It's seemingly impossible to estimate the number of individuals who make mistakes on their income tax returns. But what is known are the types of mistakes taxpayers are making. Here’s a look at some of those mistakes.
Mistakes made with IRAs
One common tax mistake Christopher Lyman, a certified financial planner with Allied Financial Advisors, sees with his clients, especially younger clients who do their taxes themselves, is that they do not receive a deduction for IRA contributions.
The rules for deducting contributions to an IRA for single filers and married filing jointly depend on whether the taxpayer has or does not have an employer-sponsored retirement plan. Here are the rules:
1. Single filers without an employer-sponsored retirement plan: Single filers who do not have an employer-sponsored retirement plan can deduct the full amount of their traditional IRA contributions, up to the annual contribution limit.
2. Married filing jointly without an employer-sponsored retirement plan: Married couples filing jointly where neither spouse has an employer-sponsored retirement plan can each deduct the full amount of their traditional IRA contributions, up to the annual contribution limit.
3. Single or head of household filers with an employer-sponsored retirement plan: Single or head of household filers who have an employer-sponsored retirement plan may be able to deduct all or a portion of their traditional IRA contributions, depending on their modified adjusted gross income (MAGI). For 2023, the deduction is phased out for single or head of household filers with MAGI between $73,000 and $83,000. (Read: 2023 IRA Deduction Limits - Effect of Modified AGI on Deduction if You Are Covered by a Retirement Plan at Work at the IRS website.)
4. Married filing jointly with an employer-sponsored retirement plan: Married couples filing jointly where one or both spouses have an employer-sponsored retirement plan may be able to deduct all or a portion of their traditional IRA contributions, depending on their MAGI. For 2023, the deduction is phased out for married couples filing jointly with MAGI between $116,000 and $136,000 if the spouse making the contribution is covered by an employer-sponsored retirement plan. If neither spouse is covered by an employer-sponsored retirement plan, there is no income limit for deducting traditional IRA contributions.
See: IRS Publication 590-A: Contributions to Individual Retirement Arrangements (IRAs), for more information on IRA contribution and deduction limits.
More frequently, Lyman said, “We are doing financial planning for new clients and notice something odd in their tax return documents; they have a Form 8606 when they have done no IRA distributions or conversions.”
Form 8606, according to the IRS, is used to report:
- Nondeductible contributions taxpayers make to traditional IRAs.
- Distributions from traditional, SEP, or SIMPLE IRAs, if a taxpayer has ever made nondeductible contributions to traditional IRAs.
- Conversions from traditional, SEP, or SIMPLE IRAs to Roth IRAs.
- Distributions from Roth IRAs.
“When you have no money coming out of an IRA, then Form 8606 is only used to track non-deductible IRA contributions and the basis of those contributions over the years,” Lyman said.
What causes this, he said, is the fact that these individuals are contributing to a traditional IRA and a workplace retirement plan (even if their spouse has access to a workplace plan and they do not have a workplace plan, they may be ineligible for the deduction); once you make above a certain amount, you can no longer take a deduction for IRA contributions if one of the spouses has a workplace retirement plan.
“Most people don’t understand it, and they click through without ever realizing they have now put money into a traditional IRA for which they have received no deduction and will pay tax on the entire amount again when they go to withdraw it, so you were taxed twice on the same dollar,” Lyman said.
“To make it worse, you need to carry forward the basis year-by-year on Form 8606 to track multiple years of these contributions. Any basis you have in an IRA does not need to have tax paid on it when you convert or disburse money from an IRA account.”
Ed Snyder, a certified financial planner with Oak Tree Advisors, sees a similar but different type of mistake made with IRAs. “It's not all that uncommon to see people not put information about an IRA withdrawal on their return because they forgot to get the 1099 to their CPA,” Snyder said.
Mistakes made with backdoor IRAs
Kevin Brady, a certified financial planner with Wealthspire Advisors, said taxpayers are also making mistakes with backdoor Roth IRA contributions.
According to the IRS, a backdoor Roth IRA contribution is a strategy that allows individuals to contribute to a Roth IRA even if their income exceeds the limits for direct Roth IRA contributions.
Taxpayers, according to Brady, are either misreporting the backdoor Roth IRA contribution on their tax return, or they are unexpectedly being taxed because there are pre-tax IRA balances (i.e., the IRS pro-rata rule).
To report a backdoor Roth IRA contribution on your tax return, according to the IRS, a taxpayer needs to file Form 8606, Nondeductible IRAs. According to published sources, the pro-rata rule applies when a taxpayer has both pre-tax and after-tax money in their IRA accounts, and it determines how tax-deferred money should be taxed upon withdrawal. Since a backdoor Roth IRA contribution involves withdrawing traditional IRA funds and transferring them to a Roth IRA, the pro-rata rule applies.
“Communication between the taxpayer and preparer helps avoid this, along with the adviser who can help ensure that if one is involved,” Brady said.
IRAs and qualified charitable contributions
Older taxpayers who own IRAs and make qualified charitable distributions, or QCDs, are also prone to making mistakes, according to Brandon Gibson, a certified financial planner with Gibson Wealth Management.
“For (taxpayers) 70½ or older who do QCDs from their IRAs, I often see these missed on tax returns,” he said. “The main reason for this is that custodians don’t report QCDs on their Form 1099-R. Even though I stress to the [taxpayer] that it is their responsibility to make sure the CPA knows they made a QCD, it is often miscommunicated in some fashion.”
According to the IRS, a QCD is a tax-free distribution of funds from an IRA to a qualified charitable organization. QCDs, which can be made up to a maximum of $100,000 per year, are not included in the taxpayer's taxable income, according to the IRS.
Mistakes made with tax withholding
Several financial planners also noted that taxpayers make mistakes with their tax withholding, which, according to the IRS, is the amount of federal income tax that an employer withholds from an employee's paycheck and sends to the IRS on the employee's behalf. The amount of tax withheld depends on the employee's Form W-4, which is a form that employees fill out to indicate how much tax should be withheld from their pay, according to the IRS.
“If you are consistently receiving a large tax refund every April, it's one sign that you may be over-withholding tax from your paycheck,” said Jeremy Hutzel, a certified financial planner with Seven Springs Wealth Group. “This essentially amounts to giving the U.S. Treasury an interest-free loan. And in today's environment of higher interest rates, this money should be working for you throughout the year by earning a competitive interest rate.”
Others agree. Those who over-withhold are giving an interest-free loan. “In today's environment, you can get 3%-5% in a savings account, so that is the cost of over-withholding,” said Matthew Benson, a certified financial planner with Sonmore Financial.
“A good rule of thumb is to be plus or minus 2%-5% of your tax liability. So, if your total tax liability is $20,000 and you owed $1,000 or got $1,000 back on your taxes, that would be fine,” Benson said.
Fixing this common mistake simply requires updating Form W-4, the Employee's Withholding Certificate, which your human resources department or manager can provide.
Likewise, there are some taxpayers who are under-withholding.
“For those who under-withhold, they may have the mindset of ‘I don't want to give out a free loan to the government. I'll just pay the liability when I file,’” said Benson. “There are penalties for underpayments that include interest, so it is wise to make sure you are withholding enough to avoid any penalty.”
In some cases, Brady said incorrect and/or missing tax withholding can happen when a person changes jobs during the year. “The new employer might not correctly withhold state taxes,” he noted. “This could be due to an error on the company's end or because a W-4 is missing or filled out wrong.”
Mistakes with record-keeping
One common mistake that Eric Scruggs, a certified financial planner with Hark Financial Planning, sees in his practice is this: Taxpayers forget what they did during the year and then fail to report important tax-saving information on their income tax returns.
“For example, they forget to report contributions to IRAs and 529 accounts and therefore miss potential deductions and tax savings,” Scruggs said. "For taxpayers, it can be helpful to keep a running list of what you did during the year and keep that with your tax info so that come tax-time it is easier to remember what you did.”
Lucas Bucl, a certified financial planner with Aspyre Wealth Partners, said taxpayers sometimes fail to report an estimated tax payment. “This is a common record-keeping error,” she said. “This can result in the overpayment of tax at filing time. The IRS or state tax authority usually catches it eventually, but it could take years to get the money returned.”
Miscellaneous mistakes
Marguerita Cheng, a certified financial planner with Blue Ocean Global Wealth, said the top three mistakes taxpayers make, from her vantage point, include:
Incorrect filing status: Taxpayers should choose the correct filing status for their situation, said Cheng. She recommends understanding the five different filing statuses: single, married filing jointly, married filing separately, head of household, and qualifying widow(er) with dependent child. Choosing the wrong filing status can affect the amount of tax owed or the refund due, so understanding the requirements for each status can help you choose the most appropriate one for your situation, Cheng said.
Not using the IRS Tax Withholding Estimator: The IRS Tax Withholding Estimator can help you determine which filing status is best for you and how to fill out your Form W-4 to ensure that the correct amount of tax is withheld from your paycheck, according to Cheng.
Not knowing your filing status: Review your filing status each year, Cheng says. Your filing status can change from year to year based on changes in your personal or financial situation. This can help ensure that you are using the most appropriate status. If you realize that you have used the wrong filing status on your tax return, you can file an amended return using Form 1040X to correct the mistake, said Cheng.
Another common mistake, says Cheng, is automatically selecting the standard deduction without checking to see if itemizing makes sense: Most tax preparation software does calculate both methods to help you determine which one is more beneficial, but taxpayers should make sure to check which is better financially, Cheng said.
Missing tax deductions
Finally, don’t overlook tax deductions, especially premiums for long-term care insurance: Qualified long-term care premiums can be included as medical expenses on Form 1040, Schedule A, Itemized Deductions, or in calculating the self-employed health insurance deduction, according to the IRS.
Of note, the amount of the deduction depends, in one case, on the age of the taxpayer. For example, for taxpayers age 40 or under before the close of the 2023 taxable year, the limit is $480. More than 40 but not more than 50: $890. More than 50 but not more than 60: $1,790. More than 60 but not more than 70: $4,770. More than 70: $5,960.
To claim the deduction, the taxpayer must itemize their deductions on Schedule A of Form 1040.
Bad advice
For his part, Craig Hausz, a certified financial planner with CMH Wealth Management, said taxpayers sometimes make the mistake of getting advice from non-experts such as friends and social media and make decisions without consulting their tax advisers. “Another issue we see is spending money for an unnecessary deduction to save on tax,” he said. “Don’t spend $1 to save 30 cents.”
Not filing for an extension
Bucl says taxpayers sometimes fail to file an extension. “Some people who are unable to get their taxes done just ignore the deadline,” he said. “This is a mistake. The penalty for failing to file is 5% per month for any amount due. The failure to pay the penalty is only 0.5% per month, so much less. I always suggest filing for an extension at a minimum to prevent the higher penalty.”
When it comes to filing for an extension, taxpayers need to know the following information according to the IRS, at least for tax year 2022: Requesting an extension gives taxpayers until Oct. 16, 2023, to file their federal income tax return for the 2022 tax year. To request an automatic extension of time to file, taxpayers can use Form 4868, Application for Automatic Extension of Time to File. This form allows individuals to apply for an additional six months to file their Form 1040, 1040NR, or 1040NR-EZ, according to the IRS.
Overlooking medical expenses
In other cases, Bucl said taxpayers are not deducting medical expenses when their income is reduced. “I see this one often with newly retired folks,” he said. “There is a floor of 7.5% of income before medical expenses are deductible as an itemized deduction. With many retirees, income goes down, and medical expenses increase. These folks are often not in the habit of tracking or deducting medical expenses when they are working because the threshold is usually too high.”
Other common mistakes
According to the IRS, there are several other common mistakes taxpayers make when filing their tax returns. Those include:
Math errors: Math errors are one of the most common mistakes made on tax returns. They range from simple addition and subtraction to more complex calculations. Using tax software should help prevent math errors, but taxpayers should always review their tax return for accuracy.
Missing or inaccurate Social Security numbers: Taxpayers should ensure that they enter their Social Security numbers correctly, as well as those of their spouse and dependents. Incorrect Social Security numbers can delay the processing of the return and any refund.
Misspelled names: Taxpayers should ensure that they spell their names and those of their spouse and dependents correctly. Incorrectly spelled names can also delay the processing of the return and any refund.
Inaccurate information: Taxpayers should ensure that all information on their tax return is accurate, including income, deductions, and credits. Incorrect information can delay the processing of the return and any refund.
Forgetting important paperwork: Taxpayers should ensure that they have all the necessary forms and paperwork before filing their tax return. For example, taxpayers who receive income from a job should receive a W-2 form from their employer. Forgetting important paperwork can delay the processing of the return and any refund.
Julio Lopez-Brito, CFP®, RICP®, MBA, EA, MPhil, is a financial planner and tax specialist with Sensible Money, reviewed this article.
The content was reviewed for tax accuracy by a TurboTax CPA expert for the 2022 tax year.
