Mindlessly plugging numbers into tax software or an online tax site might seem like a quick-and-easy way to get your taxes done. But some days that approach can lead to a disaster. Just ask someone who has been audited or an accountant who later spotted costly mistakes.
One accountant tells the story of a well-to-do taxpayer who was referred to his office on another issue.
James Jenkins, president of Jenkins in Southfield, Mich., reviewed the man’s previous returns and had to ask why someone making more than a half-million dollars a year was so short on cash that he felt compelled to tap into his IRA. Why did he take all that money out of the retirement account and create a bigger tax bill?
The man said he didn’t withdraw money. He simply rolled a large amount of money over from one IRA into another.
The man, who prepared his own return using tax software, ended up paying thousands of tax dollars on what was a non-taxable IRA rollover. Fortunately, that mix-up was later corrected by amending the returns — once the accountant spotted the problem.
It’s tempting to be a tax-time do-it-yourselfer - particularly when it can cost $300 or more for many people to get their taxes prepared by someone else. About 30 percent of tax returns that were electronically filed nationwide through last June were self-prepared, according to the Internal Revenue Service. And the IRS says electronic filing can prevent mistakes, too, so it’s typically better than filing a paper return.
But big blunders are out there. Here are a few:
• Bad typing. “One of the biggest mistakes I see is incorrectly inputting data by transposing numbers, omitting digits, or just making typing mistakes,” said Barbara Weltman, author of “J.K. Lasser’s 1,001 Deductions and Tax Breaks 2013.”
If the Form 1099 reports that you received $946 of interest but you enter $649, she said, the IRS computer could pick up the mistake and trigger a notice. It’s unlikely your entire return would be audited but it could create headaches.
Weltman said one way to avoid this is to use automatic data transfer, which is available from many large employers for W-2s and from most brokerage firms for 1099s.
• Banking on tax software to save you. Someone who pays a tax preparer or accountant is going to have another pair of eyes reviewing receipts and the return, said Mark Luscombe, principal analyst for CCH, a Wolters Kluwer business.
“You have to have documentation to support anything you put on your return in case you’re audited,” Luscombe said.
It’s not smart to report that expenses and deductions were exactly the same year after year.
Jenkins said CPAs jokingly call TurboTax “TroubleTax.” Many people with simple, plain vanilla returns, he said, can successfully use tax software. But “if you get into an area you don’t understand, it could be big trouble,” Jenkins said.
• Discarding or losing a 1099. George W. Smith IV, a certified public accountant and partner at George W. Smith in Southfield, said problems can arise when people receive IRS form 1099-R for direct rollover distributions from their employers’ plan to their IRA or from one IRA to another.
“They don’t tell us about the rollover or give us a copy of the 1099-R because it’s a non-taxable event,” Smith said.
“True. But you still have to report it on your 1040 as such or the IRS will assume it’s fully taxable and subject to the 10 percent early withdrawal penalty if you’re under age 59 1/2.”
Pay careful attention to lines 15a and 16a of the 1040, which show total IRA or pension distributions for the year. Here you’d note what portion is taxable. You’d need to put in a zero on Lines 15b and 16b if the rollover is non-taxable.
Luscombe noted that if a taxpayer takes an IRA distribution and rolls it into another IRA within 60 days, the distributed amount reported on Form 1099-R would be non-taxable and the taxpayer would write “rollover” in the margin next to line 15. He said the taxpayer would not need to attach other documentation to the return but should keep the paperwork in the event of an audit.
Smith said he typically clears up several notes on this event each year.
“You have a $500,000 rollover, and the IRS assessment is huge,” Smith said.
Joseph DeGennaro, tax director for Doeren Mayhew in Troy, Mich., said taxpayers can create headaches if they fail to include a Form 1099 for interest income, dividend income, sales of stocks and non-employee compensation.
“The IRS gets copies of these reports and matches them to the taxpayer’s tax returns,” DeGennaro noted.
• Getting flip with numbers. Ever been tempted to fool around with tax software to try to create a bigger refund? Tax experts say they’ve seen clients who have run into trouble after inflating home office deductions; using too many round numbers, as opposed to actual numbers, for deductions; claiming too many losses if they file a self-employed Schedule C.
Schedule C is more likely to trigger an audit than a regular individual return. And some tax experts say that’s especially true if the taxpayer is claiming losses on that business for three years in a row during a five-year time frame. The IRS could view all those losses for that business as a “hobby loss.”