When the IRS is reviewing your income tax return, it doesn’t care whether a filing mistake is intentional or not – a mistake is a mistake. Ignorance is no defense. And any error can trigger further investigation. While a mistake won’t necessarily lead to an audit, you want to avoid as many red flags as possible—particularly if you’re a high-income taxpayer, since they tend to be audited more frequently. We’d like to share with you several mistakes that we have seen.
1. Reporting income inaccurately
With few exceptions, any income you earn—whether from an employer, a side business or an investment—should be reported. All income you report needs to match what the IRS has on file.
- Your employer reports wages, salary and bonuses to the government on your W-2 form.
- Retirement income. Withdrawals from tax-deferred retirement accounts (401ks, IRAs) are taxed as ordinary income. Depending on your income, a portion of your Social Security benefits might be taxable as well.
- Investment income. These are reported on 1099s. Please note that the firms that hold your investment assets – called custodians (Fidelity, TD Ameritrade, etc.) – can often issue
- Self-employment income. If you’ve made at least $600 from a client, that client will report it to the IRS. But it’s up to you to report amounts under $600.
- You also must report income from prizes or gambling winnings.
2. Data entry errors and miscalculations
It’s quite easy to transpose digits or read from the wrong line of a worksheet when you’re preparing your taxes. And if you’re still filing on paper, the chance that you’ll move a decimal, add incorrectly or make other computational mistakes only goes up.
Be sure to always double check your numbers and your calculations. Be especially careful when you work with tax credits and special deductions, or if you have to file a more complicated income tax return that includes worksheets, tables or additional forms.
There is always the option of using an income tax professional to do the work for you.
3. Misreporting investment income
If you don’t know the correct cost basis of your investments, you could misreport investment gains or losses – which will raise a red flag.
Again, the common theme here is making sure what is reported on your income tax return is exactly what is reported to the IRS. So be sure your return matches the 1099 your custodian files, including cost-basis information. (Cost basis is reported for most securities bought since 2011, but if you’ve been holding on to a stock for decades, the IRS won’t have the cost basis on file.)
If there is a discrepancy between your records and your custodians, make sure it gets fixed before you file your return. And make sure you have documentation to substantiate your cost basis.
Also watch out for wash sale rule violations, which will also show up on your investment statement record. You will lose the tax benefits of a trading loss if you have purchased a “substantially identical” security 30 days before or after the sale.
4. Excessive or unusual deductions
Certain deductions can be a red flag for the IRS—especially for self-employed taxpayers who itemize and for individuals with large charitable contributions relative to their income.
Deductions can be tricky for self-employed filers because sometimes the line between business and personal expenses can be fuzzy, especially if you have a home office and have deductions like entertainment, meals, transportation and phone use. If you’re ever in doubt, check the IRS guidelines for business deductions—or check with a professional if you’re still not sure.
When it comes to charitable contributions, check the charity’s tax-exempt status first, and be sure you obtain a proper receipt. And deduct only the current fair market value of any items donated, not the amount you paid for the item.
Also – remember that your IRA contribution deduction may be limited if you (or your spouse, if you are married) are covered by a retirement plan at work and your income exceeds certain levels. However, if you do not have a retirement plan at work, your IRA deduction is allowed in full (and your spouse, if you are married) – as long as you don’t deduct more than your earned income.
5. Erroneous personal information
Sometimes it’s the simplest things that trip you up: forgetting to sign your return, for example, or listing an incorrect Social Security number.
Be sure to review the following before submitting:
- Your name. Have you changed your name in the past year?
- Your address. Have you recently moved?
- Your Social Security number and the Social Security numbers for all your dependents.
- Your filing status. Has your filing status changed?
- Your signature (don’t forget to sign!).
Next Steps for your Income Tax
During income tax season, consult the tax advisors at Apex to help review all your tax documents so that you can avoid these common tax-filing errors. Reduce your chance of landing on the IRS’s radar for an audit.