Avoid These Costly Mistakes on Your Tax Return
For many taxpayers, the anxiety of tax season doesn't end with a complete tax return. Fears about penalties, fines and other payments owed can fill even the calmest, most confident financial manager with dread.
If you're one of those taxpayers who files their return and lives with the dread of an unexpected fine, never fear. The majority of taxpayers who owe will know their fate early on, and unforeseen fines can often be the result of simple errors, which can be cleared up fairly easily.
Here some of the more common fines taxpayers face and how to avoid them.
Underpayment
"If you paid an insufficient amount of taxes throughout the year, you'll receive an underpayment penalty," says Melanie Lauridsen, technical manager on the American Institute of Certified Public Accountants tax staff. "That's the most common thing with people who aren't necessarily W-2 employees. Because taxes aren't directly withdrawn, you should always keep in mind that when you earn your money, the IRS wants a piece of it, too."
This is especially true if you should have been paying estimated taxes quarterly. "If you're supposed to pay estimated taxes and don't, you can't just write a check for the full amount on April 15," says Jackie Perlman, principal tax research analyst at The Tax Institute at H&R Block. "There will be some sort of penalty that goes with it."
The IRS has a penalty called the accuracy-related penalty, which applies to gross exaggeration or misrepresentation of information on a tax return. Even if they don't know its name, it's this penalty -- and the idea that the IRS could come after them for inaccuracies -- that keeps many taxpayers up at night.
But Perlman says for most people, it won't apply.
"The accuracy-related penalty is for people who seriously underpay, or misrepresent things like charitable donations, or claim a lot of deductions they don't have receipts for, that sort of thing," Perlman says.
Underpaying will bring its own hassles, but delayed surprise won't be one of them. Folks who didn't pay enough taxes throughout the year won't have to wait for a dreaded envelope from the IRS weeks or months later. They will know the extent of their situation when they're completing their return.
The Stray Omission
Those pesky bank accounts could bring other problems, especially when it comes to reporting minuscule interests or tiny account balances, which might slip your mind.
"It's very common for people to forget to report one thing," Lauridsen says. "For instance, if I have a bank account that I use as my primary checking, and I also have other accounts at different banks for different reasons such as favorable interest rates ... What if I forgot to pick up a 1099? It's a small error, but it will show up when the banks send in their own reports."
In such cases, providing updated information and a letter of explanation, filing an amended return or simply paying the small fine can resolve the matter.
Lauridsen warns not to overlook reporting international bank accounts, which can bring a wide array of steep penalties.
Late Payment
The easiest fee to avoid? Those incurred for late payments. It's such a common problem that the IRS has a fact sheet called "Eight Facts on Late Filing and Late Payment Penalties."
Some of the tips from the IRS include: "The penalty for filing late is normally 5 percent of the unpaid taxes for each month or part of a month that a tax return is late. That penalty starts accruing the day after the tax filing due date and will not exceed 25 percent of your unpaid taxes."
"Most people call it a fine or a penalty, but the reality is, had you paid on time, it would have been one amount, say $100," Lauridsen says. "But the interest for the IRS to hold it over a period of time, and the interest is added to the amount, but suddenly, you owe $110."
If there's a legitimate reason for filing or paying late, contact the IRS to see about getting a reprieve. According to the IRS, "You will not have to pay a late-filing or late-payment penalty if you can show reasonable cause for not filing or paying on time."
Clearing It Up
If the amount owed is something small, it's best to pay it quickly and move on. If there's a legitimate reason for a late payment or a fine was the result of a typo, contact the IRS to try to get it cleared up. It may just be a matter of providing the correct bank account information and an explanation.
"The IRS wants to hear from you, and just ignoring it and hoping it'll all go away is not a good tactic," Perlman says. "It's not going to go away. It's not going to get better. What happens is the following year, you're really scared ... so you don't file again. And that becomes something very bad for you."
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