Tax Experts Reveal the Costliest Mistakes Middle-Class Filers Make
No one can outrun the tax man, but there are those who know how to better prepare for paying taxes as if it’s a marathon, not a race.
Zachary Sahar, CPA, Managing Director at Capital Tax, said, “The biggest mistake I see is treating tax planning as something that happens when you file your return. By then, most of the opportunities to lower your tax bill have already passed. Many taxpayers miss opportunities simply because they don't realize they qualify.”
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Here are the five costliest mistakes the middle class make on their taxes, according to experts.
1. They Overlook Retirement Account Opportunities
“Take advantage of tax-favored retirement provisions whenever possible. While this is a complex area, you can gain some foundation knowledge starting with IRS information. If you have a 401(k) plan through work, do your best to contribute the maximum allowed annually. If there is an employer match, do your best to contribute enough to get the maximum match,” said Annette Nellen, CPA and Professor at San Jose University.
"Middle-class entrepreneurs often overlook retirement account opportunities, which can mean missing out on tax benefits," explained Nauman Poonja, CEO of Accounovation. "For example, if you make $120,000, you can steer up to $23,000 into a Solo 401(k) and more than $50,000 total across all tax-advantaged accounts."
To avoid these traps, Poonja recommended having separate business accounts, setting aside 30% for taxes, working with a certified public accountant (CPA) who knows what they're doing and opening retirement accounts as soon as possible.
2. They Don’t Learn More About Tax Law and Nuances
“Learn more about the tax law in general, such as by reviewing Form 1040 and Schedules A, 1 and 1-A at a minimum. This will expose you to various special deductions that may be available. It will also give you a better idea of what is in our tax law that may seem unusual,” said Nellen.
According to Nellen, by learning more about these items and asking why these rules exist, you can navigate everything from tip income deductions to benefits for low-income taxpayers.
“Health Savings Account contributions, retirement account contributions, education credits, and the Child Tax Credit can all provide meaningful tax savings, but each has eligibility rules that are easy to overlook. It's worth reviewing these annually because life changes often affect what you're eligible to claim,” said Sahar.
3. Treating Taxes as a Filing Event Instead of a Planning Calendar
Chelsea Michelle, founder of Elevated Business Advisors, a tax and business advisory firm, and host of The Power of the Pivot podcast, said, “The costliest mistake I see: treating taxes as a filing event instead of a planning calendar. Nearly every expensive error, wrong filing status after a life change, missed credits, under-withholding on side income, traces back to having the first tax conversation in March, when every lever for the prior year is already dead.”
Keep in mind that filing status has a bigger impact than many people realize. According to Sahar, “Taxpayers choose the wrong filing status simply because they don't understand the IRS rules for dependents, head of household, or separated spouses. Getting this wrong can unnecessarily increase your tax liability.”
4. Errors on Tax Returns
Some of the most common errors that the IRS reports with respect to individual tax returns are math errors, missing or incorrect Social Security numbers and missing signatures on tax forms, according to Michele Frank, associate professor of accountancy and CPA at Miami University.
"These errors are annoying because they can often delay the processing of your return, which means it will take much longer to receive any refund that you are due," Frank explained. "The use of tax preparation software may prevent taxpayers from making these types of errors."
Another common error relates to the child tax credit. To be eligible, a child must be under the age of 17 at the end of the tax year, but some taxpayers, according to Frank, accidentally claim for children who are 17.
"Again, the use of tax prep software might help prevent this issue," she explained. "In addition, only one parent can claim the credit. So if divorced parents fail to communicate and both claim the credit for the same child, their returns are likely to be flagged."
5. Treating Extra Income Too Casually
When Poonja reviews tax returns for middle-class business owners and entrepreneurs, he often sees them treating a side business or consulting income casually, such as depositing checks without setting aside taxes and missing quarterly estimated payment deadlines, then facing tax bills and penalties in April.
"Many in the workforce underwithhold for outside consulting income: assuming they'll be taxed at an ordinary rate. But they will likely have tax liability for their minimum 10% contribution, based on the higher of these three factors and in fact, it could even reach 32% to 35%," Poonja added.
According to Poonja, this problem is also compounded when employees who qualify for home office deductions do not take them or make expense calculations that may invite an audit. "The IRS insists that the space must be used exclusively and regularly for business; a rule often misunderstood," he said.
Josephine Nesbit contributed to the reporting for this article.
This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.
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