Taxes
Benjamin Franklin said "In this world nothing can be said to be certain, except death and taxes." Since 1913, income taxes have been a major part of our life (which is actually counter to the Founding Father's viewpoint on taxation). This is one element of our finances that we cannot ignore and will not go away in the forseeable future.
I'm a believer in paying your due and not a dollar more - the IRS or Federal Government have no proven track record at being a good savings or investment vehicle...
Since I'm not a tax expert, but rather a hobbyist with some basic understanding, I include this as a starting point for your own knowledge. The IRS tax code is about 4 times longer than the Holy Bible (and growing), so definitely do your own research or consult a tax professional.
I've been doing my own taxes and most of my parent's tax work for about 8 years. If your situation is not complicated and you do not have any major changes year after year, you could consider doing your own taxes without the aid of software or hiring a professional tax preparer. I was paying $150 per year for a very simple 1040-A return that didn't change year to year, and I felt that I could save some money by doing it myself. If you own your own business or have complicated taxes that involve a lot of various forms and schedules - you could still DIY, but life is too short and you may just want to bite the bullet and hire a pro or use some software.
DIY Tax Preparation:
The things you need are: tax forms (1040, 1040-A or 1040 E-Z), your employer W-2's, any forms you receive in the mail from work or the IRS, last year's tax forms, an envelope, a stamp, and access to the instruction booklets and publications.
Most if not all tax forms for the IRS and individual states are online. Go to irs.gov for Federal forms and your state's tax website for individual state and city tax forms. They come in .pdf format and most can be saved to your computer (strongly recommended).
If you have your previous year's tax forms prepared by your tax professional or printed from Turbo Tax or another piece of software, have this ready as you read and learn where each piece of information is placed. You should also read "What's New" at the beginning of every tax booklet for that tax year to catch major changes in the law that may have an affect on your return.
The instructions should, by itself, guide you line-by-line through your return. It may take a lot longer the first time you do it as you have to navigate worksheets, publications and other forms and materials. Using your previous year's return as a guide really helps answer the thousand things you don't know yet.
A 1040 individual tax return (as well as the 1040-A version) basically work like this:
1. Total income from all sources (wages, income, tips, investment proceeds and taxable interest)
2. Subtract deductions for non-payroll HSA and Trad. IRA contributions, student loans and educator expenses
3. Figure your "Modified Adjusted Gross Income" or MAIG
4. Subtract standard or itemized deductions (must use 1040 to itemize and not 1040-A) and personal exemptions
5. Figure taxable income
6. Figure taxes owed for the year
7. Subtract all qualified credits to reduce taxes owed (child tax credit, retirement saver's credit, child and dependent care credit).
8. Subtract taxes withheld on your W-2, Additional Child Tax Credit (if qualified), Earned Income Credit (if qualified)
9. Figure your refund amount or how much you owe
IMPORTANT ITEMS TO NOT LEAVE OFF:
-Social Security numbers for yourself, your spouse and your dependents you are claiming (make sure you include your Social Security number on ALL forms).
-Dependent information (and make sure you take child tax credits and child care credits if qualified)
-1099 income or 1098 items to claim as income... this is a red flag for an audit, so make sure ALL income is documented
-All legal deductions including student loan interest and educator expenses
-Standard or itemized deduction amount
-Exemptions
-Retirement Saver's Credit - I missed this one (well, my CPA missed this one), so I had to go back and ammend 3 years of returns to get my money. If you qualify and your income doesn't exceed the limitations, your pension, IRA and 403(b) contributions count towards this credit.
-Child Tax Credit and the Additional Child Tax Credit if applicable
-Tax owed and tax withheld through the year
-Earned Income Credit if your earned income is fairly low
-SIGNATURES
-Direct Deposit information
OTHER IMPORTANT TAX CONSIDERATIONS:
REFUNDS
You should not receive a large tax refund, and you certainly do not want to OWE anything at the end of the year! Receiving a large refund means you loaned the IRS your money interest-free for the entire year only to receive it back. In 2014, the average refund was $3,116 (about $260 too much taken out of your check each month!). If you have consistently received a large sum of money each year as a refund, divide that figure by the number of pay periods and that is how much less that should be taken out of each check. I got married and had a baby in the same tax year and we received about $3,500 back, so I had about $250 or so less taken out each month. Large tax refunds are not a windfall... it is simply a bad savings account. Use this money to save and invest throughout the year!
WITHHOLDING CALCULATOR
You can estimate the amount of taxes owed for next year on the IRS website's withholding calculator. Although not 100% accurate and subject to changes in tax laws, this is a good place to start. If you find you missed a credit or deduction on a previous tax year, you can file an amendment going back up to 3 years.
TAXABLE INVESTMENTS
If you use a taxable investment account to save for longer than 5 years, remember to use Total Stock Market or an S&P 500 index fund or tax-exempt bond funds. This will have the least amount of "drag" from taxation. Putting corporate bonds, international funds or high turnover mutual funds in a taxable account will do some serious damage to your tax bill. Be sure all dividends are automatically reinvested. Most Vanguard stock index funds have qualified dividends, which means you are not taxed when dividends are reinvested. If you hold investments for longer than 1 year in a taxable account without selling any shares, you will only pay Long Term Capital Gains when you sell, which is much lower than Short Term (ordinary income) rates.
BUSINESS TAXES
If you own your own business, be SURE to do your quarterly estimates and save around 25-30% of all profits to pay business taxes in a separate savings account. Taxes and accounting are a major cause of almost all business failure.
I'm a believer in paying your due and not a dollar more - the IRS or Federal Government have no proven track record at being a good savings or investment vehicle...
Since I'm not a tax expert, but rather a hobbyist with some basic understanding, I include this as a starting point for your own knowledge. The IRS tax code is about 4 times longer than the Holy Bible (and growing), so definitely do your own research or consult a tax professional.
I've been doing my own taxes and most of my parent's tax work for about 8 years. If your situation is not complicated and you do not have any major changes year after year, you could consider doing your own taxes without the aid of software or hiring a professional tax preparer. I was paying $150 per year for a very simple 1040-A return that didn't change year to year, and I felt that I could save some money by doing it myself. If you own your own business or have complicated taxes that involve a lot of various forms and schedules - you could still DIY, but life is too short and you may just want to bite the bullet and hire a pro or use some software.
DIY Tax Preparation:
The things you need are: tax forms (1040, 1040-A or 1040 E-Z), your employer W-2's, any forms you receive in the mail from work or the IRS, last year's tax forms, an envelope, a stamp, and access to the instruction booklets and publications.
Most if not all tax forms for the IRS and individual states are online. Go to irs.gov for Federal forms and your state's tax website for individual state and city tax forms. They come in .pdf format and most can be saved to your computer (strongly recommended).
If you have your previous year's tax forms prepared by your tax professional or printed from Turbo Tax or another piece of software, have this ready as you read and learn where each piece of information is placed. You should also read "What's New" at the beginning of every tax booklet for that tax year to catch major changes in the law that may have an affect on your return.
The instructions should, by itself, guide you line-by-line through your return. It may take a lot longer the first time you do it as you have to navigate worksheets, publications and other forms and materials. Using your previous year's return as a guide really helps answer the thousand things you don't know yet.
A 1040 individual tax return (as well as the 1040-A version) basically work like this:
1. Total income from all sources (wages, income, tips, investment proceeds and taxable interest)
2. Subtract deductions for non-payroll HSA and Trad. IRA contributions, student loans and educator expenses
3. Figure your "Modified Adjusted Gross Income" or MAIG
4. Subtract standard or itemized deductions (must use 1040 to itemize and not 1040-A) and personal exemptions
5. Figure taxable income
6. Figure taxes owed for the year
7. Subtract all qualified credits to reduce taxes owed (child tax credit, retirement saver's credit, child and dependent care credit).
8. Subtract taxes withheld on your W-2, Additional Child Tax Credit (if qualified), Earned Income Credit (if qualified)
9. Figure your refund amount or how much you owe
IMPORTANT ITEMS TO NOT LEAVE OFF:
-Social Security numbers for yourself, your spouse and your dependents you are claiming (make sure you include your Social Security number on ALL forms).
-Dependent information (and make sure you take child tax credits and child care credits if qualified)
-1099 income or 1098 items to claim as income... this is a red flag for an audit, so make sure ALL income is documented
-All legal deductions including student loan interest and educator expenses
-Standard or itemized deduction amount
-Exemptions
-Retirement Saver's Credit - I missed this one (well, my CPA missed this one), so I had to go back and ammend 3 years of returns to get my money. If you qualify and your income doesn't exceed the limitations, your pension, IRA and 403(b) contributions count towards this credit.
-Child Tax Credit and the Additional Child Tax Credit if applicable
-Tax owed and tax withheld through the year
-Earned Income Credit if your earned income is fairly low
-SIGNATURES
-Direct Deposit information
OTHER IMPORTANT TAX CONSIDERATIONS:
REFUNDS
You should not receive a large tax refund, and you certainly do not want to OWE anything at the end of the year! Receiving a large refund means you loaned the IRS your money interest-free for the entire year only to receive it back. In 2014, the average refund was $3,116 (about $260 too much taken out of your check each month!). If you have consistently received a large sum of money each year as a refund, divide that figure by the number of pay periods and that is how much less that should be taken out of each check. I got married and had a baby in the same tax year and we received about $3,500 back, so I had about $250 or so less taken out each month. Large tax refunds are not a windfall... it is simply a bad savings account. Use this money to save and invest throughout the year!
WITHHOLDING CALCULATOR
You can estimate the amount of taxes owed for next year on the IRS website's withholding calculator. Although not 100% accurate and subject to changes in tax laws, this is a good place to start. If you find you missed a credit or deduction on a previous tax year, you can file an amendment going back up to 3 years.
TAXABLE INVESTMENTS
If you use a taxable investment account to save for longer than 5 years, remember to use Total Stock Market or an S&P 500 index fund or tax-exempt bond funds. This will have the least amount of "drag" from taxation. Putting corporate bonds, international funds or high turnover mutual funds in a taxable account will do some serious damage to your tax bill. Be sure all dividends are automatically reinvested. Most Vanguard stock index funds have qualified dividends, which means you are not taxed when dividends are reinvested. If you hold investments for longer than 1 year in a taxable account without selling any shares, you will only pay Long Term Capital Gains when you sell, which is much lower than Short Term (ordinary income) rates.
BUSINESS TAXES
If you own your own business, be SURE to do your quarterly estimates and save around 25-30% of all profits to pay business taxes in a separate savings account. Taxes and accounting are a major cause of almost all business failure.