4 Tax Planning Mistakes That Can Compound Over Time If You Don't Catch Them
Tax planning mistakes might feel small. But, in reality, these mistakes can compound over time into significant losses. While it's impossible to avoid tax season, it is possible to avoid common tax planning mistakes. Here's what to watch out for.
Confusing Tax Filing With Tax Planning
When you start to prepare your taxes for filing, it's easy to confuse that with tax planning. But as you tally up your tax details for the year, you're simply accounting for the tax events that already happened. In contrast, tax planning involves looking ahead for tax liabilities and mitigation options to implement.
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"When taxpayers wait until April to think about taxes, most of the meaningful strategies are already off the table and you are playing catch-up or falling behind," said Linda Jensen, CFP, and tax planning strategist at Heart Financial Group.
Not Using Retirement Accounts and Business Deductions
Many taxpayers simply add up their income and file based on that. But it's important to consider ways to lower your tax obligations, such as strategically contributing to a tax-advantaged retirement account or seeking out business deductions you may qualify for.
"If you consistently fail to maximize contributions, don't structure income efficiently, or properly deduct legitimate expenses, those missed opportunities will stack up year after year and cost you," said Jensen.
For example, you might decide to contribute to a 401(k) through your employer to build retirement savings while taking advantage of tax savings.
Accidentally Under-Reporting Income
It might sound simple. But it's actually relatively easy to accidentally under-report your income to the IRS for the year. That's because many taxpayers have a range of income streams, which may or may not be at the top of their mind.
For example, you might have received income from a high-yield savings account or investment account, which might not make it into your tax return. After all, these forms are available from your bank or financial institution, but it's easy to forget to include them, especially if it's only a few hundred dollars here and there. Most financial institutions will report the income to the IRS, which means the tax authorities will know if you miscalculated.
"When there is a discrepancy, the system generates an automated underreporter notice called a CP2000, often issued months or even years after the original filing," said Alyssa Maloof Whatley, director at Frost Tax Law.
Eventually, the under-reported income will catch up to you in the form of a bill.
Waiting Until the New Year To Review Taxes
It's always tempting to put off tax filing preparation until the next year. After all, who wants to deal with this dreaded chore before you absolutely have to? But a little bit of review can go a long way.
According to Jensen, the key to avoiding most tax mistakes is "reviewing your tax situation before year-end, not after the return is drafted."
Jensen recommends a simple mid-year check-in to review your tax situation for the year, look for potential deductions and retirement account contribution opportunities.
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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