7 Tax Terrors and How to Overcome Them

Monday January 14, 2008
by Kay Bell

Admit it. You're afraid of your 1040. That's OK. A lot of us are. And our tax fears, sometimes irrational, sometimes warranted, cause us to do a lot of dumb things when it comes to our annual returns.

Some people put off filing, some don't file at all. But fear doesn't have to paralyze you. Here are seven common tax terrors, how real they are (or aren't) and how you can overcome them.

These fears paralyze many taxpayers, but Bankrate's solutions can help you move through them.

7 reasons taxpayers tremble

1. Afraid I can't do my taxes myself
This fear, unfortunately, is too often justified. And it gets truer every year as federal lawmakers add provisions and pages year after year. The tax law publisher CCH Inc. notes that the 1913 tax code took up 400 pages in its "Standard Federal Tax Reporter." By 2007, CCH filled more than 67,000 pages of that document with tax law intricacies.

"The law is very complicated and filling out the returns is somewhat mind-boggling," says Robert Simon, partner at Eisner & Lubin in New York. "The media keeps telling everyone how difficult it is and people just get panicky. They sit down and start (the filing process) with all this in the back of their minds. I can understand why people would be afraid to do it."

Such fear, says Simon, is nothing to be embarrassed about. "If you ask congressmen who actually wrote the laws, many don't do their own returns," he says. "They're writing policy, not looking at it from an accounting point of view."

The way our tax system works also adds to this fear.

"Many people aren't good with numbers, then once a year they wind up trying to deal with numbers," says Simon. "Any other time you spend money, before you walk out you have someone there telling you what you owe. But when you're doing your taxes, you're doing it yourself. You're telling the government what you owe them."

The remedy: Don't be afraid to ask for help. You have lots of preparer options, from a personal accountant who can fill out your return and help you plan throughout the year to franchise operations that gear up between Jan. 1 and mid-April. If your tax situation is not overly complicated, computer software might be enough to help you file with a bit more confidence. Take a look at your tax needs, then find the tax assistance that best meets them.

2. Afraid I'll overlook a tax break
Even folks who are brave enough to tackle their taxes on their own often face this fear. Again, it's not an unreasonable one. And once again, those folks in Washington, D.C., feed this fear.

Take, for example, the alternative minimum tax, or AMT. This parallel tax system can be quite costly for millions of filers, but rather than make a permanent change to the law, for the last several years Congress has opted instead for a temporary "patch." Even worse, the 2007 law change was enacted so late, it will caused a lot of grief not just for us filers, but also for the Internal Revenue Service. The slow lawmaking process has forced the 2008 filing season to be delayed until mid-February for up to 13.5 million taxpayers.

The remedy: Accept that tax filing is going to take some homework. Before you start your return, check out the countless publications -- including Bankrate's Tax Guide, of course -- so you'll know exactly where this year's taxes might trip you up. Again, you also can turn to software or a tax pro for help in claiming all your possible tax breaks.

3. Afraid I'll make a mistake that will cost me money
This is a close relative of fear No. 2. But here, the fear is not of omission, but commission.

This includes things as simple as filing the wrong tax form. It happens. In trying to get through filing as quickly as possible, some folks opt for the easy, in this case, the 1040EZ, way out and end up cheating themselves.

Or they choose the incorrect filing status, such as single when they're eligible to file as the more tax-advantageous head of household. Those are just a couple of the many mistakes that filers make ever year.

The remedy: Slow down. No longer how long you wait to do your taxes, you still have time to do it right. Read the instructions. If you're using software, don't skip steps just to finish. Answer all your tax pro's questions. If he or she says to provide more information, then provide it. A little extra work and attention to detail could cut your tax bill or get you a bigger refund.

4. Afraid that my tax adviser is incompetent or a crook
You know you need help, but you're afraid that the person you turn to could be more of a hindrance. Unfortunately, sometimes this fear is well-founded.

The Government Accountability Office issued a report in April 2006 with the disturbing finding that in a limited study of commercial tax prep chains in major metropolitan areas, all the returns completed in those offices were wrong to some degree.

Then in April 2007, the IRS alleged that some Jackson Hewitt franchises filed bogus returns for clients, cheating the federal government out of $70 million. The agency obtained court orders to shut down 125 branch offices in Detroit, Atlanta, Chicago and Raleigh, N.C.

Even big name, high-dollar help sometimes produces unexpected tax costs. Remember KPMG? A few years ago that global accounting and consulting firm acknowledged that some of its tax shelters didn't meet IRS standards and agreed to pay the government millions to settle the inquiry. Last month, the law firm Jenkens & Gilchrist announced it was closing its offices across the U.S. in the wake of a nonprosecution agreement it reached with the IRS about tax shelters it offered clients.

By the way, the taxpayers who participated in those companies' questionable shelters ended up owing additional taxes and penalties.

The remedy: Everybody makes mistakes, even tax professionals. The key is to make sure you don't end up paying for your tax preparer's mistakes.

Start with the hiring process. Investigate several potential preparers and thoroughly check out each before you hand over your personal tax documents.

Once you're a client, don't take every recommendation at face value. Ask questions and make sure you understand the answers. Most of all, remember the adage "If it sounds too good to be true, it probably is." There are some tell-tale signs that a tax shelter is in fact a tax scheme that could cost you dearly.

5. Afraid I'll get audited
If fear No. 4 comes true, then this is definitely one to be scared of. Audit fears, however, tend to be much greater than actual audit realities. True, there are some red flags, such as excessive medical or charitable deductions, that might catch an IRS examiner's eye. But overall, the risk of audit is small -- about 1 percent of individual returns were audited in 2006.

So don't let fear of IRS questions keep you from filing. And definitely don't let it stop you from claiming legitimate tax breaks.

"If you're really doing stupid things on your tax return, expect to get audited. Deservedly so," says Enrolled Agent Eva Rosenberg, who is based in Southern California and the Internet's Tax Mama. "But if you're afraid to use a legitimate tax break because you're afraid you're going to be audited, stop it! Stand up for your rights. There's no reason to be afraid."

The remedy: Make sure you can show an IRS examiner why you filed as you did. This means keeping good records, especially if you're self-employed. People who work for themselves and file Schedule C with their returns tend to get scrutinized a bit more, so your business record keeping needs to be more precise.

6. Afraid to e-file because my personal info could be lost or stolen
Slightly more than half of us send in our returns electronically. But that leaves another 60 million, give or take a million, folks who still file the old-fashioned paper way. This fear is one of the contributors to that mind-set.

Yes, identity theft is a major issue. In fact, the IRS keeps careful track of e-mail phishing scams that falsely claim to be from the tax agency. And yes, hackers still manage to break into online financial data systems periodically.

The biggest problem the IRS has had in recent years, though, has been with such information left on laptop computers that were lost or stolen, not with someone compromising the government's online tax database. But that doesn't mean you should ignore Internet safety precautions.

The remedy: Any tax data transference requires two parties. Make sure the starting point of such a relay, your computer, is secure.

"You're one of the end points and the IRS server is the other," says Gary Morse, president of Razorpoint Security Technologies in New York. "Make sure that your personal machine is secure, that it doesn't have any viruses, Trojan horses or any other back-door access points that could be attacked."

This means installing a firewall and virus protection, either as software or a hardware barrier, and then updating it regularly.

Of course, says Morse, taxpayers still must trust the IRS to safely store our data, but at least e-filers can know they did their part in the security process.

As for data losses, almost every computer user knows the frustration of dealing with a crashed machine. Tim Margeson, general manager of CBL Data Recovery Technologies Inc., headquartered in Armonk, N.Y., points to an oft-repeated warning as the surest way to avoid this: Save and back up your files regularly. This is especially important for home PCs, even beyond tax season, because of what Margeson calls "the unique issues -- children and pets and food" -- that the machines face.

You don't need any fancy software to back up your data, says Margeson. "You can just copy the files the same way you copy other material, send it from 'my docs' to a CD or USB drive."

"There's no reason that a computer or data loss should cause filing problems," says Margeson. "The IRS doesn't really accept that as an excuse for a late or no return."

7. Afraid to file because I can't pay
The only thing scarier than filing taxes is what could happen if you don't file. The IRS penalty for not filing is actually worse than if you file but don't pay your tax bill in full.

If you owe tax and don't file on time, the late-filing penalty is usually 4.5 percent of the tax owed for each month, or part of a month, that your return is late. However, if you file on time but just can't pay your tax bill then, you'll generally face a late-payment penalty of only one-half of 1 percent of the tax owed for each month, or part of a month, that the tax remains unpaid.

The total nonfiling and nonpayment penalties could reach a cumulative 25 percent maximum penalty. But if you file your forms on time and then make arrangements to pay, you can avoid taking that hardest tax penalty hit.

The remedy: File! And file on time. If you can't afford to pay your full tax bill, send Uncle Sam at least a down payment. Even sending in an extension request with a nominal payment is better than not filing at all. Then worry about coming up with the cash.

"Never don't file," says Rosenberg. "There's no reason to put yourself in that position. File the return and establish a plan to deal with the consequences of not having the money."

You have payment options. Use a credit card to meet your tax debt, then pay it off as quickly as possible. Go with the card that has the lowest interest rate or a zero-percent rate if possible. The IRS also has payment plans. Though these add interest charges to your tax bill, at least you can be assured that you're meeting your filing and payment obligations.

Face your tax fears early
By now, you should be a little less anxious about that impending return. And by taking a few steps now, you should be able to completely overcome most of these fears by the time your next return is due.

Look at what caused your heart to race and your palms to sweat this filing season. With those fears fresh in your mind, map out a strategy to overcome them, starting now.

"Trying to pull things together at the end of year when you're not organized during the year is not a good idea," says Simon. "You need to plan throughout the year, not in April."

That way, when next tax season rolls around, fear won't be a factor.