5 Costly Tax Mistakes to Avoid

A hand drawing a red circle around the question, How much can you save?

Some mistakes, such as forgetting to pick up your dry cleaning or leaving cardboard boxes out in the rain, can be annoying or frustrating. Other mistakes, though, like ones related to your taxes, can be costly -- sometimes significantly so.

Here are a bunch of common tax mistakes many people make. Learn not to make them yourself and you may be able to save hundreds, if not thousands, of dollars.

1. Not contributing to retirement accounts

If you're not socking away money in IRAs or your 401(k) at work, you're missing out on some valuable tax breaks -- and you may be putting your future financial security at risk, too. There are two main kinds of IRA -- the Roth IRA and the traditional IRA -- that offer two different kinds of tax breaks. The traditional IRA shrinks your current taxable income and gives you an up-front tax break, while the Roth IRA offers tax-free withdrawals in retirement. (Many employers now offer Roth versions of 401(k) accounts, along with traditional ones.) For 2017 and 2018 alike, the contribution limit for both kinds of IRAs is $5,500 for most people and $6,500 for those 50 and older. Meanwhile, a 401(k) has a much more generous contribution limit. In 2018, the limit is $18,500, plus an extra $6,000 for those 50 or older.

The table below shows what you might accumulate over various periods if you sock funds away aggressively and your investments average 8% annual growth.

Data source: Calculations by author.

If you contribute $10,000 to a traditional 401(k) and you're in a 25% tax bracket, you'll avoid paying $2,500 in up-front taxes. If you accumulate $400,000 in a Roth IRA over many years, you may withdraw it without paying taxes on any of it.

2. Not taking tax credits available to you

Many people pay attention to deductions and grab any that they can, while not doing the same for tax credits. That's a shame, because while a $1,000 deduction can save you $250 if you're in a 25% tax bracket, a $1,000 tax credit can reduce your tax bill by a full $1,000. In short, credits are more powerful than deductions.

Tax credits exist for all kinds of things, such as education expenses , energy-efficient home improvements, the adoption of children, the care of children and dependents, and much more. A particularly valuable credit, if your income is low enough to qualify, is the Earned Income Tax Credit , which might shrink your income by more than $6,000. The Child and Dependent Care Credit offers a credit of up to $3,000 for the care of one eligible dependent and up to $6,000, total, for two or more. And the Child Tax Credit offers $1,000 ($2,000 beginning with tax year 2018) for every eligible child you have who is under the age of 17 (as of the end of the tax year) -- subject to some rules and restrictions again, of course.

3. Not using your losses to offset gains

It stinks when you have to pay taxes on your capital gains, but if you're sitting on some paper losses -- perhaps from stocks that have tanked that you haven't sold yet -- you can use them to shrink your tax bill. Sell the holdings before the tax year is up and then you can offset your gains with losses. For example, if you have $8,000 in gains and you sell enough holdings to generate a loss of $6,000, you can pay taxes on only $2,000 in gains. If you have way more losses than gains, you can wipe out your gains entirely, then shrink your taxable income with up to $3,000 of your losses, and then carry over any leftover losses into the next year. (If you plan to buy back any of the losers you sold, be sure to wait at least 31 days, lest you end up with a "wash sale," which doesn't count.) Keep this strategy in mind throughout the year, as there may be particularly good times to sell various holdings for a gain or loss.

4.Not taking your Required Minimum Distributions (RMD)

If you're in your 70s or beyond -- or if you're approaching 70, be sure to take your RMDs on time, otherwise, you can face costly penalties. Some retirement accounts such as traditional IRAs and 401(k)s require RMDs, expecting you to withdraw certain amounts each year. The deadline to take your distribution each year is Dec. 30, except for the year in which you turn 70 1/2. For that year, you have until April 1 of the following year to take your RMD. (It can be better to take it before the end of December regardless, though, unless you want to end up taxed on two distributions in one year.) Many people like setting up their account so that their RMD is sent to them automatically each year.

5.Not hiringa tax pro

Another common tax mistake is not hiring a tax pro to prepare your return. It's not something that everyone has to do, but don't assume that it's not worth the cost for you. After all, most of us don't know the tax code inside and out, and only think about taxes for a few weeks of the year, at most. A good tax pro keeps up with changes to the tax code, is adept at strategizing and finding ways to shrink tax bills, and is immersed in the tax world all year long. Don't just hire anyone, though. Ask around for recommendations. Consider hiring an "Enrolled Agent," a tax expert licensed by the Internal Revenue Service and who is authorized to represent you before the IRS if need be. You might find one through the National Association of Enrolled Agents website.

Spending time reading up on and thinking about taxes is rarely exciting, but it can be quite profitable if it ends up saving you hundreds or thousands of dollars.

The $16,122 Social Security bonus most retirees completely overlook

If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $16,122 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after. Simply click here to discover how to learn more about these strategies .

The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

More Related Articles

Sign up for Smart Investing to get the latest news, strategies and tips to help you invest smarter.