DIY Tax Prep Beware
In my practice, I have reviewed numerous do-it-yourself (DIY) tax returns prepared by Turbo Tax, HR Block online or some other software program. Many taxpayers opt to prepare their taxes themselves and this is probably okay if you have a simple tax return (W-2 wages with one state). If you have business income, rental income or multiple states involved, you are better off going with a tax professional. Tax rules can get complicated and penalties too severe if you make a mistake.
Schedule C Mistakes
If you are self employed, you report your business receipts and expenses on Schedule C. From my experience, many taxpayers really do not understand what deductions to legally take. Taxpayers usually either dramatically overstate their deductions or understate deductions for fear of being audited. On the overstated side, I have experienced taxpayers take large write-offs in the other expense catch-all category. These deductions usually stand out immediately and often create a large business loss that generates an audit. Some glaring deductions I have noticed include clothing expense, loan repayments and asset purchases. To reduce audit risk, taxpayers should strive to use all relevant expense categories on Schedule C instead of just lumping everything in the other expense box.
Some taxpayers understate their deductions, particularly in the areas of home office and auto expense. Disbursements that are ordinary and necessary are potentially deductible, but many deductions may only be partially deductible. If you are working from home, you are entitled to write-off a portion of your housing expenses that you use regularly and exclusively for business. This is true even if you meet clients in another office if you perform your administrative duties at home. Many taxpayers fail to claim the home office for fear of audit, but I have not seen this as the impetus of an audit. Auto is another deduction that many taxpayers have difficulty in calculating the business use percentage. Taxpayers can either take the actual expenses or business mileage and you should compute the deduction both ways to determine the greater write-off. Actual expense are likely going to be higher, especially if you are claiming depreciation.
State Tax Mistakes
Turbo Tax software does not seem to handle multi-state tax return preparation very well. These are situations where taxpayers may owe taxes to more than one state, either filing part-year returns or non-resident returns generating a credit for taxes paid to another state. In some cases, I have noticed taxes being paid to the wrong state or paid in the incorrect amount. Also, if there was an error on your W-2 with taxes going to the wrong state, Turbo Tax won’t necessarily be able to alert you on how to fix this.
Some state tax returns are left unfiled altogether by taxpayers. There are a few state forms that cannot be e-filed, for example, the District’s unincorporated franchise tax for non-exempt rental properties and business filings. This is causing confusion for taxpayers as these forms must be paper filed.
Schedule E Mistakes
Taxpayers use Schedule E to record rental income and expenses. By far, the most common error I see is in computing depreciation on the property value. Many taxpayers neglect to take depreciation altogether, resulting in an overstatement of income. Depreciation is likely the most significant write-off and it is non-cash, meaning it can generate taxable losses without impacting cashflow. These passive losses are either suspended (if your income is too high) or can offset other income like wages.
Depreciation is generally computed on the value of the building taken over 27.5 years, as land is not depreciable. Taxpayers are deemed to have taken depreciation whether they have actually deducted it or not and are required to recapture depreciation when selling the property. Depreciation is claimed during the property’s useful life, and must be subtracted from property basis to determine any capital gains on the sale of rental property. Taxpayers who have failed to claim depreciation may seek to amend their tax returns and claim a refund.