While I didn’t spend the last three years in the financial industry as a tax accountant or CPA, I did have to learn about the various rules and implications that affect a person’s taxes especially when involving investments. Every year from December until May my former employer would be extremely busy handling client inquiries and concerns.
With that said, I will say that you can trust my knowledge of personal tax filings but I must provide the disclosure that this website and its contents do not constitute as financial advice and you are solely responsible for providing full and complete information to the United States Internal Revenue Service regarding your taxes. Consult a tax professional for any questions or concerns you may have.
For most people my age we were never really given formal training, on what taxes are and how to file them, at school. We’ve learned from either our parents, friends, family or coworkers that have done it before, or online. This is a shame because it’s an adult responsibility that most U.S citizens are required to do every year and can substantially affect your financial life. As a quick side plug, if you feel that youth should learn financial fundamentals (budgeting, saving, taxes, etc) early on, please donate and or get involved with your local Junior Achievement club. Those kids will be a lot better off because of you.
What are taxes and why do we have to pay them? They are financial “bills” that we have to pay to our local, state, and federal government via the IRS in order to fund public goods and services (police, military, road development, etc). Your “bill” is related to the amount of money you made in a given calendar year, and other factors in a given tax year (Jan-Dec plus Jan-April of next year). Arguably the United States Internal Revenue (tax) Code is long and complicated, but for the average person it doesn’t have to be thanks to the help of your local tax professional, tax software companies such as TurboTax and H&R Block, and various online articles.
So let’s start off with some important terms shall we? Even if you already know this stuff, specific info pertaining to each term is included.
Income – The amount of money you made in a given calendar year (January – December). For most this means the total money you earned from your hourly or salary paid job. For some this also includes the money you earned from investments such as stocks, bonds, mutual fund, ETFs, and real estate. For few this also includes money from self-employed business, partnerships, corporations, and foreign assets.
The key thing to note here: your total income may or may not be completely taxable by IRS standards. It all depends on your tax bracket.
Bracket – The IRS announces around October of every year the tax brackets that tax payers will refer to when determining how much they are going to owe (i.e., how big, small, or non-existent their bill could be). The U.S works off a marginal tax bracket system, which means that the more money you make the more taxes you owe (makes sense). Each bracket has a percentage of tax paid (10%, 15%, 25%, etc) as well as a bottom and top cut-off point of taxable income in which you will either enter the lower tax bracket or the higher one.
The key thing here: While it’s nice to make money, most would prefer to stay in as low of a tax bracket as possible in order to minimize their bill. That said, please do not omit information on your tax filing in order to avoid paying taxes. There are legal ways to reduce your tax bill.
Deductions – The amount of money you can subtract from your total income as non-taxable (i.e., your bill gets lower). Most people take what’s called the standard deduction, which is a pre-defined amount by the IRS that they allow people to deduct from their taxable income. Depending on investments, mortgages, a small business, and or other personal situations, some people may elect to itemize their deductions instead, which means they themselves have to add up all the allowable expenses by IRS standards (and document the appropriate receipts, legal paperwork and bank notes in case they need to prove it later) and then deduct that from their taxable income. It’s more work to itemize, but it may prove more beneficial depending on individual situations. Similar to a deduction is an exemption, which unless you have dependents (or are claimed as a dependent) means you can only claim one exemption. This is another good way to reduce your taxable income, however.
The key thing here: deductions are good and you can’t take both standard and itemize (it’s one or the other). There are also deductions for student loan interest payments, retirement account contributions, and more. Exemptions also exist to lower your taxable income and can be used in addition to deductions.
Credits – On top of deductions are credits given to people who fall under a certain criteria (i.e., married filing jointly with three kids, or above a certain income and paying for tuition). If you got a refund last time you filed taxes and are applying part or all of that refund to your taxes this year, that’s also a credit.
The key thing here: credits are also good but not as common as deductions.
Forms – There are many different important tax forms to have handy when filing taxes. First and foremost is the good ol 1040 or 1040-EZ (the actual form on which you will report your taxable income, deductions, credits, and total tax bill or refund to the IRS). Then comes your state specific tax reporting form. The next most important one is your W-2, which is provided to you by your employer and reports your income, federal and state tax withholdings, and other info. Then it’s a 1095-A,B, or C, which is newer (came along with the Affordable Care Act; Obamacare), and is also provided by your employer. Next is your 1099’s, which report your investment gains and losses, dividends, interests, retirement account redemption, conversions and other things. For students and student loan payers, don’t forget your 1098’s so that you can deduct some or all of your tuition and interest payments. For owners of a Health Savings Account (HSA), that 8889 will help you deduct contributions for qualified future medical expenses. There are many more but you get the idea.
Key thing here: If you get a form, the IRS gets one too. Don’t blind report info to the IRS, wait for the proper forms. If they find a discrepancy later in the future you may be audited and be subject to fines and penalties. If you file too early and find out later you made a mistake, it will cost you money to amend your return. So relax and wait, patience is a virtue.
Timeline of Tax Season
Since you don’t want to be rash in filing your taxes too early and having to pay to amend it later, or be lazy and file your taxes at the very end like most people do and run into issues (based on my previous employment experience), let’s talk about the typical timeline of tax season and what you can expect each month.
[Note that my suggestion for when to file taxes is solely my opinion based on personal experience and does not constitute financial advice]
December – This is the time to review any final organizational charitable donations, beneficiary gifts for college or other expenses for minors, and Individual Retirement Account (IRA) Roth conversions (pre-tax money being converted to after-tax money in order to pay taxes now but let it grow tax free for the rest of its investment life) that you want to make. No forms here, just last minute review and actions.
January – Towards the end of Jan you will start getting the W-2 and 1095 from your employer(s), 1098 from your school or student loan provider, 1099-R from the company holding your investment accounts for retirement distributions made in the last year that will count as income, and 1099-Div for mutual fund dividends you receive. This is also the month in which the IRS usually begins to accept and process tax returns.”Now I can file, right?” Not quite, it doesn’t hurt to wait because some forms don’t come till later.
February – In this time you will most likely receive other forms such such as the 1099-B for brokerage activity (stocks, bonds, real estate funds, and ETFs), your 8889 from your HSA company, and most other relevant forms. “Now can I file?” Eh, if you’re an early bird and feel you have everything you need than this may be a safe bet, but remember that you won’t be able to amend your return if needed without paying money (thereby potentially opening yourself up to an audit in the future as well). How about you use this time to consider making a pre-tax contribution to a Traditional IRA for which, if you qualify, you can deduct up to $5,500 from your taxable income. Add another $1,000 for those of you 50 years or older. Also consider raising the amount of pre-tax money deposited into your 401(k) employer plan from your paycheck each pay period. This will lower your taxable income for next year.
*March*- Any outstanding info or forms should have arrived by this time for the average American with the average tax situation. As such I consider this the most reasonable time to file. It gives you time to go through your forms, fill out your tax return, review any concerns or issues you see pop up, and it leaves you anywhere between 45 and 15 days to take action before the deadline. In addition, this is usually the time to find special discount deals from tax professionals and tax software companies. At the bottom of this post will be a link to a 20% discount from TurboTax.
April – This is the dreaded month for both tax payers and financial institutions. People have an affinity with leaving everything to last minute, and as such create huge headaches for themselves and others. You can’t find your forms, companies have a backlog, you’re worrying about midterms or planning summer vacations, mail gets lost, etc. The deadline to file personal income tax returns is usually April 15, but this year it’s Tuesday, April 18, 2017. I strongly urge you not to wait until April if you don’t have to. You should already have all if not the most pertinent info needed to file by now.
If you are not able to file your taxes by the deadline, don’t worry. You can file for an automatic 6 month extension (in most cases), giving you until October 17, 2017. Please note however that an extension to file your taxes does not mean an extension to pay your taxes. If you think you will owe money, you must estimate, pay, and file a Form 4868 before the April deadline. If you expect a refund, filing an extension may not be needed (best hope you’re right though).
Bill Paid or Refund (reflect and take action)
If you owed money and were able to file in March, you would have already paid your bill and have peace of mind knowing you can go back to your normal life. Maybe even take some time, while the experience and memory is fresh in your head, to plan out how much more money you should withhold from your paycheck via submitting a new Form W4 to your employer so that you don’t owe money again next year.
If you got a refund instead (congratulations) and filed in March, you have most likely already received your refund from the IRS and or your state by the April deadline. For nine out of ten tax payers, it takes less than 21 days for the IRS to debit a refund if the tax payer chose direct deposit into their bank account as the preferable option. Now although I say congratulations, keep in mind that a refund is basically money you loaned to the IRS interest free, because it was your earned money to begin with but it’s not coming back to you until now. So like the person who owed money, take this time to plan out how much less you can withhold from your paychecks going forward so that you come to as a close of a $1 refund as possible next year.
Audit, Penalties and Fees
A less common scenario: What happens if a few years down the road I receive a letter from the IRS saying I am being audited and assessed penalties and fees for not reporting or paying my taxes correctly? I swear I did stuff right!
Relax, this does not automatically mean you are in huge trouble. In fact, during my time at my former employer I saw a number of cases where a client just needed to show a copy of some tax form(s) or cost basis information to the IRS to show that their taxes and payments are indeed correct. Remember that people work at the IRS as well and human mistakes do happen.
On the flip side, if there really is an error or issue in what you reported or underpaid, be prepared to either review the situation yourself and work with the IRS directly or reach out to a local tax professional for assistance. It can be a short or lengthy process depending on the complexity of your tax return in question.
Conclusion, Resources and Discount Links
As a continuation of this article I will write up a Mock 1040 Tax Return so that you can see the step by step process in determining your tax bill or refund. Again, please refer to the disclosure mentioned at the beginning of this post regarding your responsibility to the IRS, and that this website, and its content, do not constitute as financial advice.
In the meantime I’d like to provide you with a link to TurboTax, the software I personally use for my tax needs, that will give you a 20% discount on federal filing products. As such it does not include a discount for state filings. I find the software very easy and user-friendly, especially for people who are not well versed in taxes. The filing process is a picture filled, short question type, guided story (so to speak) that anyone can follow. The link can be clicked here.
It’s worth mentioning as well that students and first time filers who meet certain criteria may be able to file with TurboTax completely free. Feel free to check out their website and or call their customer service for more information. Currently I see a special that if you file before March 16 you will receive an extra $25 off. That’s a tight window to the time of this posting and I would not recommend rushing through your filing just to receive the extra discount. Accuracy is better than promptness in this case.
Finally, here are a few links that I think are beneficial to those looking to self educate and be prepared for next year’s filing. I’ll end by stating that I wrote this article with the average simple tax return in mind. Those with more complex situations, like inheritances, exercised employee stock options, preferred stock, small business retirement plans, rental properties, etc; will want to talk with a qualified tax professional.
Be responsible and use your refund wisely if you get one!
IRS info regarding filing taxes
Forbes article with charts and breakdown of IRS 2016 tax rules
Common Questions Regarding Filing – USA Today
Detailed list of different tax deadlines
Free File with the IRS (I have not used the software before)