Last Updated Mar 2, 2011 3:14 PM EST
Burying your head in a pillow and trying to forget, while appealing, is not the best strategy, however. If you don't pay attention, you could easily step into gooey, gloppy tax miasmas that wind up costing you money and/or winning you unwanted notice from the IRS. So here are some common mistakes you might make and what to do about them.
1. Taking a refund anticipation loan. A RAL is a short-term predatory loan in the amount of your tax refund, minus any tax preparation fees and interest. The rates, depending on the lender and the amount, are sky-high. According to the Consumer Federation of America, one bank this season will charge $61.22 for a RAL of $1,500, which translates to an APR of 149 percent. RALs are harder to find this year, thanks to action by government agencies, and H&R Block will no longer be offering them. Instead it is marketing a variation called "the refund anticipation check." In this case, a bank opens a temporary account into which the IRS deposits your refund. The bank then either pays you with a check or via a prepaid card. The bank charges $30 for the account, and the tax preparer may lard on more fees.
To avoid: RALs and RACs are not only costly but also totally unnecessary. The IRS these days typically shoots out refunds within two weeks to taxpayers who file electronically and ask for direct deposit. Taxpayers can also save time by having the refund dispatched automatically to a pre-existing payroll card or to a prepaid card they open. (Just watch out for fees!) For advice in choosing a prepaid card, check out the National Consumer Law Center's tip sheet.
2. Getting a big refund. You may think you're hot stuff because the government is going to pay you a big wad of cash. But a fat refund simply says that you are having too much withheld from your paycheck with the result that you are giving the government an interest-free loan. Some people say that they over-withhold because they like the forced savings, but seriously, you're better off contributing any excess tax during the year to a 401(k) -- where it will earn interest -- or using it to pay off your credit cards -- which will save you interest.
To avoid: It may be too late to do anything this year, buy to make sure that your withholding is not too big and not too small, use this IRS calculator for 2011.
3. Not paying attention to your 1099s and other proof of income. If you're like me, you toss these things into a file folder and look at them on maybe April 12. Big mistake. I've learned from hard experience that banks, employers and others who provide the forms make errors. The payer has to send you the form no later than January 31 and has until February 28 to file the document with the IRS. That gives you as long as a month to correct any errors.
To avoid: Check the forms immediately. If you spot errors and the payer hasn't yet sent the form to the IRS, s/he can simply tear up the messed up 1099 and issue a new one.
4. Not itemizing. When calculating your taxes, you can elect to take the standard deduction ($11.400 for married couples filing jointly and $5,700 for single people for 2010) or itemize deductions. An admittedly ancient GAO study found that about 510,000 households overpaid on their taxes by failing to itemize, even though they qualified for the most common deductions, for example, home mortgage interest and property taxes.
To avoid: Using tax prep software programs that query you about deductions should keep you from becoming one of the half million over-payers. Conversely, that generous standard deduction may be large enough so that you won't have to endure the headache of itemizing.
5. Forgetting about the oldster deduction. The federal government gives you a little tax help if you've managed to last beyond your working years and don't itemize. If you're over 65 and single, you can add $1,400 to the standard deduction, or $1,100 each for you and your spouse if you're married filing jointly. A married couple, both over 65, can get a total standard deduction of $13,600: $11,400 plus $1,100 for each spouse.
To avoid: If you're like Nora Ephron, author of I Remember Nothing, you're in big trouble. Again, tax prep software will prompt you to take the extra deduction.
6. Failing to deduct non-cash donations to charity -- even though doing so is a big pain in the neck. This deduction (only available to those who itemize) is close to my heart since I moved this year and wound up donating about 2,500 pounds of clothing and household goods. When you give, you usually get a receipt that says "3 bags full" or somesuch. If you gave more than $500 worth last year, however, that will not be enough documentation to satisfy the IRS. You will have to struggle through Section A of Form 8283 Non Cash Charitable Contributions, which requires you to list every item's fair market value, when you got it and what you paid.
To avoid: You can't really sidestep this form, but does the IRS really want to know that you bought one dress at Nordstrom, one at Macy's and another at JC Penny? (And, as Nora would point out, who remembers?) I plan to write in "department stores" and guess the approximate dates. The Salvation Army provides a valuation guide to help determine the market value of most items you're likely to give. BTW, you may not deduct more than 50 percent of your adjusted gross income in any one year -- but you can carry over any excess to the following year.
7. Forgetting to deduct old refinancing points. If you refinanced your mortgage this year, you can deduct the points over the lifetime of the loan. If you have a 30-year mortgage and you paid $3,000 in points, you can write off one-thirtieth or $100 this year. Of course, if you refinanced in June, you only get six months' worth or $50. That's nothing to celebrate, but if you refinanced previously, let's say on January 1, 2008 (just to keep things simple), you can deduct the value of the points you hadn't yet taken -- about 28 years' worth -- in the year of a new refinancing.
To avoid: Put aside the papers documenting your old points in the front of your tax file.
8. Being too chicken to take the home office deduction. For years, you've been hearing warnings that this is a red flag for auditors. Not so. If you qualify, you can subtract a significant chunk from your tax bill. If you don't qualify, you'll get in trouble.
To avoid: Follow the rules. First, the office has to be your principal place of business, and it must be used exclusively for that purpose, not for playing video games, watching reruns of I Love Lucy on Hulu or doing homework. And, you cannot deduct more than your business income. Let's say your office is 100 square feet and your house is 2000 square feet. You can then deduct as business expenses 5 percent of your utilities, insurance, homeowner association fees, repairs, cleaning and maintenance. On top of all that, you can take off 5 percent of your mortgage interest and property taxes. (Using those deductions as business expenses rather than as personal itemized deductions reduces self-employment income, which in turn lowers your Social Security taxes.) You also get a depreciation deduction, for the wear and tear on your office over a set time, usually 39 years. It's a complicated calculation so you'll have to consult IRS Publication 534, but here's a rough idea of how it works: You take the fair market value of your home minus the land. Say it's $250,000; then figure out the amount of the property used for business, in this case 5 percent or $12,500. Divide that by 39, and you get a depreciation deduction of $320. Deductions for depreciation do come back to bite you when you sell your house, however. You will have to pay a capital gains tax on the total amount of depreciation deductions you took, assuming you sold at a profit. Right now, you wouldn't pay much -- 15 percent -- but capital gains tax rates are due to sunset in two years.
9. Throwing yourself into the arms of a "professional." Just over half of all taxpayers have their returns prepared by a supposed professional preparer. But commercial services, whether provided by Uncle Morty, H&R Block or a high-powered CPA, are often less than fabulous. When GAO investigators went undercover to have returns done by commercial preparers, they found that the results were often incorrect. And IRS data show that 56 percent of professionally prepared returns showed significant errors, compared with 47 percent of those done by the taxpayer. You have no guarantee of quality, because only California and Oregon require tax preparers to take a test. What's more, once you are a customer of a big-chain preparer or even a neighborhood accountant, you become a target for sales pitches -- for RALs and RACs as well as fee-laden insurance policies and retirement plans.
To avoid: If you are a wage earner who takes the most common deductions (home mortgage interest, property taxes, charitable donations and state taxes) and credits (child care, for example), you probably will do better simply to buy Turbo-Tax, TaxCut or some other software program to help you complete your return.
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