Slash your tax bill in 2014 and beyond
As taxpayers across the nation send their tax returns to the Internal Revenue Service this winter and spring, one question will haunt them: "Could I have saved more?"
In many cases, the answer is likely to be "yes," says Steven Hanke, assistant professor of accounting in the Doermer School of Business at Indiana University-Purdue University Fort Wayne.
Hanke says far too many Americans fail to take advantage of steps that could save them cash. That is especially true of taxpayers who fail to hire a tax preparer, or to use tax software.
It is crucial to understand which deductions are available, and whether or not you qualify to take them, Hanke says. But it is even more important to plan ahead so your spending patterns and decisions in 2014 will yield a bigger refund when you file taxes in 2015.
In the following interview, Hanke offers tips for cutting your tax bill now and in the future.
What are some of the biggest and most common tax mistakes you see people make year after year?
The following are four broad categories of "mistakes" made by taxpayers:
First, taxpayers often fail to keep sufficient or accurate records. Lack of appropriate record keeping may lead to mistakenly deducting personal expenses as business expenses, or not getting the full benefit of deductions due to a lack of proper deductions.
In addition, both tax preparers and tax software begin their process with client records. Thus, inaccurate records will reduce the accuracy of a return, regardless of how it is prepared.
Second, (taxpayers) misreport or fail to report items that occurred during the tax year. For example, not classifying income as "self-employment" income has several significant impacts on the tax return.
Third, failure to correctly add or subtract numbers on the return is usually cited by the IRS as the most common mistake. However, this may simply be the easiest mistake for them to catch, rather than being the most common error actually made.
Using either a tax preparer or tax software will reduce the impact of the second and third categories of mistakes.
Fourth is not seeking professional advice to minimize future tax liabilities. Planning for the future creates significantly more opportunities to lower overall tax liabilities.
Although not planning for the future will not prevent filing a "correct" return, it is a mistake in the sense it will cost a taxpayer more money in the future.
Do you have a favorite deduction or credit that people tend to overlook?
There are several tax deductions and credits designed to help low- to moderate-income taxpayers. Unfortunately, these taxpayers do not believe they make enough money or have complex enough returns to seek help. This causes them to pay significantly more taxes than necessary.
For example, the Earned Income Tax Credit (EITC) provides a substantial benefit to those who are working but still have a relatively limited amount of income.
If these taxpayers pay for child care in order to go to work, they can further reduce their tax liability through the Child and Dependent Care Credit.
These taxpayers may not have the means to purchase tax software or hire a tax professional. However, they can receive free tax preparation assistance through the Volunteer Income Tax Assistance (VITA) program if they make $52,000 or less.
VITA sets up sites across the country where these taxpayers can have their return prepared for free. This will help ensure they are receiving the tax incentives that are designed for them.
A lot of people worry that they are paying too much in taxes. What general advice can you offer to people -- both those who use tax preparers and those who take a DIY approach -- to make sure they keep their tax bill as low as possible?
Hiring a tax professional, or using tax software, increases the likelihood of obtaining all legal tax benefits available in a given year.
However, the ability to "find tax savings" is limited when preparing a tax return because the majority of deductions and credits are based on what has already happened.
In order to achieve greater levels of tax savings, it is necessary to carefully structure future transactions. There are countless examples of how steps taken now can decrease future tax liabilities -- for example, placing money into health savings account (HSA) in order to use pretax dollars to pay for medical expenses.
Another example is timing the sale of investments that have decreased in value since their purchase.
These are just a few ways a taxpayer can increase the amount of money they keep in their pockets by talking with a tax professional.
If taxpayers decide to prepare the return themselves, they will need to spend a considerable amount of time to better educate themselves on how to decrease future tax liabilities.
How can taxpayers best determine whether they need to hire a tax preparer?
There are several factors that increase the need of a taxpayer to hire a professional tax preparer. These factors include starting or operating a business, change in family status (e.g., having children, getting married), beginning to save for retirement, change in employer-offered benefits (e.g., HSAs), purchasing a house, spending considerable money on a hobby, etc.
If all of these factors are the same as the previous year, it reduces the need to hire a tax preparer. At the same time, it still may be beneficial for a taxpayer to seek professional advice every couple of years, since the tax laws change quickly even if a taxpayer's financial and life situation remain stable.