3 common mistakes to avoid when filing your taxes

The most common tax mistakes are pretty dumb ones, like forgetting to sign the return, garbling a bank account number or using a nickname instead of the name on a Social Security card.

Even tasks that require some wattage, such as applying common deductions and credits, are not that tough for taxpayers filing electronically, since the software checks for these errors.

Still, there are several mistakes that careful people - even those who hire tax preparers - can make.

Among them:

1. Minimizing earned income

Business owners have a number of ways to pay themselves and reduce the income subject to Social Security and Medicare taxes. But doing so could put a significant dent in future Social Security benefits, sometimes far outweighing any savings.

One common strategy is to convert a business to an S corporation, which allows the owners to pay themselves a lower salary and then take dividends, which are not subject to Social Security taxes.

That might not cause problems for someone who already has a lifetime of high income, since Social Security bases benefits on the worker’s 35 highest-earning years, said financial planner Michael Kitces, a partner with Pinnacle Advisory Group in Columbia, Maryland. For others, though, the impact can be significant.

For example, Kitces says, someone paying 12.4 percent Social Security tax on $60,000 in earnings would increase the lifetime payout by $128.58 a month.

On the other hand, he says, avoiding $7,440 in Social Security taxes on that annual pay would cost $1,542.96 a month for life in Social Security payouts. Higher earners might suffer less but still could lose more in guaranteed, inflation-adjusted retirement benefits than they save in taxes.

Advisors should calculate the potential impact on Social Security benefits before recommending strategies to avoid the taxes, said Kitces, who blogs at Nerd’s Eye View (https://www.kitces.com/blog/).

2. Choosing the wrong tax preparer

The more complicated a tax return, the more likely it is to drift into gray areas of the law. Ideally, client and tax preparer will be temperamentally compatible when judgment calls need to be made.

A tax pro who is eager to push the envelope may be a bad fit for a conservative client. Likewise, a client who wants to be aggressive about reducing taxes is likely to be frustrated with a preparer who forgoes legitimate deductions for fear of triggering an audit.

“It’s more common that the taxpayer wants to push things,” said Phil Holthouse, managing partner of Holthouse Carlin & Van Trigt in Los Angeles. “But there are some tax preparers who want to be heroes and give them an answer that’s too good to be true.”

Holthouse recommends asking tax preparers straight out how aggressive they are. Ideally, he says, the professional will make it clear that he or she stays within the law, but is willing to explain the alternatives in a given situation and help clients evaluate the risk.

When a gray area comes up or if a client is confused about an issue, he or she should ask what rules apply.

“You can tell a lot by how definitive their answer is,” Holthouse said. “If they say, ‘Nobody’s going to see this’ or ‘Nobody’s going to find it,’ that’s a real red flag.”

3. Refusing to delegate

Most people, including some who file the easiest forms (1040EZ and 1040A), hire tax preparers these days. But some with more complicated returns still insist on doing it themselves. Even when they do not make mistakes, they may be investing more time than the task is worth.

The cost for preparing 1040 with Schedule A itemized deductions averaged $261 last year, according to the National Society of Accountants. The IRS says just preparing a typical 1040 takes four hours, with another hour to file it.

That does not even take into account an additional 17 hours for record keeping and tax planning.

Not all of those hours would disappear when using a professional, of course, but the time and hassle would certainly be less.

5 Ways to File Your Taxes With Less Stress

Even with years of experience, the process of reviewing your records and filing your tax return can be stressful. With the April 15 tax deadline getting close, consider trying these five strategies that may help you lower your 2014 taxes, enhance your retirement readiness and help you get more organized for 2015.

1. Leverage your retirement accounts

If you currently have an individual retirement account (IRA), you have up until April 15 to make any contributions for the 2014 tax year. That means you may be able to lower your taxable income for 2014. The contribution limit to an IRA for 2014 is $5,500 (or $6,500 for those over 50) so try to reach that number before the deadline. Eligibility for an IRA tax deduction depends on your marital status and whether you or your spouse has a retirement plan available at work (such as a 401(k) account).

If you don't have an IRA, begin planning for tax seasons to come by taking full advantage of tax-advantaged retirement accounts such as a 401(k), especially if your employer offers a match program. Doing this will help reduce stress as you file your taxes next April, as well as relieve future stress around retirement planning.

If you're self-employed, there's also still time to open and fund an SEP IRA (Simplified Employee Pension Individual Retirement Account) for 2014. You can invest up to 25 percent of your self-employment income or $52,000, whichever is less (this will go up to $53,000 for 2015).

Contributing money automatically out of your paycheck to a workplace retirement plan such as a 401(k) provides you with tax-deferred growth on savings while also lowering your taxable income for the year. The money you contribute to your 401(k) is made on a pre-tax basis and grows income tax-deferred, which means that you generally don't pay taxes on the contributions and earnings until you withdraw these funds, typically at retirement age.

2. Get organized

Whether you will be hiring a professional or completing your return on your own, organize your records in a clear manner to ensure that you have all of the documents you need. Otherwise, you might fail to report all of the income, interest or dividends you earned to the Internal Revenue Service (IRS). This could result in federal income tax penalties and interest or, in the worst case, a tax audit.

In order to avoid any issues, review a copy of last year's tax return and put together a list of every source of income you reported. Then, make sure you have all the documents -- 1099s, W-2s, interest statements -- that align with these sources for the year. If you made new investments last year or earned income from any new employers, double-check that you have those records too.

To make sure you haven't missed any expenses you can write off or income you need to include, consider using an online tax checklist. Tax software programs could be another viable option as they ask a variety of questions that could help remind you about purchases that affect your tax bill.

3. Take advantage of workplace benefits

If you run your own or operate a side business, you may be able to write off many costs by claiming a variety of deductions for business expenses. Examples of these would include travel expenses or costs associated with running and maintaining your home office.

If you work for a company and used a flexible spending account (FSA) to help pay for health care or child care expenses last year, the amount you contributed to the account is not subject to tax. This means that your taxable earnings may be significantly less than you think. It is however, important to remember that you will forfeit any funds you contribute but don't end up spending.

4. Don't go it alone

If you're confused about completing any portion of your tax return, don't wing it. Call in a trained tax professional for assistance. This is the time of year when many people look at their finances as a whole, so it is also a good time to consider talking to a financial advisor to discuss your current finances, retirement readiness and long-term financial security. Comprehensive financial planning often requires the help of a professional, especially as retirement approaches.

5. Start planning for next year, this year

While you're dealing with your taxes, think about how relieved you would be if you were better prepared a year from now. The key to making your next tax return season less stressful is to stay one step ahead by getting organized and having a plan.

A little bit of work in advance can save a lot of time and effort in the long run. Start by collecting receipts in envelopes or files labeled with specific tax categories, such as work expenses, medical expenses or investments. Keeping digital files is another good way to stay organized. The key is to have an organization system that works for you throughout the upcoming year and can help you stay better organized next tax season.

Also, take a look at your periodic tax withdrawals to make sure they are appropriate. Did you get a lot of money back this year, or owe money? If so, you may want to adjust your deductions so that next year you are more on target.

These tips can make filing your return a less stressful process and build your long-term retirement security at the same time. If you thoroughly prepare, take advantage of tax-advantaged savings vehicles, and stay organized, you put yourself in a position to save time and money in the long run.

The 3 Biggest Mistakes People Make At Tax Time

FROM NERDWALLET.COM

It’s an annual tradition: As April 15 draws near, millions of Americans scramble to round up all their receipts and other documents from the previous year to make the federal tax filing deadline.

But that urgency can lead to poor decisions that cost thousands of dollars in the long run, tax specialists say.

NerdWallet surveyed certified public accountants and asked them to list the most common mistakes taxpayers make at tax time, as well as how to avoid them. Here’s what they said:

Mistake No. 1: Not Being Organized

Lugging a shoebox full of receipts into your tax preparer’s office may not be the best way to deal with your return, but at least those harried taxpayers have everything in one place. That’s not the case with many people, CPAs say.

“One of the biggest mistakes we see folks make is simply not being organized,” says New York-based CPA Becky Egan. “People constantly come in for their tax appointment without all their documents, forgetting their charitable contributions, neglecting to let us know they invested in a partnership, or leaving out a 1099 they received.”

Egan advises clients to keep track of their earnings, expenses, accounts and other important information during the tax year itself, instead of leaving everything for the night before their tax appointment.

“It’s impossible to do any tax planning if you’re always in reactive mode, looking behind at the year that’s passed.”

As Brian S. Devers, a CPA in Forest, Virginia, puts it: “January 31, when you receive your W-2, is not the time to do tax planning for the previous year, because that ship has sailed.”

Mistake No. 2: Not Getting Good Advice

Younger people with few financial complications can get by with filing a 1040EZ form, and tax-preparation software has turned millions of Americans into virtual tax experts. But for many people, filing taxes without getting professional help can be a costly mistake.

“The biggest mistake people make is that they prepare their own return or they go to a tax-prep shop that is not staffed with professionals,” says Huntington Beach, California, CPA Mark Prendergast. “While going to a CPA or an enrolled agent may cost more for the services, they are much more aware of tax savings techniques compared to the nationally syndicated tax-prep companies who hire and train part-timers.”

Prendergast says a tax professional can pick up on nuances that can save taxpayers plenty of cash. Knowing how to handle college tuition payments is one example. Qualified tax pros can figure out whether to use the tuition deduction, the American Opportunity Credit or the Lifetime Learning Credit to maximize tax savings.

“Determining which is the best [option] can save hundreds, if not thousands, of dollars,” Prendergast says. “Some apply to some situations but not others. Maybe one dependent child qualifies for one, but another child qualifies for another.”

Another key decision for which good advice is needed is whether to make a Roth IRA contribution or a traditional IRA contribution, he says. “Usually [people] think, ‘I save taxes with a traditional IRA but not with a Roth IRA.’ But in certain circumstances, a Roth IRA contribution will give rise to the Retirement Savings Contribution Credit (Form 8880) and save the person some taxes.”

Mistake No. 3: Not Contributing to an IRA

This issue leads to the third major mistake that CPAs cite.

“The biggest mistake people make at tax time is not contributing to an IRA because they are not eligible for an income tax deduction on the contribution amount,” says San Francisco-based CPA James Dowd. “Every taxpayer under the age of 70½ with earned income is eligible to make an IRA contribution. If the taxpayer has no existing IRA, the mistake is especially costly, and it compounds over time, because they could make an after-tax contribution and immediately convert the IRA to a Roth with no tax consequence.”

How Tax-Savvy Advisors Can Tackle Obamacare Taxes

FROM THINKADVISOR.COM

The Patient Protection and Affordable Care Act of 2010 generated a fair amount of controversy before, during and after its passage.

While its impact is mainly felt throughout the country’s health care system, the reform package also includes a number of changes affecting financial advisors and their clients.

There’s not much planning that can be done to bring down such income levels or change the amount of the surtax, of course.

“But there are strategies that you can share with clients” around other issues in the acts, Smith said. “There really are some planning opportunities.”

These issues stem from the 3.8% additional Medicare tax on interest, dividends, capital gains, annuity income and income from other passive activities, such as income from rental properties, he explains, for those with gross income levels requiring payment of the 0.9% Medicare surtax.

“In 2014, this is likely to have more of an impact on clients and advisors, because of the rise in the market,” Smith said. “With the market increase, lots of mutual funds made end-of-year capital gains distributions, and dividends and capital gains went to investors.”

This could mean that some clients may be paying an additional 3.8% tax on top of their 15% or 20% capital gains, for instance.

“We had some shock from clients last year,” Smith explained. “And HD Vest advisors are proactively working with them to mitigate the taxes.”

It’s been over a decade since the Bush tax cuts, and advisors need to keep the tax implications of the Affordable Care Act in mind when building or tweaking portfolios, he adds.

For clients in the higher tax brackets, it may make more sense for them to invest in dividend-paying stocks in qualified plans going forward.

“You could allocation dividend-paying holdings into an IRA, and then the client might not have to pay the Medicare surtax on a year-over-year tax basis when they take out the assets in retirement,” Smith noted.

“You could compound the growth on a forward basis, and they may not pay as much on the dividends as they would if they’d held them in a non-qualified account,” he stated.

Tax Savvy

Asset positioning is more important right now, Smith emphasizes, “than probably at any other time in the past 14 years.”

“Our advisors are leading the industry with this strategy, because they are tax savvy,” he said, meaning they are required to keep their clients current on the use of tax-deferred vehicles.

Clients in high tax brackets that own taxable bonds will pay a 3.8% Medicare tax on distributed coupons paid to them.

“It could be more tax efficient to look at municipals, for instance, as non-qualified assets,” Smith explained. “Especially with low Treasury yields, tax-free vehicles may make sense.Another step worth looking at is how annuities and life insurance accumulate cash value. Tax-deferred annuities, for instance, can help defer taxes to retirement, when income may be lower.

“Those in lower tax brackets may not be subject to the Medicare surtaxes in their retirement years,” the specialist said, “so in nonqualified accounts, you may want to defer the gains and add an annuity.”

These strategies, he underscores, “are not meant to be blanket recommendations: It all depends on the client, on the advisor and the suitability.”

What’s Ahead?

On the horizon, Smith says, are more tax changes. They most likely won’t affect individuals – those prosposals should get tied up in political gridlock – but they should hit corporations.

“There’s a lot of momentum for corporate tax reform” that could impact S corporations, which pass through gains to other entities.

For advisors with small-business clients, such as those with fewer than 50 employees and with retirement plans serviced by FAs, this reform may entail major shifts.

Advisors should be prepared to talk with clients about changing their businesses from S to C corporations, “which would have a lot of tax and planning consequences,” Smith says.

It isn’t always easy to keep up with such potential tax scenarios, he admits, but it is “another way for advisors to add value.”

What Every Investor Needs to Know About Basis

Until recently, when estate planners wanted to impress their clients, they offered strategies to save estate tax. Now, all the buzz is about maximizing basis and minimizing capital gains--maneuvers drawn from the income tax playbook.

About the Author Lawyer and award-winning journalist Deborah L. Jacobs covers personal finance, careers, and life transitions. She is the author of Estate Planning Smarts: A Practical, User-Friendly, Action-Oriented Guide. Combining real-life stories with practical advice, Deborah has addressed audiences of consumers, students, and professionals. Twitter: @djworking.Contact Author | Meet other investing specialists

When you sell an asset such as stock, you owe capital gains tax on the difference between the sale price and what you paid for it--your cost basis. But if you inherit certain assets, including marketable securities, you can "step up" their tax basis to whatever they were worth at your benefactor's death. That means highly appreciated inherited stock can be sold immediately with no capital gains, or later, with all the gains before you inherited it not counted. (Basis doesn't matter until there's a sale.)

Step-up isn't new, but it became more important after the legislative deal that Congress passed in 2013. It made permanent a generous exclusion from estate and gift tax. Currently, we can each transfer $5.43 million during life or at death, before a transfer tax of 40% kicks in.
In the same tax bill, Congress raised the top rate on long-term capital gains. Including a 3.8% net investment income tax, it is now 23.8%, an increase from 15% in 2012. And that's not counting state income tax, if you live in a state that has one.

Know Your Options
How does this play out in estate planning? Let's say the six-year bull market has left you holding publicly traded stocks that have appreciated. If you sell them, you will need to reckon with the dreaded capital gains tax. By all means, sell if you need to raise cash or diversify, or if it's otherwise a smart investment move (for instance, if the company seems headed for a downturn). But if you can afford to hang on to those stocks, your heirs can benefit from the basis step-up.

Another option is to give them an advance on their inheritance. In that case, there's no step-up--their basis is the same as yours. Unless recipients are in a lower tax bracket, they will have a big tax bill, too, if they sell appreciated stock. (Note that you can't give away a loss, so if asset values have gone down, you should sell the stock, book the loss and give away the proceeds.)

When making lifetime gifts, you must also keep in mind the gift tax rules. Without eating into the $5.43 million per person exemption, you can use what's called the annual exclusion, which allows you, each year, to make gifts of up to $14,000 (in cash or other assets) tax-free to each of as many people as you choose. Your gifts are counted at their fair market value.

If none of these possibilities sounds appealing, here are ways to minimize capital gains tax.

Donate to Charity
Since you're not selling the stock--just giving it away--you don't have to pay capital gains tax. And if you still want your portfolio to include that stock because you think it will continue to do well, you can buy additional shares at the higher price, notes Howard M. Zaritsky, a lawyer in Rapidan, Va. Those shares will have a higher basis than the ones you donated.

What's more, for gifts of marketable securities to a public charity, donors are entitled to an income tax deduction for up to 30% of adjusted gross income if they held the stock for more than 12 months. Your deduction is equal to the full market value of the securities--not what you paid for them. Any deduction that cannot be taken in the year of the donation can be carried forward up to five years.

Convert a Traditional IRA to a Roth
These accounts are among the best tax-planning tools available, says Paul S. Lee, a wealth manager with AB Bernstein. You must pay income tax on the amount you are converting; but after that, subject to certain restrictions, no income tax is assessed on distributions--by you or your heirs. "In effect, you are leveraging a tax cost today for an infinite amount of basis" going forward, Lee says.
What's more, any withdrawals--by you or your heirs--don't get added to taxable income. So, under current rules, it won't push any of you into a higher tax bracket that might require payment of extra Medicare premiums or the 3.8% surcharge.

Make Joint Assets Community Property
Married couples who live in a community property state (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin) have a basis advantage, says Wendy S. Goffe, a lawyer with Stoel Rives in Seattle. Unless you formally agree otherwise, most of what you acquire once you are married and living in one of these nine states is community property, and you are each considered a one-half owner. Therefore, when the first spouse dies, both halves of the property get a step up in basis. This minimizes capital gains tax if the surviving spouse sells the property.

Couples who don't live in a community property state may be able to achieve the same result by putting assets in what's called a joint revocable trust in the state of Alaska or Tennessee. In these states, community property is not automatic, but you can "opt in" to it if you live there or if you set up a trust there with a local trustee (for example, from a bank or trust company).

Community property trusts don't come cheap. There are set-up charges, and fees of professional trustees and investment managers. Plus, it will cost $500 to $1,500 yearly to have the trust tax return prepared. But the potential capital gains tax savings can be substantial, Zaritsky says. These trusts probably aren't a good idea for young, healthy spouses with high-basis assets, but they could work well for those who are old or infirm and who own low-basis assets that are likely to be sold soon after the first spouse dies.

How to Claim Those Baffling College Tax Breaks

FROM WEALTHMANAGEMENT.COM

You may need a degree just to understand the tax breaks available for a college education.

That is unfortunate, because there is evidence that many families are missing out on the available credits and deductions, leaving hundreds if not thousands of dollars on the table.

Only 42 percent of those polled in a Sallie Mae survey, "How America Pays for College 2014," said they used available tax breaks to help reduce college costs. The student lender questions 800 undergraduate college students and 800 parents of undergraduates for the annual survey.

Some high-earning parents may not think they're eligible because of income limits or deductions, but in many cases their college students could be taking advantage of the breaks, said Lisa Greene-Lewis, a CPA and tax expert for TurboTax.

At the other end of the income scale, families that earn too little to owe income taxes could still get up to $1,000 back because one of the credits is refundable. Yet only 36 percent of those who make less than $35,000 said they took advantage of tax breaks.

Even those who know the benefits exist may be defeated by their sheer complexity. Various tax breaks have different income limits, eligibility requirements and qualifying expenses. Three of them - the American Opportunity Credit, the Lifetime Learning Credit and the tuition and fees deduction - are mutually exclusive, which means you can only take one per year. Plus, you can't use any of them for expenses paid with a tax-free 529 plan withdrawal.

"You look at this and your head's swimming," said Sallie Mae spokesman Rick Castellano. "If you're not a tax professional, you might miss out."

Here's what you need to know:

The American Opportunity Credit is typically the most valuable credit, if you qualify. It reduces taxes dollar-for-dollar for the first $2,000 of college expenses and then by 25 percent of the next $2,000, for a total of $2,500 per student. Furthermore, 40 percent of the credit is refundable, which means you can get up to $1,000 back even if you don't have any taxes to offset.

To qualify, the student must attend college at least half-time, and the credit cannot be claimed for more than four tax years. Any year when the old Hope Credit was claimed counts toward that limit.

The credit phases out between modified gross incomes of $80,000 to $90,000 for singles, and $160,000 to $180,000 for married couples filing jointly.

If parents cannot take the credit, their children typically can if they have taxable income of their own, Greene-Lewis said. The parents would not then be able to take the dependency exemption of $3,950 for the child, but the value of the credit is often greater than the tax reduction from the exemption, she said.

The Lifetime Learning Credit isn't as valuable but in some ways it's more flexible. It can be taken even for a one-off course, such as one to build job skills. It offsets 20 percent of tuition and certain other required expenses up to $2,000 per tax return. In 2014, the credit phases out for modified adjusted gross incomes between $54,000 and $64,000 for singles, and $108,000 and $128,000 for married couples filing jointly.

Other Deductions

If you can't take either of these credits, you may still be able to use the tuition and fees deduction. This reduces taxable income by a maximum of $4,000 for incomes up to $65,000 for single filers and $130,000 for joint filers, and by up to $2,000 for incomes over $65,000 for singles and $130,000 for joint filers. There's no deduction for incomes over $80,000 for singles and $160,000 for joint filers.

Then there's the deduction for student loan interest, which allows a deduction of up to $2,500. The deduction phases out between $65,000 and $80,000 for singles and between $130,000 and $160,000 for joint filers. You're allowed to take this deduction even if you're claiming one of the other tax breaks.

There are other nuances you need to know, such as which expenses qualify for which credits. For example, the cost of required books is allowed for the Lifetime Learning Credit only if the money was paid directly to the school, Greene-Lewis said.

With the American Opportunity Credit, the cost of books is eligible regardless of where they're bought. Supplies aren't covered at all by the deduction for tuition and fees, which covers just that.

What you should ask before hiring a tax preparer

About six out of 10 tax filers will pay someone else to handle their tax prep this year, according to the Internal Revenue Service (IRS). If that's what you plan to do, here are five questions you need to ask before hiring a tax preparer.

What are your credentials?

A certified public accountant (CPA) has usually studied accounting at a college or university and passed a standardized CPA exam. He or she has a certain number of years of public accounting experience as required by the state's licensing board.

Enrolled agents (EAs) are licensed by the IRS and specifically trained in federal tax planning. They've either passed a comprehensive exam or worked at the IRS for at least five years in some capacity in which they're interpreting or applying the tax code.

Other tax professionals may have taken continuing education courses in accounting. The IRS recommends paid tax return preparers participate in a voluntary program that offers training in basic tax filing, ethics and federal tax law. (The IRS had required mandatory testing of paid tax return preparers, but those regulations were struck down by a federal appeals court last year.)

Some attorneys also specialize in tax preparation and planning. Attorneys should have earned a law degree and passed a bar exam and should be licensed by their state or the District of Columbia. The IRS provides a searchable database of tax return preparers who hold professional credentials it recognizes – including CPAs, EAs, and attorneys -- on its website.

Do you have a PTIN?

All tax preparers are required to have a Preparer Tax Identification Number (PTIN) if they are being compensated for preparing, or assisting in the preparation of all or substantially all of any U.S. federal tax return or claim for a refund. This includes CPAs, enrolled agents and other tax professionals. They're required to put their PTIN on your return.

How much do you charge?

Tax preparers fees can vary widely depending on where you live, the complexity of the return and the amount of time it takes to complete the necessary forms. According to the National Society of Accountants, the average tax preparation fee this year for an accountant is $273 for a standard federal tax return with a Schedule A for itemizing deductions, as well as a state return.

Enrolled agents may be less expensive, but their fees also can vary widely. Find out ahead of time what the total tax preparation fee will be. The IRS warns taxpayers to avoid preparers who base their fee on a percentage of your refund or those who claim they can obtain larger refunds than other preparers.

Also, always make sure any refund due is sent directly to you or deposited into an account in your name. If a tax preparer suggests another arrangement, look for another preparer.

Will you file my return electronically?

Most taxpayers e-file their returns, and the IRS says it is the fastest way to get your refund, usually in 21 days or less. Yet, as of March 6, the number of tax preparers who filed electronically had dropped about 4 percent compared to this time last year, according to the IRS.