Baby boomers nearing retirement can't afford to make tax mistakes. Instead, they need to shore up their capital for the future. The penalties for making these tax mistakes include triggering an audit, incurring a penalty and owing additional taxes.
Here are the five biggest tax mistakes made by baby boomers. As you file your 2015 tax return, take care to avoid these missteps.
1. Not checking the preparer's work
In a small study of randomly selected tax preparers in 2014, the U.S. Government Accountability Office reported "significant preparer errors during undercover site visits to 19 randomly selected preparers." The refund errors ranged from giving the taxpayer $52 less to $3,718 more than the correct refund amount, with only two of the 19 preparers calculating the refund amount properly.
That is why you must not trust your tax preparer -- or even a computerized program -- to get your return right. Instead, baby boomer taxpayers should be sure to tell their accountant about major life changes that might affect their tax situation, said Crystal Stranger, enrolled agent and president of 1st Tax. Trusting the tax preparer to know it all "can lead to both unreported income and not taking advantage of tax deductions they are legally entitled to," she said.
To avoid overpaying your taxes or filing an inaccurate return, you must gain a basic understanding of the IRS tax law. Here's how to make sure not to pay Uncle Sam more than you owe:
- Every year, examine the IRS changes.
- Understand the basic IRS tax preparation forms that apply to your situation and how taxes are calculated.
- Check your accountant or tax preparer's work to make certain the inputs are accurate. For example, did that person put a $5,000 deduction for office supplies on schedule C when it should have been $500?
- Review your online tax return before submitting to make sure it's correct and that you didn't make any inputting errors.
Before filing your 2015 tax return, perform your due diligence no matter how unpleasant, and review the documents.
2. Not maxing out retirement investing opportunities
For working baby boomers, now is the time to shore up your retirement nest egg. Not contributing the maximum to your tax-advantaged retirement accounts can cost you large sums of taxes today, as well as lost spending money in retirement. Furthermore, if it's a choice between helping out your older children or saving for your own retirement -- choose retirement.
If you're over age 50, you're eligible to contribute to your workplace 401(k) or 403(b) a base amount of $18,000, plus an additional "catch-up" sum of $6,000, for a total of $24,000. If you're in the 25% tax bracket, then contributing the maximum reduces your taxable income by the same amount and reduces your tax bill by $6,000.
You might also go beyond investing in your workplace retirement plan and consider an IRA, suggested Yvette D. Best, CEO of Best Services Unlimited, LLC. For 2015 and 2016, individuals over 50 can contribute up to $6,500 to a traditional IRA for a full tax deduction, even if they are covered by a retirement plan at work.
This applies to individuals earning under $61,000 and couples making under $98,000. There is a partial deduction allowed for income between $61,000 and $71,000 for singles and between $98,000 and $118,000 for couples. "This deduction can result in thousands of dollars saved on your tax bill," said Best. "You have until April 18, 2016, to avoid the tax mistake of not contributing the maximum to your retirement account."
Consider this scenario: Invest just $1,000 per month beginning at age 50, and by age 68 you might have a retirement account worth over $430,000. That assumes your investments yield an annual 7% return from a diversified stock index mutual fund. Not only will saving in a tax-advantaged account save you thousands on your tax bill, but it will also strengthen your retirement opportunities.
3. Making a mess of your small business tax reporting
Many baby boomers are starting new businesses or have up-and-running entrepreneurial ventures. If you treat the expenses from these concerns inappropriately, then you could owe Uncle Sam not only additional taxes, but penalties as well.
If you're starting a new business and racking up expenses, you might not be aware that any expenses incurred before the first sale are considered start-up costs and can't be deducted until the first sale, said Gail Rosen, CPA, PC. After the first sale, the start-up costs can be deducted over 15 years, and you can also elect to deduct the first $5,000 in the first year of business.
Another baby boomer tax mistake is made by those who have small business sales. They might think the income is so small that it's not worth reporting. "If it is a real sale, at a bona fide sales price, you should report your business sales and deduct your business expenses," said Rosen.
4. Taking an early withdrawal from a retirement account
Some younger boomers who are going through a difficult time might tap their retirement account for extra cash. This a big tax mistake, according to Anil Melwani of 212 Tax and Accounting Services. If a taxpayer takes out money from their retirement account before age 59½, they will be taxed on the withdrawal amount and incur an additional 10% tax on the amount they took out.
For example, if 55-year-old Jane Baby Boomer takes out $10,000 from her IRA, she'll owe tax on the withdrawal, plus the $1,000 (10% of $10,000) penalty. If Jane is undergoing difficult times, it's advisable for her to seek out other sources of income rather than making the mistake of withdrawing money from her IRA.
The only way this penalty can be avoided is if the taxpayer demonstrates that they have a total and permanent disability, and that the money is used for unreimbursed medical expenses or health insurance premiums paid while unemployed. There are a few additional exceptions to the penalty, but not many.
5. Thinking your hobby is a business
If you have a business that never makes any money, watch out for this mistake. Boomers are frequently guilty of running afoul of IRS "hobby loss" rules. Several tax pros, including Stranger and Dan Henn, CPA, see this baby boomer tax mistake regularly in their practices.
If you take a loss on a business for more than three years, the IRS considers your enterprise a hobby, which makes it ineligible for preferential tax treatment. The tax authority assumes that if an activity is intended to be profitable and isn't so during at least three of the prior five tax years, including the current year, then you can't use the losses from that "business" to offset other income. So the struggling entrepreneur can keep struggling after year three, but don't expect Uncle Sam to give you the OK to use your losses to offset your income.
Baby boomers, take a few hours to understand the IRS tax forms. Keep the doors of communication open with your accountant. And finally, learn to take responsibility for your own tax preparation to avoid unpleasant and expensive tax mistakes.
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