Common Mistakes

Gregory J. Cook, EA, CPA+ Accredited Tax Advisor Past President Alabama Society of Enrolled Agents Past President Alabama Association of Accountants

The person has taxable interest income and nondeductible consumer debt interest where the "spread" is negative. A negative spread exists where the after-tax cost of the borrowed funds exceeds the after-tax income from the investment.

Example: A person has an auto loan with an interest rate of 8.5%. The federal tax bracket is 28% and state is 5%. Because the interest is non-deductible, the true cost is closer to 11%. This same person has a CD that is earning 6%. The interest income from the CD is taxable and the after-tax yield is closer to 4%.

Solution; A better use of the taxable income producing investment would be to pay off the consumer debt. The person is carrying a large amount of consumer debt with the ability to obtain an equity loan on his/her home. Solution; Replace the consumer debt with a home equity loan. Reasoning; The person in the example above must earn approximately $ 1.31 to $1.37 in order to pay $ 1.00 of non-deductible interest. If the person can make the interest deductible by transferring the debt to a home equity loan, he will need to earn only $ .63 to $ .69 to pay $ 1.00 of interest!

Homeowners sometimes make extra payments to pay off their mortgage more quickly even as they continue to carry the more costly credit card debt.

Funding a tax deductible IRA while ignoring an employers 401{k} plan which offers not only a tax deduction but also a matching company contribution.

Non-cash charitable contribution. Most person s could donate enough old clothing, furniture, etc., to claim the $ 500 deduction limit IRS allows without filing form 8283.

Failure to participate, or maximize participation in retirement plans such as 401 [k], 403[b], IRA, Roth IRA, SEP, and Keogh Plans. Many person s do not realize how little this costs and how much of the plan is in essence being subsidized by government. There is a misunderstanding regarding the 10% early withdrawal penalty. The investment income earned on the tax deferred savings will generally equal the 10% penalty after 5-7 years.

Taxable Social Security. By utilizing growth stocks and tax-deferred investments, such as annuities and government bonds, taxable Social Security can often be reduced and possibly avoided. If investment income causes more of the Social Security to be taxed, the yield is not only reduced by the tax on the investment income, but also by the additional tax paid on the Social Security Benefits.

Not investing in equity securities.

Neglecting to write a will.