Top 5 List of Tax Mistakes That May be Costing You Money
By Guest Contributor Amanda Han, CPA
We were reading an accountancy journal and saw an interesting statistic that may shock you: according to ABC News, the Average American “spends” more money on taxes than they spend on food, clothing, and shelter combined.
Isn’t that shocking? We pay federal income taxes, state income taxes, payroll taxes, sales tax, property tax, use tax, and the list goes on and on. So it is no wonder why taxes are our biggest expense.
This begs the question of “Why”? Why is it that the Average American loses so much money to taxes each year?
Well, as tax strategists, we hate to say this but one of the major reasons that taxpayers lose a ton of money to Uncle Sam is really because they receive bad advice. Today, we want to share with you some of the most common and costly tax mistakes that you need to know in order to protect yourself from overpaying the IRS this year:
Mistake #1: Deducting Expenses in the Wrong Place
Have you ever heard of the phrase “all men are created equal?” Well, unfortunately, not all tax deductions are created equal. For example, did you know that your travel expenses can save you as much as 50% in taxes or save you ZERO taxes? Surprisingly there is actually a RIGHT way along with a WRONG way to take your tax deductions.
One of the most common mistakes we see as CPA’s are tax deductions being taken in the wrong places. Take the example of one of our client’s, Tony, who is a pilot. Tony also has a business in which he sells nutritional products. For all of Tony’s travel costs, his tax preparer took those deductions on his Schedule A as unreimbursed employee business expenses in the previous years. Based on his income level and the limitations on Schedule A, he was unable to benefit from any of his $20,000 of travel costs incurred. Had he correctly reported these travel costs to be part of his business expenses (i.e.: on his business tax return or Schedule C), he would have increased his tax refund by close to $10,000.
Now you can see what we mean when we say not all tax deductions are created equal: make sure you are taking your tax deductions on the right forms and schedules!
Mistake #2: Real Estate Professional Status
If you are a real estate investor, you need to watch out for this. You must understand this mistake thoroughly as not only is this by far the biggest mistake that we see time and time again made by real estate investors but this is a mistake that cannot be undone.
What we just described is the Real Estate Professional Status. Lynne has been working with a CPA for many years and was always told she has been benefiting from the tax deductions as a real estate professional. Unfortunately when we reviewed her tax return, we quickly realized that her CPA prepared her taxes wrong which resulted in lost refunds of $20,000. The worst part of Lynne’s experience was that there was nothing we could do after the fact to get that money back for her.
Contrary to popular belief, the Real Estate Professional Status is not taken by simply indicating that as your occupation on your tax return or even by filling out a specific form or checking a box.. If you invest in real estate, make sure you speak to your tax preparer to ensure that election is in place before you send off your tax return. On average, the tax savings between a real estate professional and someone who is not a real estate professional is anywhere between $5,000 or more each and every year.
Mistake #3: Limited by Passive Loss Rules
This next example is a common situation that I see time and time again. One of our clients, Carol, is a retired teacher that operates a home-based health food business with her friend Joyce. Based on the advice of her advisor, Carol and Joyce correctly formed a partnership to jointly run the business. As with many businesses, not every year was a not a profitable year. For Carol and Joyce’s business, it was especially bad and they suffered losses of around $30,000. After meeting with their tax preparer, Carol was shocked to learn that after losing so much money, she still owed taxes to the IRS.
We reviewed Carol’s prior year tax return to find out that her CPA incorrectly prepared her individual tax return showing her to be a passive investor in the partnership rather than as an active business owner. Because of this error, Carol left $30,000 of tax write-offs on the table! Fortunately for Carol, we were able to simply check a box in the tax return for her to claim that $30,000 tax write-off. So if you are a business owner or someone who receives a K-1 from any of your businesses or investments, make sure you speak to your tax preparer to ensure you are not erroneously being limited on your tax write-offs by the passive loss limitation rules.
Mistake #4: Missing Carryforward Tax Benefits
There are a lot of things on our tax returns that move with us from year-to-year, better known as “carryforwards”. For example, if you have had certain types of tax deductions, losses, or credits that you were not able to use in the past for any reason, these generally get “carried forward” on your future tax returns, from one year to the next. Carryforward tax benefits being lost between the years is yet another common mistake we see in reviewing client’s prior year’s tax returns.
For example, one of our new client’s, James, made some bad investments back in 2013 which resulted in close to a $40,000 loss carryforward on his tax return. However, his over-worked CPA somehow “lost” that carryforward when he prepared James’ 2014 tax return. It was a mistake that could have cost James close to $18,000 of tax refunds over the next few years! A small yet potentially costly mistake.
Mistake #5: Not Doing the Appropriate Analysis
Do you ever feel like your tax preparer is just not doing enough analysis to provide you with the most refund? How much is your tax preparer really costing you? Here is an example of an opportunity that we went through with a new client. Sherri has two sons who are currently in college. After a review of her previous year’s tax returns, we noticed her prior year’s tax preparer did not claim an education tax credit of $2,500 each for both her sons attending college because she was told that due to her high income level, she was not able to claim those credits. This is a correct statement (there is an income limitation for claiming the education tax credits), however, there is a loophole that was overlooked. With some analysis, we discovered an easy loophole: Sherri’s sons could have filed their own tax returns which in turn could have provided them $2,500 each in education tax credits! With a little strategy and analysis, Sherri and her sons were able to increase their overall tax refunds by $5,000 per year just by taking advantage of their education credits!
As you can see, not all tax deductions are created equal and not all tax preparers are created equal.
There are so many strategies that are available for each of us to utilize in saving taxes….all it takes is knowing “How”.
So ask yourself:
Do you know what you can legally deduct on your tax return?
Do you have a plan in place to minimize your taxes each year?
Do you meet with your tax advisor throughout the year to learn new strategies that are available to you?
We hope that you can answer “Yes” to all of the questions above. If not, then take some time to learn the ways to minimize your own taxes today.
Amanda Han, CPA