5 Common Mistakes on DIY Tax Returns
It's very common that when a new client comes to us, they had previously been doing their taxes themselves. Sometimes they are wanting to change that because their tax situation became far more complex this year, and they no longer feel qualified to handle it themselves. Other times, it may be because a certain element of their taxes has always been confusing to them and they want to make sure that they are doing it right. Another scenario is that their DIY tax return has resulted in some nastygrams from the IRS or the State that they filed in and they suddenly need help defending what they have done.
The fact is, everyone's tax situation is different. Some people's taxes are simple, while other people's taxes are very complicated.
If your taxes are very, very simple then you can totally do them yourself using one of the many DIY software packages available and yield about the same results that we will arrive at. However, if your tax situation isn't extremely simple, there is a lot of opportunities for you to do something incorrectly using a DIY software and either find yourself in a world of hurt upon IRS examination or (more likely) miss out on some tremendous savings. Here are a few of the things we see most often when reviewing a previously DIY return.
1. Rental Property Mishaps:
The scenario: You owned your condo before you met your significant other. When things got serious and you moved in together (congrats, by the way) you decided that instead of selling that condo you would make it a rental property. You're making a little extra money, and also you have a place to go just in case things don't work out with you and your new beau. Great. Excellent. Good plan. Ten points to you for excellent adulting.
However, you've now seriously complicated your tax situation.
You suddenly have income and expenses that need to be included in your taxes, and how those things get reported to the IRS depends on a lot of factors. How many personal use days during the year did this property have? How many "Fair Rental Days" did this property have? Are you acting as the landlord yourself or are you paying a management company? Are you renting it to a family member of yours? Are you charging fair market rent?
Then, there's depreciation. You see, when you have a business or a rental property, some things aren't "expenses" that can be deducted in the same year that the transaction happened. Instead, they are considered "Assets" and you have to list them completely differently and spread the cost of that thing over the "useful life" of the item in question. If you fail to properly factor these items in, not only are you potentially missing out on some significant savings during the time that the property is a rental, but you'll also be hit with a huge unexpected tax bill when you eventually sell the property.
2. Filing Status Confusion:
When completing your taxes, you have to determine what your "filing status" is because it impacts things like what your standard deduction is and how certain credits are calculated. The options are Single, Married Filing Jointly, Married Filing Separately, Head of Household, and Qualifying Widow(er).
Seems pretty straightforward, right? You'd think. However, selecting the wrong filing status is one of the more common mistakes we see people making.
Usually, when you're doing your taxes, you're pretty far into the current year but the tax return itself is reflecting information from the prior year. We frequently see people misunderstanding the software's question about their filing status and therefore selecting the wrong one. "Well, I am single today so I'll select single." But that's not right if you were married last year.
"Well, I got married in November, so I was single for most of the year, so I'll select single." Also wrong.
"My husband died last year so I'm a Qualifying Widow." Maybe, if a bunch of other factors are also true.
It's surprising how often we see people get this one wrong, and it can have a HUGE impact on your tax liability. Using the wrong filing status could result in you overpaying or underpaying your taxes by tens of thousands of dollars.
3. Accidentally Omitting Income:
Everybody knows that your W-2 needs to be entered on your tax return. That shows all the money you made this year and that's how they decide how much to tax you, right? Well... no.
That shows the money you earned from your job, and certainly needs to be included. But, there's possibly other income that you're not thinking about that also needs to be reported and factored into your tax return.
Did you cash in those savings bonds your Grandma bought for you when you were a kid? Taxable Income.
Do you receive monthly, quarterly or annual checks from a trust or estate? Taxable income.
Do you play around with an investment app on your phone? Taxable income.
Do you own virtual currency? Taxable income AND has special reporting requirements.
If you neglect to report any of this income on your taxes, you're going to get a Nastygram from the IRS stating that they are adjusting your taxes, possibly auditing you and potentially even hitting you with significant penalties for substantially under-reporting your income and failure to pay proper taxes.
It's not a good look.
4. Misunderstanding what can and cannot be claimed for credits and deductions:
There's a lot of cool credits and deductions out there that taxpayers may be eligible to take advantage of, but I have never seen DIY software help a client adequately assess whether or not they are genuinely eligible to take them.
"I wrote off my yoga teacher training as education expenses on my business." Well... you're a realtor so that's not legit.
"I claim my dog as a medical expense because he really helps me when I am stressed." Cute, but, no.
"I wrote off my gun as a deductible security item because my job is dangerous." Well... you're a yoga teacher, so... wait, what?
"I pay for my roommate's student loans to help him out so I wrote off the interest on my taxes." There are so many different things about this that all lead back to: no.
5. Failure to Make Estimated Payments:
If your withholding wasn't sufficient to cover your taxes last year, you may be required to make estimated payments this year. The DIY software will tell you that, but apparently, their instructions on this are about as clear as mud because we never see anyone making the recommended estimated payments. If you don't, you'll be hit with a penalty for failure to make proper estimated payments.
It boils down to this; often when it comes to DIY software, it can be great or it can be easy... but it usually can't be both. So when you're sitting down with your glass of wine to do your own taxes using one of the DIY software options available to you, ask yourself: does this software developer want this to be the best possible result for me, or do they want it to be easy to use?