Tax time isn’t usually an activity people consider pleasurable. It’s time consuming, there’s tedious paperwork involved, and whether the tax forms you require are simple or complicated, there is always a chance for error. What may seem like an innocent mistake not only can give you a major headache, it can also cost you plenty. That’s why I thought it would be beneficial to go over some of these common mistakes so you can be more mindful next time you go through the process.
- Spending more to earn a higher deduction
While the short-term gain may seem enticing, it’s never worth spending extra money in order to get a deduction. Remember deductions aren’t the same as tax credits, which allow you to deduct the full amount from your tax bill.
In reality, deductions only decrease your taxable income. So for instance, if you’re in the 20 percent bracket, you’ll spend a dollar to save 20 cents. A much better plan is to talk to a tax professional about finding additional deductions and credits that can work in your favor to decrease your tax bill.
- Withholding errors
The definition of withholding is exactly how it sounds—the amount the IRS withholds from your paychecks each period. While it’s up to you how many exemptions to write on your W4 forms, there is a smart way to go about it. If you write too many exemptions, the fewer taxes will be taken out of your paycheck, but you may end up owing money back to the IRS. On the other hand, if you write too few exemptions you may receive a large refund at the end of the year, but remember this is actually an interest-free loan you gave to the IRS. While some people may put their refund toward savings, investments or to pay down debts, it may be far more tempting to spend it on a new vehicle or a lavish vacation.
Instead of guessing on your withholding amounts, use this IRS withholding calculator, which will help you determine how to break even on your taxes. That way you’ll get all the money you’re entitled to on each paycheck and not owe any taxes at the end of the year. Win-win, right? Remember to revisit the withholding calculator each time you experience a major change in your tax status, such as a marriage, divorce, or having a child.
- Failing to hold on to important receipts
While holding on to receipts can be a pain, you’ll thank yourself when it’s time to file your taxes and you’re already organized. Keep things simple by storing every receipt for a deduction over $75 in a file folder throughout the year. To ensure nothing gets lost in the shuffle, also take a photo of your receipts with your phone and keep them together in one place.
- Forgetting to set aside funds for self employment taxes
If you work for yourself, taxes are not automatically taken out of your paycheck, and it’s therefore important to set aside a percentage of that money. Depending on how much you earn, you may even be required to file estimated quarterly taxes.
Those with traditional jobs have an employer that pays their share of payroll tax so self-employed people should set aside more money to cover such expenses. Make it a habit to save 20 percent of your check in a separate savings account each time you’re paid as an independent contractor. It may initially seem disappointing to only be able to keep $800 of a $1,000 job, but you’ll be glad you did come next April.
The bottom line: It’s easy to make errors when it comes to completing the tax process, but it’s also easy—with a little due diligence—to pay better attention and end up with more money back in your pocket next tax season. Take note of these four tips for easier, more cost efficient filing in the future.