5 common tax mistakes: How to avoid tax debt

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Nobody wants to get into trouble with the IRS. Making any of these five common mistakes will virtually guarantee that you'll run afoul of the IRS and end up with tax debt. Here are top situations to avoid:

Mistake #1: Withdraw from your 401(k) without withholding taxes

When a big credit card bill presents itself, the temptation to pull out your 401(k) and clear up your debt problems can be strong, even overwhelming. That money is just sitting there, you're not near retirement age, and you'd rather get some of these bills off your plate.

Unfortunately, pulling money out of your 401(k) prematurely can actually create more debt -- tax debt, to be specific. Especially if you do not have withholdings taken out of your withdrawal, the tax debt can be quite large.

Remember: you have to pay federal and state early withdrawal penalties on a 401(k) withdrawal before the age of 59 1/2, and those penalties are in addition to the income tax on the actual withdrawal. It is common to owe 35 to 40 percent of a premature 401(k) withdrawal for taxes.

Mistake #2: Don't pay any taxes on business income

Anyone who has a business knows that certain years are better than others. If you have a good year and "forget" to pay any quarterly taxes on your earnings, you're asking for a tax debt problem.

Both the IRS and the state income tax authorities can levy your bank accounts and seize assets to pay tax debt related to your business. That turns a good year bad.

Mistake #3: Don't file your tax return

You'll do the taxes later.

That's fine, but the IRS might just go ahead and do your taxes for you if you don't get it done before the filing deadline. And the IRS, unlike a professional tax preparer, won't be on your side making sure you get the tax deductions and tax credits for which you qualify.

The IRS will assess the maximum tax and send you a bill. The first step to any good tax debt relief plan is to file all unfiled returns.

Mistake #4. Forget to report your stock sale

Maybe you trade stocks on occasion. Sometimes you make money, sometimes you lose money -- and you don't realize that you should report your stock sales on your tax return. That's a big mistake.

You are only required to pay income tax on the profit of any stock sale -- the difference between what you paid for the stock (your basis) and what you sold the stock for (sales proceeds). However, investment companies only report the sales proceeds, not your basis. If you don't report the stock sale on your tax return, the IRS will automatically tax you as if the sales proceeds are all profit.

Mistake #5. Sell your business without reporting it

If you sell your business, take some time to figure out the tax implications. Above all, make sure to report the sale. Negligence in this area can create the impression of tax evasion… an impression that must be avoided if you want to avoid tax debt.