1. Not looking at the big picture. I often have clients tell me that their tax preparer said to do [something] because it would save taxes. Yet it was a bad idea if you look at their finances in the "big picture.” Like donating to charity from an IRA because it reduces their taxes, but donating appreciated stock gives them a tax deduction and saves them capital gains taxes. If they needed to trim a highly appreciated holding, it's a no-brainer and yet many tax preparers don't understand. —
Tara Tussing Unverzagt, South Bay Financial Partners, Torrance, California
2. Signing tax returns without reviewing them. The biggest tax planning mistake a client made was signing her tax return without reviewing it. When she was going through her divorce, she discovered there was a large unpaid tax liability — over $200,000. To resolve this issue, I put her in touch with an enrolled agent to file for innocent spouse relief. —
Niv Persaud, CFP, Transition Planning & Guidance, Atlanta, Georgia
3. Misunderstanding taxation of Roth accounts. A big mistake is to be confused about the goal. Many people think of Roth accounts as tax-free. Roths are not tax-free, they are merely taxed differently. The name of the game is to minimize taxes over a lifetime, not in any given time period. For some, putting [money] into a Roth actually increases lifetime income taxes! —
Chris Chen, CFP, Insight Financial Strategies, Newton, Massachusetts
4. Not taking an RMD Prior to becoming a client, an individual forgot to take a required minimum distribution. The penalty for this mistake is 50%. Fortunately, we took the RMD shortly after the new year. The CPA submitted a note to the IRS indicating that the previous advisor did not notify the client about RMDs so the client was able to avoid the penalty. —
Sterling D. Neblett, CFP, Centurion Wealth Management, McClean, Virginia
5. Not taking depreciation on a rental home. More from a prep standpoint, it's choosing to not take depreciation on a rental home, which causes huge capital gains when sold if not corrected. It was fixed with a complicated Form 3115 change of accounting.
From a forward planning standpoint, I'd say converting or creating unnecessary income that destroys health care premium tax credits and causes a huge payback. Unfortunately, usually not fixable. —
Joseph D. Clemens, CFP, Wisdom Wealth Strategies, Denver, Colorado
6. Mishandling a sale of company stock. A client sold several million dollars worth of company stock with no record of the cost basis. Without record of cost basis, the IRS treated all proceeds as taxable capital gains. We researched each position and detailed the cost basis to the IRS, which saved the client six figures in tax due.
Another client had rental real estate and planned on selling the property to buy another. Client was not aware of the 1031 exchange rules and was in escrow to close on the sale when they contacted me. Without 1031 treatment the client would have owed $250k in taxes on the sale. We quickly identified the property the client wished to purchase and made an offer in order to satisfy the 1031 exchange rule, making the entire transaction tax-free. —
Chris Russell, CFP, Tempus Pecunia, San Diego, California
7. Selling stock for cash to give to charity. A client who is charitably inclined was selling appreciated stock to get cash to give to charity. I suggested he give stock directly to the charity to avoid capital gains. —
Darin R. Shebesta, CFP, Jackson Roskelley Wealth Advisors, Scottsdale, Arizona
8. Under-withholding. A client began working an additional job that provided enough income to meaningfully increase his household income. When he filed his taxes, the client owed for federal and state because not enough was withheld throughout the year.
We suggested that he claim all of the available allowances on the Form W-4 for the highest paying job and claim zero for his secondary job. By doing so, we prevented overpayment of taxes over the following year, putting more money in his pocket, but also avoided underpayment of taxes, ensuring that there was no unexpected tax bill or penalty due the following year. —
AnnaMarie Mock, CFP, Highland Financial Advisors, Wayne, New Jersey
9. Misusing “exempt” status. A client of mine was spending nine months of each year "exempt" and was paying nearly nothing in taxes. It made him feel like he had a lot more money during that time and he saved (and spent) a lot more because his checks were so big. The result was a huge tax bill that came every year. Where did all of that savings go each year? Straight to the IRS. He didn't have a good sense for how much he was really making and was continually in a hamster wheel of paying off taxes. —
Laurie Allen, LA Wealth Management, Long Beach, California
10. Not doing any tax planning at all. Several examples are:
1. Doing a Roth conversion in a year of high income and/or high tax rates — or not doing the Roth conversion in low income/low tax rate years.
2. Selling highly appreciated stock (positive capital gains) and not matching those gains with stock losses — aka harvesting capital losses.
3. Making way too much in contributions to tax-deferred retirement plans and not balancing contributions to tax-free plans, especially in low income/low tax rate years.
4. Ignoring HSAs when one qualifies for them.
5. If a pass-through business owner, not analyzing the most tax-efficient business structure and/or not positioning the business, its earnings, and retirement plan contributions to take the utmost advantage of the qualified business income deduction, if applicable. —
Sallie Mullins Thompson, CFP, New York, New York
With tax time upon us, we tapped our best resources — advisors themselves — to learn about how they’ve helped their clients correct some big tax mistakes. Many were willing to share their horror stories, but here are 10 of the top mistakes by clients.