While it’s true that we all make mistakes, most of us try to learn from our errors and not repeat them. At Down South, we routinely see some problems over and over again. That’s why we decided to explore the issues we see most frequently so we can help others learn to avoid these pitfalls.
Love and Marriage
Perhaps the most important thing a taxpayer does is select a filing status. Practically everything else on the tax return is based upon the one chosen, yet many get this wrong. The most commonly used filing statuses are Single and Married Filing Jointly, and both are easy to understand. However, confusion surrounds Head of Household, a classification so often misused that the IRS is giving additional scrutiny to returns using this status.
Unfortunately, Head of Household (HOH) doesn’t simply mean paying the bills to maintain a house or winning a competition on Big Brother. HOH is properly used by taxpayers who are considered unmarried and who have qualifying dependents. Since paying more than half of the household expenses is a requirement, it is very difficult for a dwelling to have more than one HOH. When unmarried taxpayers with children live together, the proper filing status is usually HOH for one and Single for the other. Taxpayers who live alone are not HOH since they do not have a dependent. Whether or not love has led to marriage, there is a correct filing status for every situation.
Like Oil and Water
Just as the right filing status is important for a correct tax return, keeping separate business and personal bank accounts is critical for accurate bookkeeping. Mixing personal and business funds, called intermingling funds, can cause both tax and legal problems. Business owners should establish separate accounts, with separate debit and credit cards, and be diligent about using the appropriate account.
Failing to do so may cause transactions to be reported in less advantageous ways than if proper protocols had been followed. For example, when a business owner uses his personal credit card to buy office supplies it is difficult to prove the money was spent on the business, thereby costing him a valuable deduction for business expenses. Even worse, intermingling funds may lead to business owners losing some of the legal protections that were the primary reason to incorporate in the first place. Many problems can be avoided by treating personal and business funds like oil and water … don’t even try to mix them!
Ask forgiveness, not permission
Business owners who intermingle their funds often don’t know any better. And that brings us to our next point: anyone who is unsure of the tax and/or business consequences of an action they are considering should seek professional advice prior to making any final decisions. Much damage could be avoided with a simple phone call.
We’ve seen parents allow their teenage children to file their own tax returns, causing costly mistakes that must be fixed. We’ve seen business owners get behind in regulatory filings because they don’t understand sales and employment taxes. We’ve also seen taxpayers get slammed with huge tax bills because they didn’t understand the consequences of taking funds out of their retirement accounts. We always prefer answering questions in the planning stages over dealing with the aftermath of uninformed decisions. Sometimes, contrary to the adage, asking for “permission” before acting should be the plan!
Less is More
One action clients routinely take without asking first is throwing away records that should be kept. We’ve discussed how long to keep tax returns , but it’s equally important to keep records that will be needed to prepare those returns.
Taxpayers should keep all documents related to income (jobs, pensions, Social Security, etc.) and receipts for any potential deductions. Investors should keep paperwork related to equity purchases until the stock is sold since brokerages don’t always provide cost basis. Business owners will need all records of income, bank statements, tax forms, receipts for expenditures, payroll records, and much more. The saying that less is more does not apply here; it is always better to keep too many records than risk not having necessary documents.
Hopefully this gives some insight into common mistakes we encounter, all of which can easily be fixed. It is true … to err is human, but to follow good accounting practices is divine!