Overview
Ah, tax season! It’s that time of year when we all get to either receive a nice return or pay what we owe. While it’s an exciting time, it can also be a bit of a headache – especially for investors! Mistakes on taxes can be costly, and even the smallest slip-up, like forgetting to report a capital gain or misclassifying a deduction, can end up costing you big time in penalties and interest. But don’t worry, we’re here to help. Keep reading for a look at some of the most common tax mistakes investors make – and how to avoid them!
Omission of Income
The first mistake investors make is forgetting to report income. This includes income from dividends, interest from bonds, and capital gains from stock sales. Any income from investments must be reported on your taxes. To ensure that you don’t overpay in taxes, be sure to also report the original purchase price of any assets sold, as well as reinvested dividends, and any distributions made from retirement plans. For example, if you received stock from your work that was taxed as part of your W-2, make sure to include that in your cost basis when those stocks are sold.
Failing to Utilize Deductions
Another common tax mistake investors make is failing to take advantage of deductions that can reduce their taxable income. If you have a home office, you may be able to deduct a portion of your rent or mortgage. Additionally, investors who are self-employed may be able to deduct business-related expenses, such as office supplies, travel, or cell phone bills. When spending money on something, make it as habit to ask yourself whether this expense may be “ordinary and necessary” for your business or investment activities.
Misclassifying Investments
When reporting investments on your taxes, it is important to correctly classify them. For example, if you own rental real estate, be sure to report the income and expenses on Schedule E as a rental activity. If you have a side-hustle, be sure to report the income and expenses on Schedule C. Incorrectly reported income and expenses can result in unnecessary taxes and even penalties and interest.
Overlooking Tax Credits
Tax credits are a great way to reduce your tax liability, however many investors overlook them. One example is the Foreign Tax Credit. This credit allows taxpayers to claim a credit for taxes paid to foreign governments. One way to minimize the risk of overlooking this tax credit is to send the entire investment 1099 package to your tax preparer. This way, they can look at all the details and capture any applicable credits.
Failing to Time Capital Gains
Timing the sale of investments can be an important strategy for reducing your tax bill. By timing your capital gains you can reduce your overall tax liability. For example, if you are in a lower tax bracket, it may make sense to sell investments to capture zero or lower long-term capital gains taxes. If you are expecting some large capital gains, consider harvesting losses from other investments to offset the tax liability.
Not Taking a Charitable Deduction
Another common tax mistake investors make is forgetting to take a charitable deduction. Donations to charities are tax deductible and can reduce your taxable income. Additionally, if you donate stocks or mutual funds, you can deduct the full market value of the donation while avoiding capital gains taxes. This can be a win-win..
Conclusion
Tax mistakes can be costly, but with a little bit of preparation, you can avoid them. By understanding the deductions and credits available, as well as the timing of capital gains, investors can reduce their tax liabilities and maximize their returns.
