Watch out. It's a trap!
It's always exciting when you hear those words in the movies or read them in a book. It isn't so fun when you're doing your taxes and your inner voice shouts it. Certainly it isn't an intentional move on the part of the Internal Revenue Service, but making your way through tax forms can feel like you're Indiana Jones in a booby-trapped cave.
So if you don't want to step into a tax trap, you must know where the traps lurk. Careful. They're everywhere. These are only a handful.
Owning foreign assets. You don't have to own property outside of the U.S. to find yourself in a tax trap. Simply having non-U. S. assets, "such as bank accounts, stock of non-U. S. companies and non-U. S. mutual funds" can lead you to trouble, says Stewart Patton, a tax attorney and founder of U.S. Tax Services in Belize City, Belize.
"The IRS has created a complicated web of specialized disclosure forms for U.S. citizens who own non-U.S. assets ... Failing to file one of these forms on time carries a hefty penalty, typically starting at $10,000 per form per year," Patton says.
But on the bright side, Patton adds, "The IRS also has several amnesty procedures taxpayers can use to catch up on delinquent disclosure forms and avoid these hefty penalties."
401(k) rollovers. You really want to be careful here, according to Jeff Jones, a certified financial planner at Longview Financial Advisors in Huntsville, Alabama.
"When an individual leaves an employer, they often will roll their 401(k) over to an individual retirement account -- an IRA," Jones says. "When tax season rolls around, they receive a Form 1099-R indicating a distribution from the 401(k)."
And here comes the trap: "If the rollover was completed properly as a trustee-to-trustee direct rollover, it's likely to be a completely untaxable event," Jones says. "If not careful when completing their return, taxpayers may inadvertently cause part or all of the rollover to be counted as taxable income in that year."
Stock sales. Investments and taxes can trigger plenty of traps, but people especially get in trouble when they lose money on stocks.
It makes sense that you would report gains on stocks, but taxpayers also need to report their losses.
"These sales reduce the gain from other stock or bond transactions, and if these losses exceed total gains for the year, they will then directly reduce taxable income by a maximum of $3,000," says Michael Eckstein, owner of Michael Eckstein Tax Services in Huntington, New York.
This is what's called cost basis -- deciphering how much you paid for a stock so you can report on your taxes a gain or loss on the sale. Cost basis can blow up in a lot of taxpayers' faces, according to George Burns, of Burns and Associates in Pembroke Pines, Florida.
"Many returns seem to get audited ... when the taxpayer either sells property, stocks, mutual fund shares or has an LLC or S Corp, and their return prepared either doesn't calculate basis properly or very often exceeds basis," he says.
Losses, Burns stresses, can't exceed basis. "Too often I hear the broad but incorrect statement, that you can write off or deduct losses," he says. "You can, but subject to strict limits. Exceed basis, and you will pay severely."
Deductions. On the surface, these aren't tax traps, but your greed or fear may turn them into one.
A deduction is a certain amount of money you're allowed to deduct from your gross income. So if you make $70,000 in a given year, and you get a $1,000 deduction for office equipment that you purchased to run the business you started last year, then your taxable income is $69,000.
It's pretty straightforward. Despite the concept of deductions being easy enough to understand, exactly what's allowed to be deducted and what's not can be maddeningly tricky.
Vincenzo Villamena, managing partner of the CPA firm Online Taxman, based in New York City, says, "I see people mostly missing deductions related to job expenses, job-search expenses, investment expenses like commissions and safe deposit boxes and alimony."
So he sees people messing up deductions in virtually every way imaginable. In short, Villamena says, "People are either deducting too much, [putting them at risk] to get audited easily, or too little and missing out on savings."
Standard mileage rate. Do you use your car mostly for business? You might be losing money if you're taking the standard mileage deduction, says Leif Novie, a Miami-based CPA at the public accounting firm Morrison, Brown, Argiz & Farra.
You may be losing money by not going with actual expenses instead, Novie says.
"This often occurs when a taxpayer uses an auto predominantly for business but does not put significant mileage on the vehicle," he says.
Novie points out that actual automobile-related expenses may be repairs, insurance and fuel, depreciation or a leasing expense, all of which can add up. But if you do go with actual expenses, Novie warns, "It's imperative that the taxpayer maintain adequate records to substantiate the deduction."
Otherwise, if the IRS does audit you, and you don't have your records to back you up, you're going to be strung up in a trap of your own making.
Refund advances. And speaking of traps, don't ever accept an advance on your refund from a tax service or take out a refund anticipation loan, urges Christopher Jervis, president of Lone Wolf Financial Services LLC in Conyers, Georgia.
"Refund advances and loans are chock full of extra fees," he says, adding that you shouldn't have to wait too long for a direct deposit or mailed check. "Generally, they release refunds within 21 days of the return being accepted by them."
You waited all year to get your refund check. Do you really want to pay $35 or $50 (a typical charge) to get your money a little sooner? And don't be fooled by tax-preparation services that ask you if you want a refund anticipation check. Those refund anticipation checks allow you to deduct your tax-preparation fees from your refund, which sounds good, but these checks come with a fee. Most critics say these checks are little more than a loan in disguise.
In other words, there are plenty of traps within your tax forms without you stumbling into another trap the moment you finish your taxes. Like Indiana Jones making his way through caves and ancient temples, until you get your treasure -- in this analogy, that would be the refund check -- you're never quite safe.