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Top 5 Tax Mistakes You Should Avoid

Top 5 Tax Mistakes You Should Avoid

As tax season approaches, you’ll want to make sure your finances are in order to properly report your income and expenses to the IRS. Unfortunately, a lot of households make the same mistakes–and they’re entirely avoidable!

Simple mistakes can lead to a tax audit. That means the IRS will double check that your individual account and tax information is correct. To avoid the headache of a tax audit, be sure to report your income and expenses properly the first time.

This starts by avoiding these common tax mistakes:

Choosing the wrong filing status

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    The IRS uses five different filing statuses to determine things like your correct tax rate, eligibility on certain credits, and your standard deduction. These filing statuses include:

    • Single
    • Married Filing Jointly
    • Married Filing Separately
    • Head of Household
    • Qualifying Widow(er)

    It’s not always easy to determine which filing status you should choose. For example, if you recently separated from your spouse but are still legally married, should you choose Married Filing Jointly or Married Filing Separately? It’s also common for people to claim Head of Household when they do not meet the requirements.

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    The IRS can help with that. Take a quick five-minute survey, What is My Filing Status?, on the IRS website to ensure you’re filing correctly. Be sure to have the following items on hand:

    • Marital status
    • Spouse’s year of death (if applicable)
    • Percentage of costs your household members paid toward keeping up a home

    Failing to file taxes for household workers

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      One of the biggest mistakes individuals make is failing to file taxes for household workers. It’s not because people are trying to cheat the system, just that they are misinformed.

      If you pay household workers, such as nannies, home health aides, housekeepers, house managers, etc., over a certain amount each year, you are considered a domestic employer. The threshold changes each year as the national average wage index changes.

      According to the IRS, the threshold for 2015 is set at $1,900, but will increase to $2,000 in 2016. That means that if you paid your household workers more than $1,900 in 2015, you will have to pay Social Security and Medicare taxes. These rates are currently at 6.2 percent for Social Security and 1.45 percent for Medicare.

      Homeowners often misclassify domestic workers as independent contractors. Making this mistake may lead to fines and imprisonment. Independent contractors set their own hours, supply their own tools/machinery, and offer services to the general public. If this does not sound like your workers, do not send them a 1099! This point is incredibly important: don’t let someone tell you that you can just pay your domestic workers with cash–this is illegal! The IRS has clear guidelines for what a domestic worker is and if you fail to pay their taxes properly, you could face fines and penalties.

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      Talk to your accountant or a domestic taxes expert if you suspect workers, like your nanny, fall into this “household worker” category. Be sure to provide your financial records and payment information to ensure your taxes are filed accurately.

      Failing to report additional income

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        Too often individuals report only what they see on their W-2s and 1099s. However, you may have income from other sources that aren’t on these forms. By law, you still have to report it.

        This can include income like tips, self-employment income, income from rental properties, etc.

        Not only is this mistake avoidable if you’re proactive and keep track of your income, but omitting any additional income from your tax forms can result in fees and other penalties from the IRS.

        Claiming ineligible dependents

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          Claiming dependents on your taxes gives you certain exemptions that will lower how much you have to pay. It is common for individuals to misinterpret what is meant by “dependent.” For example, you can claim children and relatives as dependents, but you can’t claim your spouse.

          A dependent is someone you support financially, usually a child or relative that lives with you.

          Unfortunately, the rules for claiming someone is often misunderstood. For instance, if someone can claim you or your spouse (if filing jointly) as dependents on their tax return, you cannot claim someone else as a dependent. This is true whether or not the person actually claims you.

          For example, if you live with your parents and also have your own child, your parents may be able to claim you as a dependent. In that case, you can’t claim your child on your tax return.

          You can claim dependents if:

          1. They are a U.S. citizen, U.S. national, resident alien, or resident of Canada or Mexico. The only exception is for adopted children.
          2. The dependent is not married or filing jointly.
          3. The dependent is a Qualifying Child or Qualifying Relative according to the IRS.

          If you’re unsure, visit the IRS website and take a short survey, Who Can I Claim as a Dependent?

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          Be sure to have the following items on-hand:

          • Marital status, relationship to dependent, and amount of support you provided them.
          • Income information, including your adjusted gross income.
          • Terms of a multiple support agreement you may have for the dependent.

          Making mistakes on paper tax forms

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            While taxes were once filed exclusively through paper forms, the Internet has made filing taxes easier than ever. The benefit to filing electronically is that the system can check for miscalculations or mistakes, like forgetting to sign your name. Unfortunately, the IRS won’t even accept returns that aren’t signed, and making a single math mistake can cost you, either in a reduced refund or in various fees.

            It’s tough to catch mistakes like this with the human eye, but they can be easily mitigated when you eFile through the IRS.

            Tax season can be stressful for both individuals and accountants. However, you can relieve some of that stress by paying attention to these common mistakes. That way, you know you’re not headed down a path toward incurring fees, penalties, and even jail time. If at any point you’re unsure of what’s expected of you or whether you qualify for certain categories or not, talk to a professional to get expert advice on your personal situation.

            photo credit: Pinterest

            Featured photo credit: El Nariz via thumb9.shutterstock.com

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            Kathleen Webb

            Co-Founder, HomeWork Solutions

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            Last Updated on September 2, 2020

            How to Set Financial Goals and Actually Meet Them

            How to Set Financial Goals and Actually Meet Them

            Personal finances can push anyone to the point of extreme anxiety and worry. Easier said than done, planning finances is not an egg meant for everyone’s basket. That’s why most of us are often living pay check to pay check. But did anyone tell you that it is actually not a tough task to meet your financial goals?

            In this article, we will explore ways to set financial goals and actually meet them with ease.

            4 Steps to Setting Financial Goals

            Though setting financial goals might seem to be a daunting task, if one has the will and clarity of thought, it is rather easy. Try using these steps to get you started.

            1. Be Clear About the Objectives

            Any goal without a clear objective is nothing more than a pipe dream, and this couldn’t be more true for financial matters.

            It is often said that savings is nothing but deferred consumption. Therefore, if you are saving today, then you should be crystal clear about what it’s for. It could be anything, including your child’s education, retirement, marriage, that dream vacation, fancy car, etc.

            Once the objective is clear, put a monetary value to that objective and the time frame. The important point at this step of goal setting is to list all the objectives that you foresee in the future and put a value to each.

            2. Keep Goals Realistic

            It’s good to be an optimistic person but being a Pollyanna is not desirable. Similarly, while it might be a good thing to keep your financial goals a bit aggressive, going beyond what you can realistically achieve will definitely hurt your chances of making meaningful progress.

            It’s important that you keep your goals realistic, as it will help you stay the course and keep you motivated throughout the journey.

            3. Account for Inflation

            Ronald Reagan once said: “Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hitman.” This quote sums up what inflation could do your financial goals.

            Therefore, account for inflation[1] whenever you are putting a monetary value to a financial objective that is far into the future.

            For example, if one of your financial goal is your son’s college education, which is 15 years from now, then inflation would increase the monetary burden by more than 50% if inflation is a mere 3%. Always account for this to avoid falling short of your goals.

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            4. Short Term Vs Long Term

            Just like every calorie is not the same, the approach to achieving every financial goal will not be the same. It’s important to bifurcate goals into short-term and long-term.

            As a rule of thumb, any financial goal that is due in next 3 years should be termed as a short-term goal. Any longer duration goals are to be classified as long-term goals. This bifurcation of goals into short-term vs long-term will help in choosing the right investment instrument to achieve them.

            By now, you should be ready with your list of financial goals. Now, it’s time to go all out and achieve them.

            How to Achieve Your Financial Goals

            Whenever we talk about chasing any financial goal, it is usually a two-step process:

            • Ensuring healthy savings
            • Making smart investments

            You will need to save enough and invest those savings wisely so that they grow over a period of time to help you achieve goals.

            Ensuring Healthy Savings

            Self-realization is the best form of realization, and unless you decide what your current financial position is, you aren’t heading anywhere.

            This is the focal point from where you start your journey of achieving financial goals.

            1. Track Expenses

            The first and the foremost thing to be done is to track your spending. Use any of the expense tracking mobile apps to record your expenses. Once you start doing it diligently, you will be surprised by how small expenses add up to a sizable amount.

            Also categorize those expenses into different buckets so that you know which bucket is eating most of your pay check. This record keeping will pave the way for cutting down on un-wanted expenses and pumping up your savings rate.

            If you’re not sure where to start when tracking expenses, this article may be able to help.

            2. Pay Yourself First

            Generally, savings come after all the expenses have been taken care of. This is a classic mistake when setting financial goals. We pay ourselves last!

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            Ideally, this should be planned upside down. We should be paying ourselves first and then to the world, i.e. we should be taking out the planned saving amount first and manage all the expenses from the rest.

            The best way to actually implement this is to put the savings on automatic mode, i.e. money flowing automatically into different financial instruments (mutual funds, retirement accounts, etc) every month.

            Taking the automatic route will help release some control and compel us to manage what’s left, increasing the savings rate.

            3. Make a Plan and Vow to Stick With It

            Learning to create a budget is the best way to get around the uncertainty that financial plans always pose. Decide in advance how spending has to be organized

            Nowadays, several money management apps can help you do this automatically.

            At first, you may not be able to stick to your plans completely, but don’t let that become a reason why you stop budgeting entirely.

            Make use of technology solutions you like. Explore options and alternatives that let you make use of the available wallet options, and choose the one that suits you the most. In time, you will get accustomed to making use of these solutions.

            You will find that they make it simpler for you to follow your plan, which would have been difficult otherwise.

            4. Make Savings a Habit and Not a Goal

            In the book Nudge, authors Richard Thaler and Cass Sunstein advocate that, in order to achieve any goal, it should be broken down into habits since habits are more intuitive for people to adapt to.

            Make savings a habit rather than a goal. While it might seem to be counterintuitive to many, there are some deft ways of doing it. For example:

            • Always eat out (if at all) during weekdays rather than weekends. Weekends are more expensive.
            • If you are a travel buff, try to travel during off-season. You’ll spend significantly less.
            • If you go shopping, always look out for coupons and see where can you get the best deal.

            The key point is to imbibe the action that results in savings rather than on the savings itself, which is the outcome. Focusing on the outcome will bring out the feeling of sacrifice, which will be harder to sustain over a period of time.

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            5. Talk About It

            Sticking to the saving schedule (to achieve financial goals) is not an easy journey. There will be many distractions from those who are not aligned with your mission.

            Therefore, in order to stay the course, surround yourself with people who are also on the same bandwagon. Daily discussions with them will keep you motivated to move forward.

            6. Maintain a Journal

            For some people, writing helps a great deal in making sure that they achieve what they plan.

            If you are one of them, maintain a proper journal, where you write down your goals and also jot down the extent to which you managed to meet them. This will help you in reviewing how far you have come and which goals you have met.

            When you have a written commitment on paper, you are going to feel more energized to follow the plan and stick to it. Moreover, it is going to be a lot easier for you to track your progress.

            Making Smart Investments

            Savings by themselves don’t take anyone too far. However, savings, when invested wisely, can do wonders.

            1. Consult a Financial Advisor

            Investment doesn’t come naturally to most of us, so it’s wise to consult a financial advisor.

            Talk to him/her about your financial goals and savings, and then seek advice for the best investment instruments to achieve your goals.

            2. Choose Your Investment Instrument Wisely

            Though your financial advisor will suggest the best investment instruments, it doesn’t hurt to know a bit about the common ones, like a savings account, Roth IRA, and others.

            Just like “no one is born a criminal,” no investment instrument is bad or good. It is the application of that instrument that makes all the difference[2].

            As a general rule, for all your short-term financial goals, choose an investment instrument that has debt nature, for example fixed deposits, debt mutual funds, etc. The reason for going for debt instruments is that chances of capital loss is less compared to equity instruments.

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            3. Compounding Is the Eighth Wonder

            Einstein once remarked about compounding:

            “Compound interest is the eighth wonder of the world. He who understands it, earns it… He who doesn’t… Pays it.”

            Use compound interest when setting financial goals

              Make friends with this wonder kid. The sooner you become friends with it, the quicker you will reach closer to your financial goals.

              Start saving early so that time is on your side to help you bear the fruits of compounding.

              4. Measure, Measure, Measure

              All of us do good when it comes to earning more per month but fail miserably when it comes to measuring the investments and taking stock of how our investments are doing.

              If we don’t measure progress at the right times, we are shooting in the dark. We won’t know if our saving rate is appropriate or not, whether the financial advisor is doing a decent job, or whether we are moving closer to our target.

              Measure everything. If you can’t measure it all yourself, ask your financial advisor to do it for you. But do it!

              The Bottom Line

              Managing your extra money to achieve your short and long-term financial goals

              and live a debt-free life is doable for anyone who is willing to put in the time and effort. Use the tips above to get you started on your path to setting financial goals.

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              Featured photo credit: Micheile Henderson via unsplash.com

              Reference

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