Lack of knowledge regarding complicated matters in life creates a sense of mystery which often leads to avoidance, because the thought of tackling the task is overwhelming. Taxes do not need to be mysterious or even confusing. Gaining an understanding of the basic principles and rules will remove the uncertainty and give you confidence to tackle taxes as they come around each year.
Here are basic tax rules that are commonly misunderstood.
- You May Not Need to File. Not everyone is required to file a federal tax return by the tax deadline in the middle of April, even with earned income. Those earning less than the personal exemption and standard deduction combined are generally not required to file. Earners in this range can claim ‘exempt’ status on your W-4 withholding form, eliminating tax deductions throughout the year from your paycheck. Social Security and Medicare will still be deducted based on income. For the 2015 tax year there is a $4,000 personal exemption. The standard deduction is determined by the number of dependents, age and filing status which begins at $6,300 for single filers. The IRS has a complete list here: http://www.irs.com/articles/2015-federal-tax-rates-personal-exemptions-and-standard-deductions.
- You May Want to File No Matter What. Access to a tax refund can only be achieved by filing. Any tax payments are forfeited if you are under the income thresholds and choose not to file. Another reason to file is when you qualify for tax credits. These might be available for those with earned income, even in cases where you did not pay any taxes. The EIC or earned income credit is the most common credit available to low and moderate income families that may be missed, potentially resulting in a refund, even if no taxes were paid.
- Some Deductions Are Available Without Itemization. The technical term is called “above the line” and “below the line” deductions. Above the line deductions are available to anyone filing a 1040 or 1040A. They reduce income prior to the calculation of the AGI or Adjusted Gross Income. Be aware that applying for loans, you want a higher AGI and above the line deductions reduce AGI. If you want to qualify for aid or income dependent scholarships, you want the AGI to be lower. Above the line deductions lowers the AGI, where below the line deductions do not.
Itemization is required for most deductions and benefit the tax payer when they are higher than the standard deduction, which is a set dollar amount that reduces taxable income without itemizing. There are 13 above the line deductions available. A few of the most popular include IRA contributions, student loan interest, moving costs, and educator expenses for teachers.
- 1099 or Self-Employment Income Requires Filing Above $400. Part time and full time income received as a 1099 requires a tax return. 1099s are becoming more common and they are reported to the IRS, making it essential that you report the data as well. Small businesses including sole proprietors, LLCs and S Corps must file if income was higher than $400 whether you receive a 1099 or not. Profitable businesses should file quarterly taxes and pay any anticipated tax liability at that time. This reduces the amount owed at tax time and can prevent a penalty which is accessed if you owe more than $1,000 in April.
- Filing Dates Must Be Met. Missing a filing deadline will result in penalties and interest. Inability to pay should not be a reason to file late. Payment arrangements can be made in the event the full amount cannot be covered by the filing date. Either way, file, and then work with the IRS to get the taxes paid.
- Extensions Relate to Filing, Not Payments. Individuals and businesses can apply for an automatic three-month extension if you are having trouble getting everything together on time. The extension form requires you to estimate taxes and make corresponding payments by the tax deadline. You will then have a few months to make those numbers accurate and file your official return. Filing an extension will prevent a penalty related to a late filing, but it does not prevent penalties and interest from accruing on amounts owed.
- Retirement Contributions Extend to The Tax Filing Date. Traditional IRAs and business accounts such as a SEP or SIMPLE IRAs can accept contributions for the previous year, until the date taxes are due. This is one of the few deductions available to reduce taxable income after December 31. Contributions are available for up to 100% of earned income or $5,500 per year per person. Even non-working spouses can contribute through a special spousal IRA. An additional $1,000 in contributions is available for those over 50. All accounts except Roth IRAs, reduce taxable income and grow tax deferred. The Roth IRA is not immediately deductible, but instead grows tax free.
- IRS Collection Powers Are Extensive. The IRS is not one to ignore. Open and address all correspondence from the IRS. They have the ability to garnish wages and extract funds from your checking account without requiring a lawsuit. When you connect with them and make arrangements, interest and penalties will still accrue, but they will give you time to catch up your bill without taking more drastic measures.
- Online Filing Programs Are Easy. They offer simple step by step instructions and guide you through the tax filing process. You literally input information and answer questions and the program will calculate your taxes. They are incredibly user friendly for simple returns without business income, itemization, or other variables that might complicate your return. This is a simple way to get returns completed and for many, the filing for state and federal might be free. Filing with a tax preparer does not speed up your refund in any way.
- Regardless of Who Files, You Are Liable. It is easy to think one preparer is better than another because they offer a bigger return. It is also a mistake to think hiring a tax preparer will protect you from the IRS if you provide false or inaccurate information to the preparer. They use the information you provide to calculate your return. If you get audited, you are on the hook to prove all your deductions were legitimate, not them. They are only responsible if the calculations themselves were wrong. Computerization has reduced errors in calculations leaving you responsible for maintaining receipts and records for at least 7 years.
Taxes do not need to be difficult or mysterious. Get organized, know the rules, and you will be ready to file. Whether you choose to do it yourself or hire a tax preparer, the more you know, the better information you will have to limit your liability and maximize your refund.
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If you are burdened with high amounts of credit card debt and are struggling to make your payments, or you’re just not seeing your balances go down, call Timberline Financial today for a free financial analysis.
Our team of highly skilled professionals will evaluate your current situation to see if you may qualify for one of our debt relief programs. You don’t have to struggle with high-interest credit card debt any longer.