“Everybody makes mistakes” is a common saying that many individuals, who end up in a mess they create, normally turn to for solace. Unfortunately, when it comes to taxes, it is acceptable but comes with serious consequences, some that might leave you with a few extra dollars on your tax bill. We can however, learn from every mistake we make in life. Below are some common tax mistakes that tend to haunt taxpayers. If you haven’t committed any of them, ensure that you don’t; they are serious blunders..
1. Errors Related to the First-time Homebuyer Credit
Taxpayers love credits, but the IRS has perfected the art of tightening the rules around every credit they introduce; and first time home buyer credit was not an exception. First, the qualifying home must have been your primary personal residence for not less than 36 months at the time of claiming, (and not 35, 30 or 22). Many rushed to sell their home without understanding the restrictions, only to count their losses thereafter.
Taxpayers who were savvy enough to ask for professional help were guided, some choosing to stay a little longer to qualify as opposed to joining in the excitement only to be hit by reality later. To avoid the repayment, one has to repay the credit up to the value of the profit. If you sell at a loss or even get evicted, it might lead to no repayment or having to repay smaller amounts. Be warned that if the loan you took exceeded the price of the house, it is very possible that you owe more of the credit than you might have projected. Alternatively, rent out some rooms if you cannot afford the house, it allowed.
2. 401 (k) or Retirement Plans Withdrawals
You can withdraw money from your IRA account to cover medical insurance or for a house down payment. As much as you can avoid early withdrawal penalties by doing this, due taxes remain intact. Furthermore, the waiver on penalties is only applicable to IRAs and not job-related plans like 401 (k) or 457. If however you need money badly, you can borrow up to 50% of the account balance ($50,000) tax-free, and pay back yourself over the years. Alternatively, move the funds into your IRAs first from the retirement plans and then withdraw. Finally, get a credit card loan, which has lower rates than federal and state tax penalties.
3. Spouse’s Retirement Funds in Divorce
The Tax Code contain a special provision that allows waiving of penalties and taxes whenever the court orders a distribution from one spouse’s retirement plan that should be paid to the former spouse, a Qualified Domestic Relations Order (QPR). You can evade the 10% early withdrawal penalty by taking the money and cashing it all or cashing it all into the bank account, but you will have to pay taxes on cash you don’t necessarily need currently. The best way out is to split distribution into two funds; withdraw the much you need currently and stash the rest in an IRA.