are still a few things you can do by the April 18th tax filing deadline. One is to contribute up to $6,000 (or $7,000 if you turned 50 or older last year) to an IRA. If you don’t have a retirement plan through work or do but meet the income limits, you can deduct your contributions to a traditional IRA, which can be invested to grow tax-deferred until withdrawn. There’s a 10% penalty for withdrawals before age 59 ½, but exceptions include qualified education expenses and up to $10k over a lifetime for a first-time home purchase.
Another type of IRA you can choose is a Roth IRA. The contributions aren’t deductible, but the earnings can be withdrawn tax-free after 5 years and the age of 59 ½. Unlike a traditional IRA, you can also withdraw the sum of your contributions (but not any earnings) at any time without tax or penalty. If your income is too high to contribute to a Roth IRA, you can do a “backdoor” Roth IRA by contributing to a traditional IRA and then converting it to a Roth IRA.
Finally, if you’re in a high-deductible health insurance plan, another way to reduce your current and future taxes is to contribute to a health savings account or HSA (up to $3,650 for individuals and $7,300 for families with an additional $1k if you turned age 55 or older last year). Like a traditional IRA, the contributions are tax-deductible, but the withdrawals are tax-free as well if used for qualified health care expenses. You can also use it for non-medical expenses without the normal 20% penalty starting at age 65 (although it will be taxable when used for non-medical expenses).
2) Waiting to file.
There are several reasons why taxes aren’t something to procrastinate on until the last minute. First, you never know when your tax return may end up being more complicated than you thought. You might need additional paperwork or other information or even need to switch from using software to hiring a professional tax preparer. In that case, you’ll want time to find the right person rather than whoever happens to be available during the busiest time of tax season.
Second, the only thing worse than owing a large sum to the IRS is finding out just before the payment deadline that you aren’t able to make the payment. You’ll then be subject to interest and penalties as well. By filing early, you’ll have more time to save up or otherwise find the cash to pay your tax bill.
If you get a refund, filing earlier lets you get your money back sooner and put it to work for you. You also often need a tax return if you apply for a mortgage or have a child applying for financial aid. Getting it done early gives you a head start on filing those forms too.
Finally, one of the most common forms of identity theft is for someone to file an income tax return in your name and run off with the refund, leaving you stuck explaining to the IRS why everything on your return is wrong. Unlike other forms of identity theft, this can’t be prevented by a security freeze and it won’t show up in credit monitoring because no credit is involved. One way to prevent this is to file your return before someone else can file it for you.
3) Choosing the wrong person to file your taxes.
With a plethora of tax software out there, doing your own taxes is easier than ever. If your adjusted gross income is $73,000 or less, you can even qualify for free file software here. Just be aware that these free options only cover very basic returns.
If you don’t qualify, you can still access free fillable tax forms. However, they just do the math and offer only basic guidance, so you have to be able and willing to do your taxes by yourself. Also, all your info is eventually deleted, so you won’t have access to it in the future unless you save it somewhere else.
In any case, doing your own taxes isn’t the right choice for everyone. If you own a business or investment real estate, ambiguities in the tax code can make it hard to figure out what income is taxable and what expenses are deductible. Living or working in multiple states or countries, buying and selling investments in taxable accounts, or being a non-US citizen can all make your taxes more complex and time-consuming. These are all cases where a tax professional could make sense.
However, hiring a preparer is generally more expensive than doing it yourself. In 2021, the National Society of Accountants found the average cost was $220 for a 1040 and state return with no itemized deductions, $323 for 1040 with itemized deductions (Schedule A) and a state return, and $778 for a business owner with capital gains and/or losses and rental income and/or losses. Compare that to software programs that are typical $80 or less for federal and state filing.
For a simple return, your local H&R BlockSQ -1.6%, Jackson Hewitt, or mom-and-pop tax preparation service should be fine. But for more complex situations not involving a business, you might want to hire an Enrolled Agent (EA). Enrolled Agents are licensed by the IRS to prepare individual income tax returns and represent taxpayers before the IRS. However, they’re generally more expensive than non-credentialed preparers. You can search for one here.
Finally, if you need to have a business return done, you might want to hire a Certified Public Accountant (CPA) that specializes in tax preparation. Keep in mind that their fees tend to be the highest of preparers so it might be overkill for just an individual income tax return. If you’re also looking for more comprehensive financial planning, consider a CPA who’s also a Personal Financial Specialist (PFS).
Of course, there’s a myriad of other tax filing mistakes to avoid like being disorganized or making computational errors, but these are three that can really cost you. Try to take advantage of remaining tax-saving opportunities, get started early, and choose the right person to prepare your taxes. Then maybe tax season won’t seem quite as taxing.