Tax Day comes around just once a year (it’s April 18 in 2016) but staying on top of taxes can feel like a year-round job. Whether you file on your own or use a tax professional, you need to know what your filing obligations might be and how your choices can affect your bottom line when it comes to money. Here are the 10 Things You Absolutely Need To Know About Taxes:
1. You may not have to file a federal income tax return. Not every person who receives income during the calendar year has to file a federal income tax return. There are a number of factors that affect whether you have to file including how much you earned – and the source of that income – as well as your filing status and your age. For most taxpayers, the quick “cheat sheet” formula is this: find your standard deduction and add your personal exemption to that number. You can find those numbers here.
2. Even if you don’t need to file a federal income tax return, you may still want to take advantage of tax breaks and credits. Tax credits are dollar for dollar reductions in your tax due and are usually more beneficial than tax deductions which simply reduce your taxable income. Additionally, sometimes, as with theAmerican Opportunity Credit (AOC) you can get money back with credits even if you don’t owe any tax. If you’re still in school, you may be able to claim the AOC (now permanent) for qualified expenses (generally, tuition and fees): the maximum credit is $2,500 per eligible student and up to 40% may be refundable. The earned income tax credit (EITC) is a benefit for working people with low to moderate income. Despite popular opinion, having kids isn’t a prerequisite but it does increase the benefit: you can claim a credit of up to $503 with no qualifying children and up to $6,242 with three or more qualifying children (click here for more on EITC rates and limits for 2015).
3. You don’t have to itemize to take advantage of certain deductions like the student loan interest deduction. To take advantage of most deductions, you have to itemize – and most taxpayers (2/3) don’t itemize. But all is not lost. The IRS still allows for certain deductions (called adjustments to income) that you don’t have to itemize to claim: that handful of deductions can be found at the bottom of the front page of your form 1040. Among the most popular? The student loan interest deduction, the IRA deduction (see #8) and the moving expenses deduction.
4. If you’re self-employed, you likely need to make estimated payments. Our tax system is considered “pay as you go.” If you’re employed, your employer will withhold taxes from your paycheck and turn those over to the Internal Revenue Service (IRS) for you as you get paid: at the end of the year, you’ll either owe more, break even or be owed a refund, depending on your financial situation. But what if you don’t have an employer or you get paid without having federal income taxes withheld? The IRS expects you to do the work and pay up if you expect to owe more than $1,000 at tax time. This applies not only to the self-employed (including freelancers) but also to landlords, S corporation shareholders, partners in a partnership and taxpayers with significant investments – almost anyone that gets a form 1099. To make estimated payments, you’ll use federal form 1040ES, Estimated Tax for Individuals (downloads as a pdf). Estimated taxes must be paid quarterly. If you skip a payment or pay late, you may be subject to a penalty.
5. You should file a return even if you can’t pay your tax bill. Penalties apply for failure to file a return and failure to pay your tax. To reduce the hit to your wallet from penalties, be sure to file your return even if you’re going to owe and you can’t pay up. Options are available, including payment by credit card and a payment plan with IRS, if you don’t have the ability to pay your entire tax bill by Tax Day.
6. Due dates matter. If you don’t file and pay by your due dates, you can get socked with penalties and interest, which can add up quickly. Your employer and financial institutions have their own set of due datesto get info to you. The IRS also has due dates: there are limits on how much time can pass before the IRS may no longer assess and collect on federal income taxes, sometimes called the statute of limitations. Here’s the kicker: if you don’t file your return, there is no statute of limitations. That means that the IRS can generally assess and collect at any time. To avoid that result, file your return as soon as possible – even if it’s past the due date. If you need to request an extension, you can do so right up to the due date (see #7).
7. An extension of time to file is not the same as an extension of time to pay. If you’re not ready to file your tax return by Tax Day, you can request an automatic extension. The most common way to file for extension is with a federal form 4868, Application for Automatic Extension of Time To File U.S. Individual Income Tax Return (downloads as a pdf), but other opportunities are available. Remember that an extension of the time to file is not an extension of time to pay. There’s no cost to file an extension but if you expect to owe at tax time, you should make a payment with your extension request in order to avoid interest and penalty. If you can’t pay, file on time – or with a timely extension – anyway (see #5).
8. Once the year-end passes, you still have one more opportunity to reduce your tax bill. To take advantage of most tax breaks, you have to act by year-end. There’s one big – and really helpful – exception: funding your individual retirement account (IRA). By rule, you can contribute to your IRA in your filing year and make it count for the previous tax year so long as you act by Tax Day (for example, you can fund your IRA through April 18, 2016, and claim the break for 2015). You can claim a tax deduction – above the line, so you don’t need to itemize in order to take the deduction – for contributions made to your traditional IRA (but not a Roth IRA). You can make those contributions all the way up to Tax Day; be sure to tell your financial advisor that the contribution is for 2015 so that it’s coded properly. For 2015, you can contribute up to $5,500 or the amount of your taxable compensation (whichever is smaller) to your traditional and Roth IRAs. And don’t forget about a spousal IRA: if you file a joint return, you and your spouse can each make IRA contributions even if only one of you has taxable compensation.
9. If you fail to file and pay, the government can take some pretty drastic measures – even seizing your passport. I’m not big on scare tactics because I don’t think they’re helpful. But it is important to understand that taxes are serious business and if you don’t follow the rules, the government does have some tricks up their sleeve to make you comply. If you owe back taxes, the IRS can ding your refund, levy your wages or bank account, and even have the State Department revoke your passport. All that said, in most cases, IRS is willing to work with you to move you into compliance. Don’t ignore letters from IRS: open your mail. And if you do find yourself in a bind, get some help.
10. A good tax preparer doesn’t have to break the bank. I don’t do my own taxes. I used to prepare my own returns but as I got busy, I had to make tough choices – like squeeze in time to do my own taxes or sleep? I went with sleep. I use a tax pro at tax time because it makes my life easier. I realize that hiring a tax pro isn’t for everyone but when making the choice, don’t assume that hiring a good tax pro will be complicated or expensive. Pricing is important but don’t hire just on cost. Ask questions. Get a referral from a friend and check out local ads (but be on the look out for these red flags). Finally, tax pros who prepare returns for compensation must have a PTIN; the IRS has a database that can help you find one near you.
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