Thursday, January 23, 2014

Wait! Don't make these common (and costly) tax mistakes

Kelley Holland  for CNBC writes: As if the short days and dreary weather of January aren't depressing enough, it's time to think about filing your taxes.
Taxes are never as simple as we would like. But you can easily avoid a number of common missteps and make filing season a lot easier.
For starters, with tax identify theft on the rise, it's a mistake to file late or close to the April 15 deadline. That's because waiting gives criminals more of a chance to appropriate your Social Security number and submit a fraudulent file to receive your refund.
"The sad fact of the matter is it takes about six months to clean up an identity theft on a tax return," said Mark Steber, chief tax officer at Jackson Hewitt. "File your tax return as early as you can and lock out the thieves who may be planning to use your Social Security number or your dependents' Social Security number."
Electronic filing is optimal, according to Steber. "You get your money faster. It's safer; it's generally more accurate."
Other frequent errors are of the mathematical variety.
The IRS receives reports of all your income from every source, and if you don't report everything they see, you can have a problem. That includes income from side jobs and investment income. For consultants and freelancers, it means income from every client.
Some taxpayers neglect to count all their charitable deductions, particularly in-kind donations of clothing, furniture and the like. Others take deductions that are too large for the goods they are donating. The IRS publishes guidelines for determining how to value your donations of goods, and it's best not to claim a $50 deduction for that old blouse from three seasons ago.
Life changes you have experienced over the past year—a child moving back home, an older relative moving in or a spouse rejoining the workforce—will affect your tax picture.
"More common and more commonly overlooked than tax law changes are life changes," Steber said. "All of those have huge pro-taxpayer implications."
Most Americans are saving too little for retirement, and tax season is a great time to take steps to help eliminate the shortfall, said John Sweeney, executive vice president of retirement and investing strategies at Fidelity Investments.
According to its latest assessment of retirement savings, in which Fidelity surveyed 2.200 households, only 30 percent were saving adequately, and 40 percent were saving less than 6 percent of their salary—including employer matches. (Fidelity recommends a savings rate of 10 to 15 percent of salary.)
Until April 15, "you've got an opportunity to make a contribution to last year's retirement plan," Sweeney said. "It's a really good opportunity for people to do that."
Tax season is often when people consider converting a traditional IRA to a Roth IRA. Doing so requires you to pay taxes on the account now instead of in the future, when you take withdrawals. Though conversions make sense for many people, Sweeney warned against paying those taxes with IRA funds.
"Take the money out of a taxable account to pay the taxes on a Roth conversion," he said. That way you don't erode the amount of money converting to post-tax status.
Sweeney also has suggestions for those who realize too late that they had more taxable investment gains than they had hoped. Tax filing season provides an opportunity to plan for next year, perhaps by reallocating assets.
"We talk about having tax diversification as well as investment diversification," he said. "Think about what account you hold different asset classes in. High-income bonds kick off ordinary income. If you are still working, you have to pay that ordinary income rate. You want to look at household accounts and put high-income bonds in tax-deferred accounts. You might not want the same allocation in all of your different accounts."
The bottom line: Some attention to detail and forward thinking can make this season a lot less taxing—in every sense of the word.

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