As comprehensive financial planners, we review our clients tax returns every year. And guess what? A lot of people are paying too much in federal taxes. Every year we find errors and missed items which mean that clients overpaid by hundreds, and sometimes thousands, of dollars in taxes than they should have!
1. Required minimum distributions
SPECIAL NOTE FOR 2020! If you are over 70 ½, generally you must withdraw a required minimum distribution from most of your retirement accounts such as IRAs, 401ks, 403b, etc. In 2020, this was requirement was waived, even for beneficiary IRAs. Because many taxpayers took distributions prior to this ruling, the IRS did allow return of those distributions. Unfortunately, the 1099 R (official tax statement whereby the account custodian reports the distribution) only shows the distribution, but not the rollback.
It is up to the taxpayer to provide that information on the return, (or to their tax preparer) to properly provide the taxable portion. Often the rollback is listed on the December statement from your custodian, so we advised our clients to provide their tax preparer with that statement page to ensure they are not taxed on the rollback!
2. IRA contributions
Be sure to include all IRA contributions that you and/or your spouse made for the year. Of special importance are not only deductible contributions to an IRA but any non-deductible contributions as well! Non-deductible contributions should be tracked on Form 8606. This will help you stop paying too much in federal taxes.
While this will not impact your current taxes, you want to track the non-deductible portion so that you are not taxed twice on the same money. Though not as critical, ideally Roth contributions should also be listed on the 8606.
3. Note that IRA contributions are reported on Form 5498
If the contribution was made after the calendar year-end for which it was intended (i.e., IRA contribution for 2020 was made in February of 2021), then Form 5498 may not be sent until well after the tax-filing deadline. So be sure to let your tax preparer know that you made the contribution – this can help avoid you paying too much in federal taxes.
4. HSA contributions
Remember to take report any contributions made. If contributions were made via payroll, that information was likely captured on your W2. But if you made them yourself or made additional contributions outside of payroll deduction, be sure you report those.
5. HSA distributions and your federal taxes
Rarely, if ever, have we seen clients take non-qualified HSA distributions. Yet often they are mistakenly reported as such, and then taxes were paid unnecessarily.
6. Qualified Charitable Distributions
Taxpayers over the age of 70 ½ often can save many tax dollars, especially if they can’t itemize, by making charitable contributions directly from their IRAs. Again, as noted in Item #1, the custodian reports the entire distribution from the IRA on the 1099 R, and it is up to the taxpayer to either deduct the contributions from their gross income, or have their tax preparers do so. This is missed consistently!
Sidenote: No matter your age, you can now take charitable contributions of up to $300 even if you use the standard deduction!
7. Other missed items
Be sure to thoroughly complete the tax organizer your tax preparer has provided! That way, if you provided your tax preparer the proper information and an error was made, then the preparer should amend the form without any charge. We have seen all kinds of other missed deductions, such as a deduction for a dependent, 529 contributions along with any carry forwards (applies only to some state returns), etc. Often this occurs because the tax preparer never received the information!
8. FINAL TIP! Always double-check
Even if you don’t understand all the ins & outs of our federal taxes, I find that one of the best double-checks for catching missed items is to compare your current return to the prior one. If there are differences, think about why these differences exist!
Sometimes the difference is due to a change in your situation (a child is now self-supporting, or you sold your home), or the tax law has changed. But often, this year’s tax return should look a lot like last year’s, and big differences means an error was made. Comparing this year’s return to the previous is a great double-check!
All these tips can help you avoid common mistakes and stop paying too much in federal taxes.