Thanks to tax preparation software, more of us are making fewer mistakes on our annual tax returns. But still, just one slip in entering information on your computer could end up costing you, either in the form of a larger tax bill or a smaller refund.
Almost half of individual filers, however, still send in paper forms each year. This process multiplies the opportunities to make a tax-filing mistake.
And even if a mistake, either on your computer or paper forms, doesn’t cost you cash, it could delay the receipt of any refund you’re expecting.
To get exactly what you should from the IRS — and as quickly as possible — look out for these filing pitfalls. A few are new, thanks to recent law changes. Others are perennial problems taxpayers face each filing season. With a little care, you can avoid them all.
|1.||Direct deposit dangers||6.||Math miscalculations|
|2.||Hybrid vehicle credits||7.||Social Security numbers|
|3.||Charitable contributions||8.||Ignoring IRS mailing material|
|4.||PMI deductions||9.||Signature required|
|5.||Overlooked unearned income||10.||Missing the deadline|
1. Triple direct deposit dangers
Taxpayers can have a refund directly deposited into as many as three accounts. This option is a great way to save your refund money, but the more numbers you enter on a tax form, the more chances you have to enter them incorrectly. And a wrong account or routing number could cause you to lose your refund entirely.
You can divide your refund into three accounts by filing Form 8888 along with your individual return. It’s not a difficult document to complete, but if you put in wrong account numbers, your refund could end up in someone else’s account or be sent back to the IRS. Either way, you might not be able to retrieve your refund because there is no IRS procedure for replacing lost electronically transferred funds.
Also remember that the IRS can correct errors, such as a miscalculated amount, that you make on your return. If the change reduces your refund amount, the IRS has a specific procedure for determining how the lower amount will be deposited. “Any adjustments come from the bottom up, starting with line 3 then from line 2 and then the first account,” says Jim Keller, senior tax analyst with the Tax & Accounting business of Thomson Reuters.
This could pose a problem if one of your direct deposit accounts is an individual retirement account. “There are no rules for a normal refund, but there are rules for IRAs, and they are fairly strict,” says Keller. An unexpected change in an IRA deposit could create confusion at the IRS and your financial institution that is accepting the direct-refund deposit. To guard against that possibility, Keller suggests making an IRA the first account so it would be the least likely to be adjusted in case of error.
2. Fluctuating hybrid vehicle credits
The prospect of rising gas prices makes alternative fuel vehicles more attractive. The U.S. tax code has added to the appeal of these fuel-efficient vehicles via a tax credit. The tax break, however, has a couple of drawbacks.
First, the credit is not a fixed amount. It varies for each qualifying vehicle. Even more problematic is that once a manufacturer sells 60,000 IRS-approved autos, the credit amounts start phasing out.
That’s the case for Toyota and Honda hybrids. These Japanese automakers quickly reached the 60,000-sale mark and the credit for their hybrids have been phased out. No Toyota credit was available in 2008, but buyers of Honda hybrids may be eligible for a reduced credit when they file this year.
If you bought a Honda last year, make sure you claim the correct credit amount. In addition to different credit amounts for each eligible Honda hybrid, the amounts also differ depending on whether you bought your vehicle before or after July 1, 2008. And if you bought another manufacturer’s eligible, alternative-fuel auto, take care to enter that correct amount, too. There are more than 40 hybrids and a handful of compressed natural gas vehicles that qualify, each with a specific allowable credit.
3. Complete charitable contributions
Did you give to charitable groups last year? All types of donations, from cash to cars, could be valuable tax deductions, so make sure you count them all when you file. Be sure to follow the donation tax rules, the most important being that you give to a qualified organization — that is, one that has tax-exempt status with the IRS. Also be careful when calculating any gifts of clothing and household items. Tax law now requires that these donations be in good or better condition or the deduction is disallowed.
4. Deducting private mortgage insurance
Homebuyers who don’t come up with a down payment of at least 20 percent typically must purchase private mortgage insurance, or PMI, when they get a home loan. Although the buyer pays for PMI as part of the monthly mortgage payment, the policy protects the lender in case of default. Usually, this added expense is, in most cases, simply part of the price of owning a home.
But beginning in 2007, some homeowners could claim a tax deduction for PMI premiums, and a new law extends the deduction to certain premiums paid in 2008 through 2010. There are specific eligibility guidelines, the most critical being that your home loan that includes PMI was taken out on or after Jan. 1, 2007. PMI payments on loans issued in prior years remain nondeductible. Also, when your adjusted gross income, or AGI, reaches more than $50,000 as a single filer or $100,000 for a married couple filing a joint return, your PMI deduction begins phasing out.
But if you and your mortgage do meet the PMI deduction eligibility rules, be sure to claim this new tax break on Schedule A.
5. Overlooking unearned income
Because your Social Security number exists on bank and investment accounts, the IRS knows precisely how much unearned income you made as soon as you did, thanks to the 1099 forms that financial institutions send to the tax agency. If you forget to include this info on your return, the IRS examiners will let you know that you owe taxes on it, too. And depending on when your oversight is discovered, you also could owe penalties and interest on the unreported earnings.
In fact, the 1099-INT form, which tells you and the IRS how much interest an account earned, has two boxes with specifics on these earnings. Box 8 includes various tax-exempt interest payments. Box 9 reports how much of that tax-exempt interest is subject to the alternative minimum tax, or AMT. Pay close attention to this amount if you’re subject to the AMT.
Also, be careful in figuring any tax due on your investment earnings. Some dividends, reported to you and the IRS on Form 1099-DIV, are eligible for lower capital gains tax rates. These amounts are in box 1b (qualified dividends) of that form. You’ll have to do some additional work to compute this tax amount, especially if you’re filing your returns without the help of a tax software program, but it’s worth the effort to shave some dollars off your eventual tax bill.
6. Math miscalculations
The most common error on tax returns, year after year, is bad math. Mistakes in arithmetic or in transferring figures from one schedule to another will get you an immediate correction notice. Math mistakes also can reduce your tax refund or result in you owing more tax than you thought.
Using a tax software program to file your return can help reduce math errors. The built-in calculators do the work for you, adding, subtracting and inserting numbers on additional forms as needed. But you still have to make sure that your initial numbers are correct. Entering $3,500 when the real figure is $5,300 makes a lot of tax difference. Getting the numbers right is crucial because you can be sure that the IRS will be double-checking numerical entries against its copies of your tax statements (W-2, 1099s and the like). When IRS examiners find a discrepancy, they’ll definitely let you know and, in many cases, will correct your mistake and refigure your taxes for you. Don’t give them the chance. Make sure your math entries are right.
7. Social Security number oversights
Because the IRS stopped putting taxpayer Social Security numbers on tax package labels in response to privacy concerns, some taxpayers forget to write in their identification numbers. Your tax ID number is crucial because there are so many transactions — income statements, savings account interest, retirement plan contributions — keyed to this number. The nine-digit sequence also is vital to claim several tax credits, such as the Child Tax and Additional Child Tax credits and ones for educational expenses and dependent care costs. Without the numbers, or with wrong ones, the IRS will disallow these tax breaks.
8. Ignoring IRS-provided mailing material
Almost 90 million people filed electronically last year, but around 66 million others sent in paper forms. If you plan to fill out your return by hand this year, be sure to use the preprinted label and the envelope that came with your tax packet.
The label will ensure that IRS employees can easily and accurately read your personal information. Even if it’s not correct because, for example, you moved, go ahead and stick it on your return; just cross out the wrong information and correct it by hand. The label is not a way for the agency to more easily track and audit you — honest!
In fact, if you’re expecting a refund, you’ll probably get it sooner if you use the label. And using the preaddressed envelope will ensure that your return goes to the proper processing site. The IRS has reorganized its Service Center operations in recent years, so it’s possible your return could be handled at a different location than where it went last year. Your envelope has the correct delivery data.
9. Signature required
Sign and date your return. The IRS won’t process it if it’s missing a John Hancock. If you’re filing electronically, this shouldn’t be a problem. The software packages won’t let you send a document until you complete every step. But if you’re still mailing your return, don’t be in such a hurry that you stuff your 1040 in the preaddressed IRS envelope without signing it. And if it’s a joint filing, you and your spouse both must sign.
10. Missing the deadline
If the impending April 15 tax deadline is a problem for you, make sure you buy yourself six extra months by simply asking the IRS for more time to complete your tax paperwork. All you have to do is submit Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return, by the regular filing deadline. Remember, though, that the extension is only for the forms; you still have to pay any tax you may owe by April 15.
If you make the mistake of not filing or paying on time, you’ll end up facing even more costs in late-filing penalties and interest fees.