Common Tax Pitfalls to Avoid This Filing Season

Lesley: Welcome everyone to our next webinar on our series. I’m joined with Andrew Randisi and Christopher Mallon, they’re both certified financial planners here at Pennsylvania Capital Management. Today we’re gonna be talking about tax pitfalls. We’re all coming up on tax season here, filing our tax returns, so we wanted to give you just some things to keep an eye out for as you’re getting ready to file your tax returns.

Andrew, you wanna start us off?

Andrew: Sure. First wanted to we’ll call it, ask the audience what do we think are, and I’ll help Lesley and Chris, I’ll have you, I’ll have you draw straws on who wants to tackle this question first. What do we think are the, we’ll call it top five most common math errors that the IRS sees on people when they’re filing their tax returns.

Lesley: Don’t call on me ’cause I have the answers in front of me so it wouldn’t be fair.

Chris: Yeah, I think I’ll take one just from knowing from what clients have run to the, and then this happens less and less now, but [00:01:00] it’s mostly if someone’s doing these by hand, right? So good old, pen and paper.

I’d say it’s pretty rare now just with the software available. Is just doing the calculation on the actual tax owed wrong. Sometimes the marginal the marginal tax rates with the different brackets and everything can, if you’re just doing it by hand, can be a little bit cumbersome to deal with.

Yeah, it’s just plain old math issues. That’s why, if you’re using any sophisticated software or hopefully you know, an accountant they’ll those math mistakes are missed.

Andrew: That tax calculations are the, are number one, followed by, second would be adjusted Gross Inc, adjusted, calculating your adjusted gross income and taxable income.

Three and four kind of go hand in hand because it often happens to a lot of us that have children would be calculating your child tax credit and also calculating the earned income tax credit. That usually winds up getting messed up a lot. And also the IRS usually pays extra careful [00:02:00] attention to those returns ’cause those are often the returns that can be sought for fraud with a lot of those hackers trying to steal money from the government. And then last but not least, the other common math error we see most is taking deductions. Sometimes we’ve even seen clients be a little bit too judicious with how they go about taking their deductions.

Not everything is necessarily deductible. But let’s now get into it on what are the often common pitfalls we often see, one of the very first ones we see is missing investment income. This happens a lot for if you have a brokerage account, a bank account that is generating, whether it be interest or dividends.

Your custodian brokerage bank will send you a 1099, whether bank, 1099 INT, fidelity or a Schwab will send a 1099 div at the end of that theme in the beginning of the following year for last year’s taxes. Oftentimes if you don’t know you had one, these often get missed. For [00:03:00] one if it’s technically, sometimes you don’t think it might be generated, but the banks are usually pretty good. If it’s over 10 bucks they are legally required to generate one and report it to the IRS, and oftentimes we see these get missed, especially if new accounts get opened or new accounts get transferred.

Lesley: Great. Chris, how about the next one?

Chris: Yeah, next is also one that it it’s something that happened with, I’d say do it yourself first.

Most more likely selling investments too soon, especially ones that are at gains. This is usually more of an issue. So there’s a pretty significant difference between the taxable, the tax bite hit if you sell an investment within one year versus waiting past one year. So for example, if you are, if you hold an investment pass one year, you’re most, more than likely, I’ll make some assumptions here, paying about 15% in capital gains tax. If you sell it within one year, it is not categorized as a long-term. Capital gain is short-term capital gain, which means it’s tax at your ordinary income rates. [00:04:00] So if you’re in that 20 ish percent tax bracket on your ordinary income, then you’re gonna be paying, five plus percent more in taxes on the gain if you sell within a year.

So we, we will see this happen if and maybe there’s a circumstance where if you’re buying something and then you get a quick, fast return, then yeah, go ahead and maybe sell, just know, going with clear eyes that you’ll be paying some more taxes on it. But again, that’s why investing for the long term is, there’s different incentives out there and taxes is one of them.

Lesley: Yeah, absolutely. Pretty big difference between that short term and long-term gain rate for sure.

Chris: And there’s some nuance there too. If you are a higher earner, you’re making over, $ 250,000 with the MAGI modified adjusted gross income as a married couple or $200,000 as a single filer.

There you can be some, extra 3.8% in that investment income tax that might come into play. Yeah, so it’s, it usually pays to wait a little bit on those investment returns, unless you’re a day trader. But that work case, then you’re, you’re probably not watching this. We’re worry about your short term capital [00:05:00] gains taxes.

Lesley: All right, Andrew, what’s next on the list of tax pitfalls?

Andrew: The next one that we also see a lot, and this also, this happens with a lot of clients who have older positions, is gonna be poor record keeping. With custodians now there’s what’s called, or the IRS has determined what’s there, is covered and non-covered.

So if you would’ve purchased shares from a brokerage firm after 2011, for the most part, everything would be covered, meaning your brokerage firm, Schwab, Fidelity, Vanguard, they’d be required to track the purchase prices, your cost basis, as with each position as you’ve been buying and selling various stocks and mutual funds.

Anything prior to that was uncovered. So at that point, the, if the custodian didn’t do it. The burden of proof of tracking your cost base is if you were to sell a position along the way, falls on you. So it would be good to make sure if you have something rather older positions, if you have, whether it be an old [00:06:00] trade confirmation or a schwa or a span or a state investment statement that would’ve had the cost basis from years prior, we can go, you can go back in and be able to have that proof when it comes time to sell, your taxes on determining what your capital gains are.

Lesley: Good, good point. Especially for those, as you said, those older positions, ’cause the IRS will come after you if you try to claim, you didn’t make any gains on that, prove that you didn’t make any gains on that.

Andrew: Or if there is a gain we often see a lot, we’ve had this happen with clients, we, there is a gain.

And it’s not the IRS says, oh, it’s not long term, it’s short term. Prove me wrong that it’s not short term. So then you have the burden of proof falls on you of determining, okay, 15 year, 20 20 years ago I purchased 10 shares of Apple at what would it be? A few dollars a share at that point to determine that the gain was indeed long term versus short term.

‘Cause that’s, that is big dollars from what Chris mentioned above on the difference in the tax brackets between selling too soon ordinary [00:07:00] versus those short-term, which are versus long-term capital gains tax brackets.

Chris: Next up we got forgetting losses. So this would be sitting on losses in your taxable brokerage account, especially going into the end of the year. So we’ll see this and we do this internally, we do tax loss harvesting, really any position that our loss is above a certain dollar threshold, we’ll make sure that we sell and rotate out of, to capture that loss.

‘Cause that loss can be used to offset, capital gains that have been accumulated throughout the year. As well as the first three, $3,000 can be used to set off to offset ordinary income. One day they’ll adjust that for inflation. That’s been the case for I don’t know how many years, Andrew?

20? 15? years on the $3,000 for offsetting ordinary income with capital gains losses.

Andrew: Yeah, it’s been like that for a few decades now.

Chris: Yeah. But yeah, so that’s important ’cause especially if you say you’re sitting on, say there’s a thousand bucks in losses in there and you have no gains for the year that you’ve taken, tax gains on it’s good to sell [00:08:00] ’cause that’ll help offset your, your regular ordinary income taxes when you go ahead and file.

So that’s something we’ll see missed a lot. A lot of people forget that there’s, deadlines with that and we’ll just sit on investment ’cause. It’s easy to get wrapped up in the, oh, I don’t wanna, sell, if something’s down, I want it to, get back to even, or turn into a game.

But it’s important to capture those losses. Those losses are an asset.

Lesley: Yeah. I love that line that losses are an asset. Yeah.

Chris: Silver it’s a glass half full thinking of a, yeah. Losing on an investment.

Lesley: True. Yeah. All right, Andrew, what’s next on our list?

Andrew: The next one would be waiting too long to strategize.

And a lot of this usually pops up for on the brokerage. I would say on the invest on the investment side would be waiting too long to do any tax loss harvesting or gain loss harvesting. So as an example of what Chris just mentioned if you’ve realized a lot of gains throughout the year, whether it be working with selling your stock portfolio, or you might have sold an investment property or anything else [00:09:00] outside that would’ve generated long-term capital gains. At the end of the year is a good opportunity. If there are losses in your portfolio, you can take them and those losses can be used to offset the current, your current realized long-term capital or short-term capital gains.

If you decide to wait too long, and don’t look at this until January. You are outta luck on trying to go back and being able to do any reducing taxes for reducing taxes by using tax loss harvesting for 20 for the previous year. Flip side, if you have a lot of losses from carry forward, as Chris mentioned, that $3000 you can deduct right off $3000 against ordinary income.

The rest gets carried forward. There could be opportunities where you might want to. Take capital gains and raise them. Whether it’s be meeting cash for the beginning of the year or wanting to use some of the just produ, rebalance your portfolio generally. You have that, those losses to be able to be used at the end of the year to be able to take some gains.[00:10:00]

Lesley: Yep. So good to strategize your gains and losses throughout the year and not just wait till, oh shoot, it’s tax return time maybe I should have thought of this in December.

Andrew: Yeah. And then there’s also some strategies that could be deployed throughout the year where you don’t have to necessarily look at it.

Direct indexing is one where direct tax loss harvesting is not being done, at year end, it’s being done daily. So that also kind, that also will definitely help.

Lesley: Great.

Chris: And next up we got wash sales. So this is something to be careful of especially if you are actively trading. So if you’re, if you’re going in and rebalancing your account once or twice a year and not really messing with it, this isn’t something you’ll come across very often.

This can happen if you are, so you sell something at a loss and then you buy that same, ETF or stock back. So you sell, Apple at a hundred dollars a share, and then you buy it back the next day at $90 a share thinking like, oh, I sold it. I have this $10 loss [00:11:00] that I can use for, taxes.

The, unfortunately, the answer to that is no. You have to, you’d have to wait a full 30 days before going back in to repurchase it to get that lower cost basis and to actually keep that loss on your books. So yeah, that’s why it’s called a wash sale. ‘Cause it washes out that loss gets added back on your basis, essentially would stay the same as you had purchased it at, the a hundred dollars a share.

So again, at the end of the world, it’s not, the worst thing. As long as you’re cognizant of ‘ Hey, I’m not gonna be able to capture that loss’. Just know that, if you wanna buy something, you want to capture the loss. Wait at least 30 days before going back to, something that you believe that you believe in.

One important caveat here. This doesn’t apply to crypto currency assets. It’s gonna coming up more and more If you have, Bitcoin held at Coinbase or something like that wash sales don’t apply. To crypto assets. So you can in theory sell it, capture loss, and purchase it back and not have to, and still be able to keep the loss.

But that’s, specific to different crypto assets.

Lesley: Sounds good. Andrew, what do [00:12:00] we have next?

Andrew: Next would be not taking advantage of tax breaks that need to be eligible for. Few examples would be if you have children seeing if you qualify for the child tax care credit. Or if your kids are a little bit older, the dependent care credit or the dependent credit.

If you make depending upon where your income might fall, you could also additionally be eligible for the retirement contribution credit or the earned income tax credit, which is often a credit that gets used by a lot of lower income families. And then there’s also some other things when it comes to deciding whether you are taking the standard deduction or you’re itemizing.

Standard deduction is fairly high now since the new tax, since the couple tax bills that have passed in the last decade or so, but. It is still good to go through the exercise. I know the accountants will usually ask for it, or TurboTax will ask for it as well. Going through the exercise of adding up all your itemized deductions, that might include the mortgage interest you’ve paid, outside medical bills, donating to charity real estate taxes that [00:13:00] you might have paid for to state and local for state and local income. Doing a comparison there to make sure you are indeed getting the higher of the two. That is important ’cause we’ve seen a lot, client doesn’t wanna forgets to itemize and the itemize actually might have been a few thousand dollars higher than the standard deduction.

Lesley: Yep. It’s a good idea to go through the exercise and check it out. Good. Thanks Andrew. What’s our last one, Chris?

Chris: Yeah. Last one is just simply forgetting deadlines for things. So one is obviously making sure, you file on time. You don’t necessarily have to, pay, right? It’s make sure you file at the very least, ’cause then you avoid the, non file penalties, which can be quite can be quite onerous to deal with. So yeah. And then just being aware of, okay, these are my deadlines for IRA contributions, HSA contributions, those can be made until tax time, but then other things, mortgage interest, the investment losses things like that are throughout the calendar year.

So yeah, just being aware of when deadlines are so you don’t [00:14:00] miss filings and therefore, give up your hard-earned money in penalties. And then being aware of when, different contributions need to be made so you can take full advantage of the, tax benefits that those offer.

Lesley: Great. Thank you both very much for going through the list. Can you pop up our dis disclaimer slide, Chris? Just to remind everybody, we are not tax accountants. We are just giving you some suggested things to keep an eye out for on tax pitfalls and if we can answer any questions here at Pennsylvania Capital Management, please reach out to us anytime.

Thanks for joining us. Bye-bye.