The more money you make, the higher your tax liability could be. And making a mistake in your filing can end up costing you more in fees and penalties. Here’s a roundup of common tax mistakes that could cost you money this tax season. A financial advisor who specializes in tax planning could also help you avoid some of these costly errors.
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Why Taxes Matter
Few financial moves are free of tax consequences. Many strategies, in fact, gain most or all of their attraction from the way they help savers and investors avoid or reduce tax obligations. If not for the tax-advantaged treatment of retirement savings plans such as Individual Retirement Accounts (IRAs), for instance, there would be little incentive for retirement savers to use them.
But while using tax-smart methods such as saving for retirement in an IRA can save you money, there are lots of other moves that will cost you at tax time. Here are 10 common mistakes that can cost you plenty, along with ways to avoid them.
9 Common Tax Errors That Could Be Costly
| Error | How It Costs You | How to Avoid it |
| Making a large retirement withdrawal that bumps you into a higher tax bracket. | If a retirement withdrawal is treated as income, it can push your income into a higher tax bracket, increasing the percentage of that income that has to be paid in taxes. | Spread large retirement account withdrawals over multiple years, gauging the amounts so you are not moved to a higher tax bracket. |
| Buying and selling the same asset (like a stock) in less than one year. | Gains on assets sold one year or less after they were bought are taxed as ordinary income. Holding them for more than a year means they will be taxed at capital gains rates, which are usually much lower. | Hold appreciated assets for more than one year before selling them for a profit. |
| Missing a Required Minimum Distribution (RMD) withdrawal. | If you skip an RMD or don’t take the required amount, the IRS will demand an excise tax equal to 50% of the sum you should have taken. | Make all RMDs on time and in full. |
| Miscalculating your cost basis on securities, real estate or other assets. | If you calculate the cost basis of an asset too low, you may owe more in taxes than you should when you sell it. | Keep good records and use the method of calculating cost basis appropriate to the specific type of asset. |
| Missing out on savings from tax-advantaged accounts. | Neglecting to save using tax-advantaged accounts such as IRAs and 401(k)s means you lose current tax deductions and the opportunity to let your investments grow tax-deferred. | Contribute the maximum allowed to tax-advantaged accounts. |
| Failing to appropriately harvest your capital losses. | Failing to harvest tax losses means you won’t be able to offset gains from more successful investments. And this could also increase your tax liability. | Offset capital gains by selling money-losing investments dollar for dollar. Work with a financial advisor to decide on which losing investments make most sense to sell off. |
| Not accounting for state income taxes. | If you fail to pay state taxes due on your income, you may be liable for interest and penalties, just as you would for unpaid federal taxes. | Make sure you follow the laws in your state. They can vary widely. |
| Choosing the wrong filing status. | Your filing status determines which deductions, exclusions and allowances you can take, and also affects your tax rate, so choosing the wrong one can cause you to miss out on opportunities to reduce your taxable income. | Don’t choose a filing status without considering whether another status might save you money. Make sure you’re eligible to use the filing status you choose. |
| Filing too early. | If you file before you’ve received all your tax documents (such as 1099s and K-1s), you may underreport your income and have to pay penalties and interest. | Wait until after you’ve gotten all 1099s and other documents you’ll need to file a complete return. |
Bottom Line
Tax mistakes can cost you money, from failing to take advantage of tax benefits to setting yourself up for penalties and interest. Every tax situation is different. So what is a serious mistake for some taxpayers may not be a consideration at all for you. However, some mistakes are more common than others. This list of widely made and significantly expensive tax errors can serve as a guide to help you avoid them.
Tax planning Tips
- Consider working with a financial advisor to optimize your financial plan for a lower tax liability. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Use SmartAsset’s income tax calculator to prepare an estimate of how much you’re likely to owe next time you fill your taxes.
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