As a financial advisor and CPA, I like to review my clients’ tax returns before they are finalized. Although most of my clients work with accounting professionals, I almost always catch a mistake.
This isn’t to say the CPAs preparing these returns did a bad job. It’s because I am privy to many more details of my clients’ financial situations, and my clients may not realize how much of that information is relevant to their taxes.
This week, I’ll highlight some of the most common mistakes I see. Review your tax return before filing and double-check these lines to make sure you’ve included as much detail as possible.
Form 1040, Page 1
Box 1: Dependents. Did you have a child this year? Are you caring for a relative in your home who qualifies as a dependent? If so, make sure your dependent is listed under this section. Otherwise, you may miss out on important benefits, like the child tax credit and credit for dependent care expenses.
Lines 4a and 4b: Backdoor Roths. Did you do a backdoor Roth IRA for the tax year in question? If so, make sure that the amount you converted is reported on line 4a but not on line 4b. Anything reported on line 4b is considered taxable income.
If you are not sure why a taxable amount is populating on line 4b, review form 8606, which is where nondeductible IRAs are reported.
Line 10: The qualified business income deduction. If you own your own business or received self-employment income in the tax year in question (including 1099 income), you may be entitled to the qualified business income deduction. This deduction is not calculated on the return itself — it requires a separate worksheet that is not part of the tax return. Request this worksheet from your CPA so you can see how the deduction works and understand whether you received the full benefit or not.
Make sure your dividends are reported accurately. Ordinary dividends are subject to tax at your ordinary income tax rates, while qualified dividends receive capital gains treatment.
Capital losses can be used to offset capital gains and up to $3,000 can be used to offset ordinary income, and any amount remaining can be carried forward to future tax years. Review your prior year’s tax returns to see if you have a capital loss that can be carried over — I’ve seen a few instances in which my clients have forgotten capital losses from one year to the next.
Understand how your Social Security benefits are taxed. Social Security benefits can be taxed at as little as 15% or as much as 85%. Talk to your CPA about yours.
Schedule 1: Additional Income and Adjustments to Income
Schedule 1 is a lengthy document, so let’s go one section at a time.
Part I
Line 1: Taxable refunds. If you itemize your deductions, then you are required to report any taxable refunds received. (If you do not itemize, then you don’t need to report this as income, because you didn’t receive a tax benefit for the expense in a prior year.)
Line 3: Business income or loss. Review Schedule C, where you report your business income from self-employment, to ensure you’ve captured all of your reasonable business expenses. Make sure to deduct these expenses from your business income.
Line 5: Other business income. This line includes real estate income and income from partnerships.
If you are a partner in your medical group, you probably receive a K-1. The information on this document is reported on Schedule E and must be subsequently reported here, on line 5.
If your partnership does not reimburse you for partnership expenses incurred, you may be able to take those deductions on the tax return to reduce your K-1 income. Talk to your CPA about this possibility and ask your group for a copy of the partnership agreement.
If you earn income from real estate investments, make sure to share the details of your real estate business with your CPA. That income should be reported on line 5.
Part II
Line 10: Educators’ expenses. If you are a teacher or educator, you can claim expenses incurred from buying supplies for your classroom.
Line 12: The HSA deduction. The HSA deduction can be confusing. If you are self-employed with a private insurance plan that is HSA eligible, and if you make contributions to that HSA with post-tax dollars, then make sure you claim the deduction on your return.
If you have an HSA through your employer and the contribution comes out pre-tax, then you do not receive a deduction on your tax return, because you have already received the pre-tax benefit.
Line 15: Profit-share contributions. If you are self-employed and have a Solo 401(k) or SEP IRA, make sure you report any profit-share contributions here.
If you are an S Corp and take a salary and make employee deferral contributions to your 401(k), that amount reduces the salary that is reported on page 1 of your return. The employee deferral is not reported here — only the profit-share contribution.
Schedule 2: Additional Taxes
Line 4: Self-employment tax. If you are self-employed and earn income, you are required to pay self-employment tax, which is reported on Schedule SE. Make sure your W-2 wages are reported on Schedule SE along with your 1099 income so you do not overpay on Social Security. Review Schedule SE to ensure the calculation there is correct.
Line 7a: The nanny tax. If you pay taxes for in-home childcare, you report the amount of tax here. Your nanny tax payroll provider will give you the numbers to report. Usually the amount of tax is reported on this line, and any payments you’ve made during the year are reported on Page 2 of your tax return.
Line 8b: Net investment income tax. This is an additional tax imposed on interest, dividends, rental income from real estate, and other passive investments. This tax is imposed once your income exceeds certain limitations.
I usually double-check Form 8960, which is where the net investment income tax is detailed, because I have seen business income incorrectly classified as investment income. Business income is not subject to net investment income tax, as the form name suggests. This tax is only imposed on investment income.
Schedule 3
Part I
Line 2: Credit for child and dependent care expenses. Expenses that you pay to a taxable entity — note that the school or business needs to have a Tax ID number — to care for your child while you work are eligible for this credit.
Your child and dependent care expenses are reported on Form 2441. Often, my clients forget to provide their CPAs with details of the childcare costs they’ve paid throughout the year, including preschool, day care, and summer camps.
Part II
Line 8: Reporting your estimated tax payments. Make sure you report all of your estimated tax payments made during the year. I’ve seen payments missed, which reduces the filer’s refund or creates a liability with penalties and interest.
Double-check the amount from your prior year’s tax return. If you applied an overpayment to the following year, ensure that you receive the benefit of that payment in the current tax year.
Form 1040, Page 2
Line 13: Child tax credits. Review Form 8862, which is where child and dependent tax credits are reported. The child tax credit is $2,000 per qualifying child under age 17. The credit is phased out once your income exceeds $400,000 as a married couple or $200,000 as a single person.
Line 20: Your refund. If you are receiving a refund, congrats! Now decide whether you want your refund now or whether you want to apply it to next year’s tax. A refund makes sense for those who consistently receive refunds each year and would like the extra cash flow. Applying an overpayment to the following year makes sense for those who make estimated tax payments or need to do additional withholding during the year.
Line 23: Taxes you owe. If you owe money, determine why that is and what you can do in the future to avoid a surprise tax bill. Do you need to adjust your withholding on your wages? Should you make estimated tax payments throughout the year?
One of the biggest mistakes I see clients make (prior to working with FIT Advisors!) is not paying enough in taxes throughout the year, resulting in them having to write large checks during tax time. In addition to writing a big check, they may also owe penalties and interest, which can and should be avoided by making payments throughout the year.
Line 24: Penalties. If you owe a penalty, make sure to adjust your withholding or make estimated tax payments to avoid this in the future. There is no need to pay hundreds or even thousands of dollars in penalties.
To understand how much you should have paid in taxes throughout the year, look at line 16, or “total tax,” on your previous year’s tax return. Multiply that number by 110%. Review your current withholding and the estimated payments you’ve made this year, and see if those payments add up to 110% of your previous year’s liability. If not, adjust your withholding or increase the size of your estimated tax payments.
Note that the IRS asks you to pay your liability evenly throughout the year. Withholding always meets this requirement, even if you do it all at the end of the year. Estimated tax payments need to be made evenly or all in the first quarter.
Always Review Your Return Before Filing
If all of this seems overwhelming, don’t worry. Taxes are complex. But the better you understand your own numbers, the easier reviewing your return will become.
The easiest way to start is to take your most recent return and compare it with the prior year’s return. Many CPAs provide a year-over-year comparison, which is a great way to see what changed and what might be a mistake. You can also pull up your own returns and just go through them line by line.
CPAs are human, and mistakes can and do happen. The more sets of eyes reviewing a return, the better the return will be.
