Yahoo Finance 5 Tax Blunders That Can Leave You Broke
Everyone has to file taxes, not everyone does it right. What might seem like a small tax mistake can result in major financial woes.
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Tax season is around the corner, so it’s important to be educated. Here’s a look at a few costly tax mishaps you don’t want to make.
5 Tax Blunders That Can Leave You Broke
Failing to Report All of Your Income
The IRS wants to know about all of your income.
“Taxpayers will occasionally sell their primary residence but do not report the income, believing that it’s not taxable,” said Brad Paladini, tax attorney and owner of Paladini Law, a tax law firm. “While that may be true, the income still needs to be reported.”
If you’re eligible, he said some or all of the gain can be excluded from taxes, but you still need to report it on your return. He said his law firm also frequently sees taxpayers who use PayPal to fund online gambling activities.
“They’ll then use the same PayPal account to withdraw any winnings,” he said. “Unfortunately, both PayPal and the gambling website report income under the taxpayer’s Social Security number, but the taxpayer only reports the income from the gambling site.”
“The IRS will send the taxpayer a CP2000 stating that there’s additional income missing from the return, due to earnings from a PayPal account,” he said. “It can be quite a process to get corrected and get the IRS to understand the money is being double counted.”
IRS Collection Notices: 4% of Americans Fear ‘Catastrophic Financial Stress’
Not Keeping Good Records
“Taxpayers need to keep receipts for all expenses they are deducting,” Paladini said. “They can’t rely solely on a credit card statement or bank statement.”
For example, he said business owners sometimes purchase company supplies from Walmart or Costco.
“They’ll have the credit card [statement] showing the expense was paid, but fail to keep the receipt,” he said. “If they are selected for audit, the IRS will not allow the expense because they don’t know if the taxpayer was purchasing supplies at the store or buying a new television for their house.”
Failing to Pay Your Taxes
“Taxpayers don’t understand the difference between the filing deadline and the payment deadline,” Paladini said. “For 1040 filers, the deadline to file the return and pay the tax is usually April 15.”
He said you can file an extension of the time to file your return, but this isn’t an extension of time to pay your taxes.
“Any tax owed is still due April 15, even if they have until Oct. 15 to file the return,” he said. “Every month the payment is late, taxpayers are charged interest and a failure to pay penalty of 0.5 percent per month.”
Failing to File a Tax Return
No matter what, always file your tax return.
“Some taxpayers decide not to file a tax return, if they do not have enough money to pay the taxes due,” said Mark Luscombe, principal Analyst for Wolters Kluwer’s Tax and Accounting Division, North America. “This can result in not only owing the taxes, but also being subject to interest charges, a failure to file penalty and a failure to pay penalty.”
Not Taking Required Minimum Distributions
Taxpayers sometimes forget to take Required Minimum Distributions from their IRAs or 401(k)s.
“This can result in a penalty of 25% of the amount that was not taken,” he said. “It can be reduced to 10% if corrective action is taken quickly.”
If this seems like a lot, he said it’s actually better than last year’s rate, which was a 50% penalty.
What To Do If You Owe Tax Debt
If you owe money to the IRS that you don’t have, you’re not alone. In Fiscal Year 2022, returns filed with additional taxes due had a gross total yield of $98.4 million from unpaid assessments, according to the IRS, very top number on the 2022 spreadsheet).
Hiring a debt relief company to assist with your tax debt can be a good idea. Since these professionals do this for a living, they should be able to help you find the best way to settle your debt, and they can often help reduce the total amount you pay. Some tax resolution companies, such as Tax Relief Advocates, will offer a free consultation to go over your situation.
You might be tempted to try to ignore this tax debt and pretend it isn’t there, but don’t. Instead, use this advice to handle the situation the right way.
File a Return
As noted above, you always need to file a tax return. File your return by the deadline and pay as much as you can. The more you pay, the less you’ll owe in interest and penalties(4).
Request a Short-Term Extension to Pay
If your total debt is less than $100,000 in combined tax, penalties and interest, you can apply for a short-term payment plan. Simply complete the online application on the IRS website and you’ll be notified immediately if you’re approved. If so, you’ll have 180 days to pay your balance in full.
Request an Installment Agreement
Otherwise known as a long-term payment plan, you may qualify for an installment agreement if your total balance — combined tax, penalties and interest — is less than $50,000. Under this option, you’ll have 72 months to settle your tax debt.
Apply for an Offer in Compromise
If you’re truly unable to pay your tax debt or doing so will create a financial hardship, you can apply for an offer in compromise. If your application is accepted, this will allow you to settle your tax debt for less than the full amount owed.
You’re eligible to apply if you’ve filed all required tax payments and made all required estimated payments, aren’t in open bankruptcy proceedings, have a valid extension for a current year return — if applying for a current year — or an employer that has made tax deposits for the current and past two quarters.
Do note, only 37% of offer in compromise applications were accepted in Fiscal Year 2022. Therefore, it’s probably best to carefully weigh your likelihood of acceptance before submitting an application.
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