When it comes to making your money work for you, transparency is key. Just like it’s important to disclose
potentially embarrassing life events to your wealth advisor, it’s equally, if not more, important to be honest with your tax preparer.
However, that’s not always the case. In a 2011 IRS report, twice as many Americans (8%) believed a little fibbing on tax returns is “fine,” compared to the same survey issued in 2010.
And although it’s true that the IRS doesn’t exactly go after “small potatoes” taxpayers for fibs (generally, you’d need at least $US1 million in assets to interest them), even a few missing details could put your refund in jeopardy.
Here are seven confessions we recommend making:
“I made a nondeductible contribution to a traditional IRA.”
“While nondeductible contributions have no impact on your tax liability in the year they are made, by not reporting these contributions on your return, it’s more difficult to claim these same amounts are not taxable when they’re later withdrawn from the IRA, usually many years later,” says Tim Steffen, CPA and director of financial planning at Baird.
“I’ve earned income outside of my regular 9-to-5 job.”
Whether it’s a lawn-mowing service you keep on the side, or freelance writing gig at your local newspaper, any additional income will need to be reported on your tax forms.
We know. It’s a pain to gather all your 1099 forms and keep track of every dollar and cent that you’ve earned yourself, but it’s a big red flag to potential auditors if you don’t. At least 4 million people were audited in 2010 for under-reporting their income, according to Minyanville.
The IRS uses document-matching programs that let agents cross-check income reported on tax returns against what is reported on forms like a W-2, 1099-INT, 1099-DIV, and 1099-B.
“I converted my IRA to a Roth IRA.”
If you’re among the plethora of workers who’ve decided to ditch the traditional IRA model in favour of a Roth IRA, you’ll need to tell your tax preparer. Since Roth contributions aren’t taxed when you contribute, half of that the amount you converted to a Roth is considered taxable in the year you switch and the other half in the following year.
“I rented out my apartment to get through the housing slump.”
Even part-time landlords are required to fill out a Schedule E form at tax time if they’re planning on claiming deductions, and Minyanville’s Stephanie Christenson stresses the importance of knowing all of the nuances behind the process.
“Real estate rentals tend to reflect losses due to depreciation write-offs, and most of the time, those losses are limited on an individual’s tax return — unless he or she qualifies as a real estate professional,” she writes. “Many taxpayers take the losses on their individual tax returns, and as a result, get audited.”
“I exercised employer stock options (or received restricted stock) and then sold the shares right away.”
Even if the sale didn’t net any profit for yourself, the IRS will still want to see it reported on your tax return, Steffen says. Your broker should issue a 1099-B form with that information included.
“I earned interest from municipal bonds.”
“While that interest is usually not taxable for federal purposes, the interest on some bonds is taxable under the [Alternative Minimum Tax] rules,” Steffen says. “In addition, that interest is usually taxable for state tax purposes.”
“I’ve had credit debt forgiven by debt collectors.”
Negotiating with debt collectors to settle unpaid debts for a lesser amount is a smart way to dig out of debt for people who have no hopes of paying off the full balance. But things get tricky when tax season rolls around.
As far as the IRS is concerned, that debt you got away with is considered income.
“If a debt is canceled, forgiven, or discharged, you must include the canceled amount in your gross income, and pay taxes on that ‘income,’ unless you qualify for an exclusion or exception,” writes Credit.com’s Gerri Detweiler. “Creditors who forgive $US600 or more are required to file Form 1099-C with the IRS.”