The 7 Most Expensive Errors Taxpayers Make When Using Tax Software

(And One Real Big Disincentive on Their Guarantee)

7. Missing or Incorrect Forms

Even using tax software, it's easy to overlook entering an important item or to answer a question wrong. A seemingly innocent error could end up costing you thousands of dollars and a lot of wasted time. For example, forgetting to mark the box when filling in Form 1099-R showing a distribution from a retirement plan could cause your software to not compute the 10% penalty when it should. Two year down the road when the IRS computer checks your return, you'll get a nasty surprise in the form of a bill plus interest and penalties added.

Sometimes, adding the right form can save you money from the outset. If you have a 1099-C, Cancellation of Debt, it is normally included in income. Unless, that is, you fill out a special form to indicate one of the cases which it is not taxable.

Understanding the Alternate Minimum Tax is difficult, at best. Failing to include the AMT calculations can cause undue stress when the IRS sends correction notices. Certain consumer tax programs don't handle AMT correctly, and as a result, are prone to errors.

Most alarming: the major tax software programs allow you to bypass the interviews altogether and enter information directly into your tax return. This may sound like a big timesaver, but it makes it many more times more likely that you will miss something really important.

6. Wrong basis for sales of assets and investments

Your tax software isn't smart enough to know how much you paid for a stock or other investment. Unfortunately, neither is the IRS. Not knowing the rules on how to calculate the basis of investments causes many people to overtax themselves on sales of their investments. You may not realize, for example, that if you own an Original Issue Bond (OID), you have been paying taxes on the interest every year. You probably have no taxable gain if your bond reaches maturity, yet a lot people incorrectly assume the basis for the bond is the price they paid for it years ago.

Another situation is when you have received an investment through an inheritance or upon the death of a spouse. Seeking knowledgeable help on determining basis can often save a lot of money. Because determining basis can be very tricky and subject to many rules, not all software may have the right questions for you.

Tax software for consumers usually carries some sort of warranty for the accuracy of its calculations. Unfortunately, in order to keep such a guarantee, the software programmers often take very conservative and sometimes simplified choices. Therefore, while you may have a mathematically correct tax return and one that complies with the law, you may not have the BEST tax return.

5. Failure to take legitimate deductions

In a 2003 study, researchers at Texas Tech University found that when novices to tax law (typical taxpayer) were compared to experienced tax students, the novices were more likely to follow the advice of the tax software to remove questionable deductions and to avoid items that may cause an audit. Experienced tax preparers avoided the warning flags and took deductions they knew would be legal, even though they might trigger an audit. Study researcher Robert Ricketts said, "The deduction could be 100 percent legitimate and the taxpayer has proof to back it up, but still could very well trigger an audit flag, which might cause the taxpayer to decrease the amount and actually lose money in the process". In fact, novices overstated taxable income by as much as 50% more than the experienced tax preparers using the same software and the same facts to prepare the return.

4. Incorrectly carrying prior year losses and credits

Nearly everyone who uses a software program to prepare a return had his or her tax return prepared by hand or by another program at some point in the past. This leaves open the possibility that some items that needed to be carried from an old year to a new year may not have been done correctly. Forgetting a carryover of capital losses, for example, may not make much difference this or next year, but a few years down the road when you have a taxable gain, may mean the difference of a few thousand dollars of tax.

Even sophisticated software used by tax professionals costing thousands of dollars doesn't always carry all the information from one year's returns to the next. Professionals, too, area always on the lookout for items carrying forward.

3. Forgotten/Lost tax documents

If you lost or forgot a tax document, you won't get the right answer with your software. If you misplaced your W-2 and rely on your paycheck stubs, you're likely to leave off important codes that can seriously affect your tax return.

No matter what you've forgotten, the IRS gets copies of your W-2's, interest statements and more. If you've forgotten an item that impacts you, you may get a letter from the government asking you to not only pay up, but with penalties and interest as well. Even more disappointing, you may have left off documents that include tax withholding. If the IRS computes your return and determines you left off items that help you, do you think they'll tell you about it and send you a check of their own volition?

2. Failure to have a tax savings strategy

Even if you have entered every bit of raw data correctly, you are still in the mode of "reporting history." There are almost no tax moves you can make after December 31 has come and gone, save for a retirement plan contribution. The trick to real tax savings has less to do with reporting things after the fact than planning on ways to do this to avoid income tax in the first place. For example, if you own your own small business, are you paying salaries to both yourself and your spouse and therefore over-contributing to the Social Security system? Are you allowing your kids to help you in your small business, but not paying them a small wage, too? There are dozens of sound, proven strategies, that, had you known about in advance, could have saved you tens of thousands of dollars over the last 3 years alone!

1. Incorrect Taxpayer or Dependent Social Security numbers

Believe it or not, this is still the Number One error on tax returns, nationwide, year after year. People must forget who they are! Your tax software doesn't know if your SSN begins with 456 or 465, so don't look for it to find the error. Some tax forms (like 1099’s) may even have your wrong SSN number. This is an issue for your dependents, too. The IRS will kick out any taxpayer number discrepancies, and even if your tax return is correct on everything else, your refund can be delayed weeks or months. Very often, you may overlook incorrect numbers on your tax documents simply because it's human nature. You KNOW your SSN, so it must be right, right? If you put down the wrong SSN for a dependent, you may not get the credits you deserve. So, whip out your Social Security card and check your number now!

And here's a BONUS reason why you should not always trust those guarantees that tax software makers offer:

TurboTax® currently offers a "100% guaranteed accurate calculations" policy, which according to Bob Meighan, VP of Customer Advocacy at Intuit, the maker of TurboTax, would extend to calculation errors resulting in an overpayment. The policy provides for reimbursement of any IRS or state penalties imposed because of TurboTax calculation errors, according to Intuit's Web site. It is unclear how the policy benefits a taxpayer who overpays tax due to missed elections. A recent case in which it was discovered that a TurboTax "hint" caused a client to significantly overpay taxes, highlights the uselessness of this warranty. In any case, "there are no penalties or interest when the government owes you $70,000," said Claudia Hill, an Enrolled Agent in California. So, not only was this client out money to have a tax professional go back and do difficult work that should have been done correctly the first time, but he also was out the use of the money for more than 2 years.

In other words, just because there is no penalty levied by the IRS, it does NOT mean the tax return is correct!

When was the last time your computer gave you a strategy to save on taxes for future years?

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