(Contributed)
Every year, taxpayers face tax surprises that could be avoided if they knew the rules. Here are five big surprises that are easy to avoid with simple planning.
Error #1
Under-withholding. This results in a tax surprise when you file your income tax return. Don’t be too hard on yourself if this happens to you. Social Security withholdings change every year, and not understanding how your employer calculates how much tax to withhold can also contribute to withholding too little.
The plan: Check your withholdings after filing each year’s tax return. Make any necessary adjustments by submitting a new Form W-4 to your employer. This is especially important if you have received unemployment benefits or need to make estimated payments for taxes owed.
Error #2
Accidentally withdrawing funds from retirement plans. Amounts withdrawn from pre-tax retirement plans, such as 401(k)s and individual retirement accounts (IRAs), can result in taxable income. The most common accidental withdrawal occurs when funds are transferred from one retirement plan to another. If done incorrectly, the entire transfer could be considered taxable income.
The Plan: Leave your retirement accounts alone as much as possible. (Exception: When you reach age 73, you may be subject to required minimum distribution rules.) If you withdraw funds, make sure that the appropriate taxes have been withheld at the time of withdrawal. Direct rollovers to your new plan are always a better alternative than receiving the withdrawal from the retirement plan administrator and then making the rollover yourself.
Error #3
Failing to take advantage of tax-deferred retirement programs. There are numerous opportunities to shield income from taxes through tax-deferred retirement programs.
The Plan: Review your retirement savings options and plan to contribute as much as possible to your retirement accounts. Pay particular attention to plans that include an employee contribution component. This review can reduce your taxable income each year.
Error #4
Direct deposit errors. You can have tax refunds directly deposited into up to three bank accounts. The problem: What happens if one of the account numbers is entered incorrectly? Unfortunately, unlike replacing a lost check, the IRS doesn’t have a good method for correcting this type of error. There have been cases where taxpayers have lost their refund when this happens.
The plan: Many taxpayers aren’t comfortable giving the IRS direct access to their bank account. If you’re in this group, the digital deposit problem is solved, since you’ll receive a physical check for any overpayment. If you use direct deposit, avoid depositing your refund into more than one account. Ideally, have a second person verify the account number on your tax form before you submit your return.
Error #5
Not carrying the correct documentation. You know you drove miles, donated the items to a charity, incurred medical expenses, and paid for daycare. How can the IRS reject your valid deductions? Remember that the IRS is quick to reject a valid deduction without the proper documentation.
The plan: Establish good journaling habits at the beginning of each year. Create a paper and digital binder organized by income and expense type. Keep a running log of your mileage and properly document your charitable contributions.
James Angell is a certified public accountant based in Willits. His office is located at 461 S. Main St. and he can be reached at 707-459-4205.
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