Every tax season, many fear the tax return preparation process. Preparing and filing your taxes can be complicated and costly; not to mention the impending fear of owing money to the government. Tax season should not be this stressful though. With a little advanced planning and by following a few simple tips, you can make tax season painless as possible. Here’s how to make it through your annual filing obligation and save yourself both time and money.
Tax Season Survival Tip #1: Estimated Tax Payments
I see more people get themselves into trouble with the IRS because they fail to plan ahead. W-2 employees will sometimes misstate their withholding allowance on their W-4 in order to have less taken out of their paychecks. Small business owners and independent contractors sometimes fail to make their required estimated tax payments. Although this provides a greater cash flow during the year for personal and business expenses, this is a double-edged sword. Those who do not properly prepare for their liability often get hit with a big tax bill in April. In addition, there are penalties associated with not timely paying or filing timely with the IRS. In addition to the estimated tax penalty (line 77), the IRS charges a failure to pay penalty for each month or part of the month after a due date that the tax is not paid. If a proper extension is not filed, there is also a failure to file penalty that is associated with the return that increases when the return remains outstanding up to a certain maximum. Those penalties plus an interest that accrues from April 15th can make the decision not to budget during the year an expensive one.
So here is the easy way to make sure that you stay ahead of the curve when April 15th rolls around. For employees, right around the time you get your first paycheck in July, take a look at your year-to-date earnings and withholdings. Compare these figures to the gross income and total tax on your last year’s tax return. Both year to date numbers should be roughly half of the ones on your tax return. This system is not perfect, but this simple check can help ensure you are on the right track. Making a little more money this year or expecting a large bonus? You may want to consider making an estimated tax payment or increasing your withholdings a little bit to make up for the difference. Worst case, is that you get a little extra back when April rolls around. Self-employed? The same check works by taking a look at your net revenue and a little foresight into how the remainder of the year is going to go. It will take you less than five minutes to have a little more peace of mind when you head into April.
Tax Season Survival Tip #2: Keep Receipts and Accurate Records
For many, the task of keeping track of receipts and proof of purchases is a hassle, but is ultimately the best way to ensure you are getting every dollar for deductions that you are entitled to. There is a common misconception that if a transaction is recorded on a bank or credit card statements it is sufficient for the purposes of the IRS. Let us be clear about this up front: You need a receipt for every expense item that you plan on deducting. It is also helpful to handwrite notes on the receipts such as “office supplies” or “gas for business trip.” If you are having trouble keeping all these receipts or are not the most organized person in the world (like yours truly) then start keeping a receipt folder and throwing all your receipts by there. Bonus points for separating them by month or by expense category, but for now, just throw them all in one place and forget about them until it is time to do your taxes. Come tax time, you will have substantiation for every expense that you plan to write off. Hate organizing receipts? There are numerous local bookkeeping options that will likely handle that task for you for very little out of pocket. This way, you will already have nice organized expense categories premade when you walk in to get your taxes done. This will save you from scrambling around during tax time and will prevent the more burdensome task of recreating expense categories by bank statements and memory. Hang on to your receipt folder after tax season and you have a readymade audit defense shield should the IRS come back and start questioning your returns. As a reminder, taxpayers should keep receipts and a copy of their tax return for six years prior to discarding.
Tax Season Survival Tip #3: Life Changes Require Extra Care
Life is often unpredictable and changes in income levels or circumstances can create new challenges during tax time. Individuals who have given or received large gifts, started new businesses, gotten married or divorced, or purchased/short sold real estate may have potential tax consequences that they may be unaware of. While TurboTax may be a good tax preparation option for a standard W2 employee, ultimately it is just software that responds to the inputs that you give it. No one has yet invented a machine that can analyze the particularities of your specific financial situation when calculating your overall tax liability. By not understanding the full tax consequences of an event, you may miss out on valuable tax savings in the form of credits or deductions when inputting your return. Worse is that you may make a mistake so significant that it triggers an audit of your return, which often occurs years later and can add penalties and interest to the cost of the mistake. When there has been a major change in your life, it is always best to consult a tax attorney or CPA who can assist you in preparing the return. Small preparation fees may equate to big tax savings.