Every year taxpayers are hit with tax surprises that could be avoided if they just knew the rules. Here are five big ones that are easy to avoid with some simple planning.

Mistake #1. Withholding too little. This results in a tax surprise when filing your income tax return. Don’t be too hard on yourself if this happens to you. Social Security withholdings change each year and not understanding how your employer calculates how much tax to withhold can also contribute to withholding too little.

The plan: Check your withholdings after filing each year’s tax return. Make adjustments as necessary by filing a new Form W-4 with your employer. This is especially important if you have received unemployment benefits or need to make estimated tax payments due to the recent pandemic.

Mistake #2. Inadvertently withdrawing funds from retirement plans. Amounts taken out of pre-tax retirement plans like 401(k)s and IRAs can create taxable income. The most common inadvertent withdrawal occurs when you roll over funds from one retirement plan to another. If done incorrectly, the entire rollover could be deemed taxable income.

The plan: Do not touch your retirement accounts if at all possible. (Exception: When you reach age 72, you may be subject to required minimum distribution rules.) If you do withdraw funds, ensure you have the proper withholdings taken out at the time of withdrawal. Direct rollovers into your new plan are always a better alternative than receiving the withdrawal from the plan administrator and then conducting the transfer yourself.

Mistake #3. Not taking advantage of tax-deferred retirement programs. There are numerous opportunities to shelter income from tax through tax-deferred retirement programs.

The plan: Review your retirement savings options and plan to contribute as much as possible to your plans. Pay special attention to plans that include an employee match component. This attention can reduce your taxable income each year.

Mistake #4. Direct deposit mix-ups. You may now have tax refunds directly deposited in up to three bank accounts. The problem: what if one of the account numbers is entered incorrectly? Unfortunately, unlike replacing a lost check, the IRS does not have a good means of correcting this type of error. There have been instances where taxpayers have lost their refund when this occurs.

The plan: Many taxpayers do not feel comfortable giving the IRS direct access to their bank account. If you are in this camp, the digital deposit problem is solved as you will receive a physical check for any overpayment. If you use direct deposit, avoid depositing your refund into more than one account. Ideally, have a second person double check the account number on your tax form prior to submitting the return.

Mistake #5. Not keeping correct documentation. You know you drove the miles, donated the items to charity, had the medical expense and paid the daycare. How can the IRS be disallowing your valid deductions? Remember that without correct documentation the IRS is quick to disallow them.

The plan: Set up good record keeping habits at the beginning of each year. Create both a digital and paper folder separated by income and expense type. Keep a contemporaneous mileage log and properly document your charitable contributions.

The kids are out of school and summer is well underway. Make sure you understand the rules regarding the tax deductibility of summer activities and related daycare expenses through the use of the Child and Dependent Care Credit. Collecting those receipts now can save plenty during tax time.

What is deductible?

20 to 35% of qualified un-reimbursed expenses with a maximum amount of $3,000 for one person and $6,000 for two or more qualifying persons.

How it works

To receive the credit you must;

• Have a dependent under the age of 13 or have a spouse or dependent who is physically or mentally unable to care for themselves
• Have earned income (wages) to support the dependent
• The expenses allow for care while you work or look for work
• Have qualified expenses
• Financially support and maintain a home for the dependent
• If married, both you and your spouse must be working or looking for work.

Some summer-time tips

1. Daycare expenses are the most common qualifying expense for the Dependent Care Credit.
2. In-home daycare during the summer months also qualifies. Your sitter cannot be a dependent, a spouse or someone under the age of 19.
3. Day camps qualify for the credit.
4. OVERNIGHT camps and summer school/tutoring do NOT qualify
5. Track the mileage of qualified transportation to and from any qualified activity. For instance, if your daycare provider takes the kids on a field trip, the mileage would be part of the qualified activity.
6. Even cooking and housekeeping expenses can count if at least partly for the protection and safety of a qualifying person.
7. Placing your child in a day camp while one of you volunteers at a charity would not work in determining qualified dependent care expenses.

Don’t forget to get the provider’s name, address, and Social Security Number/Tax ID number. Also retain and receipts and canceled checks to support your proof of payment. This information will be required when you fill out your tax return.

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Most taxpayers ignore the federal estate tax, thinking they will never be touched by it. Unfortunately, you do this at your own peril. Why? Because states often have this tax AND politicians have a habit of frequently changing the rules. The best approach for all taxpayers is to understand the basics of the estate tax. Here is a quick summary of common questions you should be able to answer.

Q. Who pays estate taxes?

A. The tax is levied against the estate of a deceased person, which is considered a separate legal entity by the IRS. But the surviving family is effectively responsible for paying the estate tax because it cuts into their inheritance.

Q. What is included in the taxable estate?

A. Your estate includes personal property owned at the time of death, such as a home, cars, cash, collectibles and investments. Investments include securities, real estate, bank accounts and retirement accounts. The total taxable estate is the value of these assets minus deductible expenses and debts.

Q. How are assets valued?

A. The value for tax purposes is generally the property’s fair market value (FMV) on the date of death. Therefore, the basis for computing gain or loss is stepped up to this value. For example, if Diane Monet paid $10,000 for a painting and it’s worth $25,000 at her death, the estate value is $25,000. There are other valuation options in addition to FMV, so this area can get complicated in a hurry.

Q. How is the estate tax calculated?

A. For federal purposes, the tax is 40% of assets in excess of the federal exemption. The federal exemption for 2020 is $11.58 million. The exemption amount is scheduled to decrease to $5 million in 2026. There continues to be an ongoing debate over what this federal exemption amount should be, so it is a good idea to pay attention to future discussions out of Washington, D.C. to understand how it could impact your estate.

Q. Can a married couple double the exemption?

A. Yes. If handled correctly, a couple can effectively shelter up to $23.16 million ($11.58 million times 2) from federal tax in 2020. Remember, this amount is scheduled to be dramatically reduced in 2026.

Q. What is an inheritance tax?

A. Not to be confused with an estate tax, an inheritance tax is paid by those who receive the money from the estate of the person who dies. While there is no federal inheritance tax, six states (Iowa, Pennsylvania, New Jersey, Kentucky, Nebraska and Maryland) could tax you if you inherit money.

Q. What about state taxes?

A. Eight states and the District of Columbia currently have an estate tax. The exemption amounts in these states vary, with one as low as $1 million! If you live in one of these areas you better know the rules and have a plan: Connecticut, District of Columbia, Illinois, Massachusetts, Maryland, Minnesota, New York, Oregon and Washington.

Q. How are gifts to others handled?

A. When you give a gift to someone, the federal government generally does not care. But when the value of all gifts to one person in a given year exceed an annual threshold, you must report this to the federal government. This threshold in 2020 is $15,000. The gift tax rules are currently incorporated into the estate tax system. So careful planning is required in this area, especially if you are providing gifts to help finance various items like someone else’s education.

Does this cover everything about estate taxes? Not by a long shot. But hopefully by understanding some of the basics, you will have a better idea of knowing when to ask for help.

With the tax filing extension giving you until July 15th to file your return, it is easy to overlook ways to avoid receiving a letter from the IRS. Here are some of the most common tax filing mistakes:

Forgetting a W-2 or 1099. The IRS does an effective job comparing W-2s and 1099s they receive from organizations to the amounts you claim on your tax return. If they do not match, rest assured you will receive a notice in the mail asking for clarification.

Duplicate dependent reporting. If more than one tax return claims the same person as a dependent, the second return will be rejected. The IRS does not try to determine which tax return is correct. They leave that up to you.

Forgetting a name change. If you fail to change your name with the Social Security Administration after getting married and you file a tax return with your new last name, be prepared for either a rejected tax return or an adjusted tax return.

Other missing information. When preparing your tax return, often the return is held up because key information is missing. These missing items range from property tax and mortgage interest statements, to confirmations of charitable donations and tuition.

Signing the e-file authorization form. Your tax return cannot be e-filed without proper authorization. After reviewing your return, a properly signed Form 8879 must be received.

The IRS has allowed tax payments with credit cards for the past few years. Is it a good payment method for you? Here is how it works.

Effectively using your investment losses can make a big impact in your taxable income. Why? These losses could offset income that is barely taxed, or it could offset income taxed at 39.6% or higher! Here are some ideas to make those losers into winners on your tax return.

One of the biggest tax benefits available today is the exclusion of gains when you sell your qualified home. Here is what you need to know.

The tax benefit explained

For those who qualify, a married couple can exclude up to $500,000 ($250,000 for unmarried taxpayers) in capital gains from the sale of your principal residence. This exclusion can be taken once every two years as long as you meet a two-years out of five residency and ownership test before you sell the property.

Special situations can cause complications

Often tax planning is required to ensure you maximize this tax benefit. Here are some situations that require a review prior to selling your home.

Given the potential for tax savings, please ask for help before selling your home or vacation property.

Lost in the media storm during the coronavirus pandemic is a law change enacted in late 2019 that eliminates an IRA withdrawal technique known as the stretch IRA. Here is what you need to know.

Time to review beneficiaries

While the chances of you having a severe reaction to the coronavirus are low, it is a reminder of the importance to review your retirement and legal documents. Key among this review should be the beneficiaries you have assigned to all your retirement accounts. This includes reviewing primary beneficiaries and establishing secondary beneficiaries on all your IRAs, 401(k)s, 403(b)s and similar accounts. But it doesn’t stop there, you also need to understand and adjust beneficiaries because of new stretch IRA rules.

The old stretch IRA technique

With the stretch IRA technique, you name a younger person—say, a child or grandchild—as beneficiary of your account. When you die, this non-spouse beneficiary can stretch out receiving the balance of funds from these inherited accounts over his or her longer life expectancy. A stretch IRA could allow withdrawals to go on for decades!

In the meantime, the funds in the account continue to grow with any taxes owed being deferred until the funds are withdrawn.

Current situation

As you can imagine, the federal government wants their share of the earnings built up in these accounts. The old rules could put off the receipt of tax for another 30 years or more! Under the new rules, funds in an IRA or defined contribution plan, like a 401(k), must now be distributed to non-spousal beneficiaries within ten years of the account owner’s death.

What you need to know

This rule change makes assigning beneficiaries for your retirement accounts more important than ever, but the rule does not apply in all cases. The new rules do not apply to:

• A surviving spouse.
• Disabled or chronically ill individuals.
• Individuals who are not more than ten years younger than the account owner.
• A child of the account owner who has not yet reached the age of majority.

So as you review your beneficiaries, be aware of who will be required to withdraw funds sooner using these new rules. Changing your account beneficiaries with an understanding of these new rules can provide significant tax savings.

Consider converting funds into another account type. Fortunately, you can take some of the sting out of the situation by converting a traditional IRA to a Roth IRA. Unlike a traditional IRA, Roth contributions are never tax-deductible, but payouts from a qualified Roth account are 100% tax-free. While you must pay tax on the transfer in the year of the conversion, your heir will not have to deal with getting taxed when taking funds out of the account.

In other words, your beneficiary can arrange to take tax-free withdrawals from the Roth IRA, as long as the account is emptied out within ten years. Not quite a stretch IRA, but still a good deal.

Tax efficiency becomes more important than ever. Should you pay the tax with a pre-conversion to a Roth IRA to save the hassle for your heirs? Should an heir take the money out all at once? How much should you take out of an inherited account each year? Given the progressive nature of our tax system (currently 0% to 37%), taking a planned approach can save you a bundle in tax as the funds are withdrawn. This makes creating a tax plan and reviewing it more important than ever!

In light of all the pandemic uncertainty, this is an area you can review now to not only be better prepared, but to create a strategy that can yield tremendous tax savings for you and your heirs.

The coronavirus pandemic is bringing out the best in most of us. Unfortunately, it is also bring out some of the worst of us as well. Be aware of the following scams.