1. Not paying taxes as you earn income
The U.S. has a pay-as-you-earn tax system, so most people can’t just wait until the end of the year to pay all that you owe to the IRS.
For most people, this isn’t a big deal because employers withhold an appropriate sum based on information you provide on your W-4 form when you’re hired. As long as you provide accurate information, employers will send the correct amount — and often a little extra — to the IRS.
But if you earn income outside of the traditional employment relationship, such as money from your own business or from a side gig, the responsibility falls on you to understand what you owe and pay taxes as you earn.
For many, this means submitting quarterly estimated taxes in April, June, September, and January. If you fail to make these payments, you could end up owing penalties on top of having a big tax bill at the end of the year.
2. Failing to file returns on time
Your tax return is due on April 15, or the next business day when the 15th falls on a weekend or a holiday.
You need to file your return on time, even if you aren’t able to fully pay your tax bill when you submit it. If you can’t complete your paperwork on schedule, you can request an extension until October — but you must submit that request by the April deadline.
If you don’t file on schedule, you’ll face a penalty of 5% of your unpaid tax balance for each part of a month you’re late, up to the maximum penalty of 25% of what you owe. But if you’re more than 60 days beyond the deadline, there’s also a minimum penalty of the lesser of $205 or 100% of the amount owed. By contrast, if you file on time but can’t pay your taxes, the penalty is much smaller — just 0.5% per month up to a maximum of 25% of what’s owed.
Be sure to avoid a costly increase in your total tax bill by at least submitting your return by the deadline even if you need more time to get money together for the IRS.
3. Failing to use tax-advantaged savings accounts
One of the single best opportunities you have to reduce your tax bill is to invest in accounts that provide tax breaks for saving for your own future.
Depending on your situation, these accounts could include a 401(k) if your employer provides one, a traditional IRA if your income isn’t too high to make deductible contributions, a Roth IRA if your income isn’t too high to contribute, and a health savings account if you have a qualifying high-deductible health plan.
Your tax savings could be substantial if you contribute to some or all of these accounts — especially if you can max them out. But any contribution can make a difference. In fact, contributing even $1,000 could save you up to $220 on your taxes if you’re in the 22% tax bracket.
4. Not maximizing the deductions and credits you deserve
Finally, you’ll want to claim the maximum in deductions and credits. Deductions reduce taxable income, while credits reduce your tax bill on a dollar-for-dollar basis. Although credits are much more valuable, both can provide substantial savings.
You’ll need to know which ones you’re entitled to claim and make sure you have the documentation necessary to show your eligibility. If you deduct for business expenses, for example, be sure to keep receipts.
You’ll also want to compare the value of the standard deduction, which everyone is eligible to claim, with the value of itemized deductions — which are deductions you get for specific things such as paying mortgage interest or donating to charity. If you can score a bigger tax savings using the standard deduction, you’re better off doing that.
Avoid these and other costly tax mistakes
Now that you know how to avoid these common errors, you can research the rules and understand your obligations to keep your tax bill to an absolute minimum.
*Stock Advisor returns as of June 1, 2019
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