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How to avoid 3 common personal income tax mistakes

Written by Kristen Grau on Feb 02, 2021 | Last updated on Aug 30, 2021
Reviewed by John Kirkland

Avoiding these mistakes can save you from surprise tax bills.

Moving to another state can bring major life changes — and major income tax changes, too.

Knowing what happens to your income taxes when you move, do business in another state or become self-employed can save you money in penalties and tax bills from the IRS.

However, the IRS isn't the only source of those bills. State tax authorities are hungry for revenue, and if you divide your time among different states, you may find it difficult to establish nexus, a connection between a taxing entity and your business, and may even have to file taxes in multiple states.

Below are some of the most common personal income tax issues you might come across.

You didn’t make enough estimated tax payments

Self-employment is the most common cause of this. When you're used to having taxes withheld from your paychecks at work, it can be a shock to have to pay taxes yourself. You can end up owing not just a large amount of self-employment and income taxes, but also penalties for not making estimated tax payments on time. Estimates must be deposited quarterly, or you will face an underpayment penalty.

If your total tax due when you go to file is under $1,000, you won't have to worry about getting smacked with an underpayment penalty. However, it's a good idea to set aside at least 25 to 30 percent of your income for estimated tax payments and commit to paying this amount every month if quarterly taxes are too complicated to figure out.

Other situations like freelancing on the side or rental income while you're still employed can also cause you to fall short at tax time, so make sure to have extra taxes withheld from your paycheck if you don't want to make estimated payments. You should also take state tax payments into consideration.

You didn't correctly file state tax returns after moving

Moving to a state with little or no income taxes like Nevada or Florida can be appealing if your bank account feels squeezed in high-tax states like New York or California. Many people divide their time between multiple states for work or personal reasons, and if it's not just a two- or three-week creative retreat or corporate assignment, it can make nexus difficult to determine in some cases.

With the prospect of a lower tax burden becoming even more appealing, it seems logical to just move to the low-tax state you've been eyeing. But even after you file for a change of address with the postal service, change your voter registration, and get recognized as a resident by your new state, the high-tax state that you left is likely to also still treat you as one.

Typically, you must spend at least 183 days of the year in your new state and maintain a primary residence there. Simply having property in another state won't do if the rest of your family doesn't also live and wait there for you after your work or travel. Where you spend time outside of work also matters because where you sleep every night is ultimately what counts.

If your move is permanent and your residency is valid, you may have to file a part-year resident tax return for the final months you stayed in the old state. You won't need to worry about it for the following years, but keep track of how many days you spent in each state before and after moving day.

You neglected to file state income tax returns as a nonresident

If you have business or rental income in another state, you may be required to file state tax returns as a nonresident. If this income is significant, it can end up producing a large tax bill if you're unprepared.

If you have an out-of-state job, chances are that your payroll provider may also be incorrectly withholding taxes for your appropriate state and/or city. In concentrated regions like the tri-state area, especially for New York City and Philadelphia residents, ensure that city taxes are being correctly withheld if you are a resident, and that withholding curtails if that is no longer the case.

There are usually reciprocity agreements among states and municipalities in areas where state lines cross, but you should carefully check to make sure you don't owe nonresident taxes in addition to what you owe your home state.

The bottom line

Failure to make tax payments on time, and to the right agency, are income tax problems that are often overlooked and can quickly spiral out of control. If you’re running into these issues, you can schedule a free call with a DiMercurio Advisors team member to find the best solution for you.

John Kirkland

John Kirkland

John empowers our clients by educating them on tax rules and processes. When not fighting the good fight at DiMercurio Advisors you can find John cheering for the UCF Knights. Charge On.