The IRS has called knock it off on tax season. Let’s spin the tapes and pull out some debrief focus points execution errors, and lessons learned!
There is no greater unifying hatred in America than paying taxes. Our system is needlessly complex, and even the tax savvy among us remain suspicious that we are overpaying compared to others. For the vast majority of us, filing taxes has gotten simpler since 2017. But there are still a lot of ways to make mistakes and overpay your lifetime tax bill. Let’s look at some of the common pitfalls that we might face:
Paying someone else to do your taxes. If your taxes are very simple, i.e., you only have income from your job, there’s a good chance you can use one of the many free filing systems (IRS, MilitaryOneSource) or have your taxes done on base for free.
Not paying someone else to do your taxes. If your taxes aren’t very simple, or you are very busy, not only do you stand a chance of making a costly mistake, but you’re probably paying more in your own hours of frustration than you would pay a good tax professional.
Tax professional overkill. Most of us think of a Certified Public Accountant (CPA) when we think of a tax professional. In reality, CPAs also focus on auditing, accounting, and compliance. It’s possible that your CPA firm only spends a little bit of its bandwidth on taxes. Enrolled Agents (EAs) are tax professionals that generally only focus on tax preparation, planning, and client representation to the IRS. Enrolled Agents often charge less than CPAs but may have more bandwidth for tax planning.
Tax professional underkill. The national tax firm in your local strip mall is not a bad place to get your taxes done. However, even if the preparer that you work with is highly qualified, s/he will be governed by corporate strictures and may not have great expertise in military matters. These national chains often charge more for less complex work than some CPA and Enrolled Agent firms.
Filing too early. If you’re getting a refund, it’s nice to get it early. While W-2 forms are supposed to show up by the end of January, and 1099 forms are supposed to show up by the end of February, fog and friction can delay their arrival. If you file too early and need to deal with late forms or corrected forms, then you have the hassle and possible expense of filing an amendment.
Filing too late. Generally, the deadline for personal tax returns is April 15th. You can always get an extension to get the paperwork in after April 15th, but you must pay what you owe by April 15th. If you don’t pay on time, you’ll pay both a penalty tax and interest on the delayed dollars. An extension is no big deal and if it buys you a couple extra weeks to get things right, it’s well worth your time.
Not filing at all. This one isn’t too common since we need to keep our financial house in order to keep our clearance and cool jobs. If you’re deployed and things get busy, you might sail past your automatic filing extension from the deployment. The penalties for failure to file are even stiffer than the penalties for paying late. You also can’t get a refund if you don’t file for it.
Not using an identity protection PIN. The IRS offers an additional layer of security by allowing you to apply for a special PIN number that prevents anyone else from filing in your name. It would be nice if someone filed our taxes and paid them for us, but these scams are about claiming your refund. You can apply for an IRS identity protection PIN at this link.
Names and numbers. It’s best practice to keep the order of spouse names the same on tax returns. If the husband has always been the primary taxpayer’s name, keep it that way. Make sure you, the software, or the tax professional did not mangle Social Security numbers.
Crypto. For the past few years, the tax return asks if you’ve transacted in crypto assets. This is not a place to take a chance on fibbing.
Kiddos and credits. Young adult children starting at age 17 are worth a $500 tax credit if they meet certain conditions. It’s important to deconflict whether they claim themselves for a standard deduction or you claim them for a credit.
Excess Roth IRA. If you earn too much money, you can’t contribute to a Roth IRA in the normal manner. You have to do a Backdoor Roth IRA. This is an exceptionally common mistake when families transition out of the military and start to earn more money, or there are two working spouses.
Improper Backdoor Roth IRA. Performing the Backdoor Roth IRA process is relatively simple, but it’s unfamiliar and frequently mis-executed. This will show up on line four of the 1040 tax form as well as on form 8606.
Deducting a Traditional IRA with low income. The use case for a Traditional IRA is to pay less tax today and hopefully less tax tomorrow. At the same time most of us hope to have high income and wealth during our retirement. As military members we generally don’t have high income and wealth yet. Thus, even if we make so little that we are allowed to deduct a Traditional IRA, we’re usually better off contributing to a Roth IRA today to have a lower lifetime tax bill tomorrow.
Skipping an IRA. IRAs exist so that we can pay for ourselves when we no longer work. The door closes each Tax Day on contributing to an IRA for the previous year. When we skip contributions for a year, not only do we lose out on the potential tax break, but we lose the power of compounding returns for yet another year. There may be years where cash flow does not permit contributing to an IRA, but if there’s any way to pay yourself first by maxing out an IRA for both spouses you won’t regret it.
Over-contributing to an IRA. Each brokerage will only allow you to contribute the annual maximum to an IRA. ($6,500 in 2023 underage 50) Brokerage houses can’t see what you have contributed elsewhere, but they all report both your contributions and your balances on form 5498 to the IRS. You must withdraw excess contributions by October 15th each year or face a 6% penalty per year on the excess contributions.
Confusing IRA and TSP limits and rules. In general, how you contribute to an IRA has no bearing on how you contribute to the TSP. If you make too much money for a Front Door Roth IRA, you can still contribute to Roth TSP. You are also allowed to contribute the maximum to each type of account each year. ($6,500 in 2023 under age 50 to an IRA, $22,500 to the TSP underage 50)
Dollar cost averaging into a backdoor Roth IRA. If you’re in Backdoor Roth club, best practice is to contribute with a lump sum. To do a proper Backdoor Roth, you don’t want to have earnings during the transit through a Traditional IRA. If you dollar cost average each month, there’s a good chance you’ll forget to do the conversion at least once during the year. Now your earnings can grow and you’ll have to pay taxes on them that you could have skipped when you convert them.
Backdoor Roth with a Traditional IRA balance. The first rule of Backdoor Roth club is to talk about Backdoor Roth club. The first step of a Backdoor Roth is to make sure there’s no balance in a Traditional IRA. If you have a balance in a Traditional IRA, then Backdoor Roth can invoke what is called the pro rata rule. While the pro rata rule doesn’t inherently make you pay tax twice on your contributions, there’s high risk that you will. The pro rata rule requires diligent tracking on your form 8606, potentially over years and years. It’s best to deal with the Traditional IRA balance first.
Failing to correct excess Roth contributions. If you’ve come to realize that you probably were over the Roth IRA contribution limit in prior years but still contributed to a Roth IRA, it’s time to come in out of the cold. You will pay 6% on the contribution for each year that you left it in the account. You also must remove the contribution, which puts a dent in your tax-advantaged retirement savings. There are a lot of specific rules about removing excess contributions, so this is definitely a use case for a great tax professional.
Withholdings, Estimated Payments, and Tax Payments
Withholding too little. Uncle Sam expects us to pay our taxes as we earn our dollars. If we don’t have enough money withheld from our paychecks, we may face an underpayment penalty plus interest that shows up on line 38 of your tax return.
Failing to estimate. If you have lumpy income from self-employment or asset sales, you probably need to make estimated payments. The IRS expects them to arrive by April 15th, June 15th, September 15th, and January 15th—basically quarterly throughout the year. If you don’t make them on time and don’t achieve safe harbor, you’re back in the penalty box.
Paying too much. You’re probably already aware that a large refund is like giving a negative interest loan to the government. At the same time, it’s very difficult to get a shack on your tax bill. I would argue that owing less than $1,000 or getting a refund of less than $1,000 is basically a shack. If your refund is much larger than that, it’s time to adjust your withholdings so you can use the money throughout the year.
Business and Real Estate
Business expenses. If you or your spouse operate a small business, there’s a very good chance that you can deduct at least part of expenses like your cell phone, internet service, computer equipment, home office use, and mileage on your car. At the same time, small business owners have a reputation for tax speeding. Why not get together with a good tax professional to understand your left and right limits so you don’t get a love letter from Aunt IRS?
Depreciation of real estate assets. If you self-prepare your taxes, it’s crucial to understand what the basis of your property is. You also must understand the difference between what is an expense that you can deduct in the current year versus costs that must be amortized or depreciated over a number of years. What’s more, if you switch tax professionals, and lose some of the data that goes into Schedule E and the worksheets of your tax forms where such things are tracked, you may set yourself up to underpay or overpay your taxes. DIY tax software is great, but it is not a bulletproof substitute for a career of tax experience.
Good Help is Hard to Find
If you use a tax professional to prepare your taxes, choose wisely. You also need to know what you want. If you are OK with a short burst of transactional interaction between February and April each year, good news, that is the default. However, if you would like advice and counsel throughout the year, you may find that hard to get from a tax preparer. Make sure to ask what service your tax professional offers throughout the year (and what it costs).
The rear-view mirror versus the windshield. It’s been said that tax professionals often focus on the rear-view mirror. They want to help you pay the lowest possible tax bill for this past year. A good comprehensive financial planner will focus more on the future. They are looking out of the windshield. This can create tension between your tax professional that wants to lower your court your current year tax bill, and your financial planner that’s focused on your lifetime tax bill. If you work with both professionals make sure this is a topic of conversation.
Mistakes happen. A tax professional typically prepares hundreds if not thousands of returns each year. It’s unfair to expect that mistakes won’t happen. Additionally, tax professionals don’t know what they don’t know. More explicitly, they don’t know what you don’t tell them. Often this results in errors on the tax return. Most errors can be fixed with an amendment, but that takes time, money, and hassle. If you work with a financial planner, make sure he or she reviews your taxes with you before signing them. An ounce of prevention is worth a pound of cure.
Cleared to Rejoin
You may have noticed there were not just 10 listed mistakes… “Top 28…” just doesn’t have the same ring to it! Hopefully this list has not made your head explode. Unfortunately, it only scratches the surface of potential mistakes each year. We didn’t even get to the part about tax planning throughout the rest of the year because we focused on the period leading up to April 15th. Taxes touch every financial decision that we make. Minimizing the mistakes maximizes our dollars. Use this list and share it with your friends to avoid leaving the tax man a tip.
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“Winged Wealth Management and Financial Planning LLC (“WWMFP”) is a registered investment advisor offering advisory services in the States of Florida and Texas and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training. The presence of this website on the Internet shall not be directly or indirectly interpreted as a solicitation of investment advisory services to persons of another jurisdiction unless otherwise permitted by statute. Follow-up or individualized responses to consumers in a particular state by WWMFP in the rendering of personalized investment advice for compensation shall not be made without our first complying with jurisdiction requirements or pursuant an applicable state exemption. All written content on this site is for information purposes only. Opinions expressed herein are solely those of WWMFP, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to other parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.