If you're pretending to nod along when your pal's complaining about her taxes, perhaps you need to read this quick cheat sheet by LearnVest that addresses everything you've been wondering about filing.
Exemptions, filing status, and freelance taxes — if any of these have you scratching your head, we can help. We talked to LearnVest Planning Services certified financial planner Samantha Vient for answers to all your (really, not that embarrassing) questions.
1. Are there any benefits to filing early? And what happens if I file after the deadline?
The main benefit of filing before April is getting your tax refund back sooner. But filing really close to the deadline could also cost you money. "If you're working with a CPA and you dump your tax stuff on them two weeks before April 15," Vient says, "most people will charge you a premium." And doing your taxes earlier will mean that if you hit a snag like a missing form or needing to resolve a big question, you have more time to solve it.
Read on for more.
As for filing late, you can easily ask for an automatic extension if you think you won't be able to file on time. But if you were just being absent-minded, didn't ask for an extension, and filed after the April 15 deadline, then you'll owe the IRS fines and interest, which can be a big chunk of cash.
Related: IRS Has $917 Million For You
2. What's the difference between an exemption, credit, and deduction?
Exemptions and deductions work the same way. They reduce your taxable income, which lowers your tax bill. For (a grossly simplified) example, if you take a $1,000 deduction, and you're in the 20 percent tax bracket, you could save $200 on your taxes. Or if you get a $3,800 exemption, that's about $760 less in taxes.
The difference between exemptions and deductions lies in what you get and take them for. You can take deductions for a variety of stuff: student loan interest, charitable deductions, tax-preparation fees . . . the list goes on and on. But exemptions are what you get for people in your family. You get one for being you, one for a spouse, one for each child and one for any other dependents. Read more about exemptions.
Credits work differently. They're a straight-up discount on your tax bill. So if you get a $1,000 credit, you pay $1,000 less in taxes. You get credits for things like having a low income, buying a plug-in electric car, and other stuff. Read more about credits.
3. I'm married but I want to file my taxes as married filing separately, because my spouse and I like to keep our finances separate. Is that OK?
It actually doesn't matter if you and your spouse have completely separate bank accounts, as long as you are married. If you want to file separately, you can, but you might miss out on some advantages that couples who file jointly get. Jointly filing couples get a bigger standard deduction, can take two exemptions, and can take multiple credits like the Earned Income Tax Credit, the American Opportunity and Lifetime Learning Credits, the exclusion or credit for adoption expenses, and the Child and Dependent Care Credit. And filing separately could even lower how much you're allowed to save tax-free for retirement.
But it's also possible you would pay less filing separately, perhaps because you want to deduct medical costs — a very big deduction — and filing jointly would mean your combined income is too high to do so.
We could go through all the pros and cons, but it all depends on your specific situation. You can consult a tax preparer, who can give you a definitive answer on which will get you the bigger refund after looking at your situation. Or if both your finances are fairly simple, online tax filing software will compare your refund for filing separately and jointly.
There's another thing to consider too: Filing jointly puts you on the hook for your spouse's tax debt if he doesn't pay, and any misinformation he puts on his return. If this makes you uncomfortable, even if you just know your spouse's business has complicated taxes, then by all means, file separately.
4. What receipts should I be saving throughout the year, so I can "write them off"?
Let's back up a moment and define this. When people talk about "writing off" items for tax purposes, they mean that they're deducting that expense from their taxable income. (See question 2, above.)
How you take your deduction is up to you: You can either take the standard deduction (from $5,950 to $11,900 for tax year 2012), or you can itemize, listing out a lot of different deductions in the hopes that they add up to be bigger than the standard deduction. So you should only save receipts for things like charitable donations if you're itemizing. Otherwise, don't worry about it. Find out if you should itemize.
But there are some deductions you can take without itemizing. Those include student loan interest, supplies if you're a teacher (though only up to $250), moving expenses, alimony, tuition you're currently paying, and IRA contributions. So, save receipts and records of those regardless of whether you're itemizing.
If you freelance, then you don't need to itemize to write your business-related expenses off. All those things will be listed out on your Schedule C. You can deduct as little as $5 for coffee with a business contact. So save your receipts for gas, taxi fare to meetings, materials, client dinners, and other stuff necessary to running your business.
5. How do I know if I need an accountant? What should I look for?
Whether you need an accountant depends on how complicated your finances are. Going through a big life change, itemizing your deductions, owning your own business, being a freelancer, and having complex investments or stock options are all situations in which an accountant would be a good investment. To get a more definitive answer, take our quiz.
If you do decide to hire an accountant, whoever it is should obviously be certified and registered with the IRS. Ask for their Preparer Tax Identification Number (PTIN). If you're just doing your own personal taxes (not freelancing or business taxes) and you're a full-time employee with simple finances, Vient suggests you go with an Enrolled Agent, which can cost you about 30 percent less than a CPA. More complicated situations call for a certified public accountant.
Next, look for someone with your values and who has gone or is going through your life stage: a parent if you have kids, or an older preparer if you're retired, for example. If you're in your early 30s, a 70-year-old might not be right for you, because they might not be as tech-savvy as you.
Finally, if you own your own business, then you're looking for someone who is skilled in dealing with business taxes. "You're looking for someone to be your personal CFO," Vient says. "They should be excited about your business." And they should be proactive. "They should be emailing you quarterly, and contacting you in October to talk about tax planning."
6. Since I'm freelancing, none of my taxes are being withheld from my paycheck. So . . . what do I do?
If you're a sole proprietor (as in, you're the only one running the "business" and you're not legally incorporated), simulate withholding by sticking 25 to 30 percent of your income in a savings account. You should pay your taxes quarterly to the IRS to avoid fines.
7. I don't have kids or a mortgage. Are there any other big tax breaks I can take advantage of?
You're right; you're missing out on two of the biggest tax breaks. But you might have others. Everyone — really, everyone — should take advantage of the big tax break for retirement contributions. The more you contribute, the less you pay in taxes.
If you're paying interest on student loans or are paying tuition currently, those are two other big deductions you shouldn't miss. Learn more about tax breaks for tuition.
Finally, if you make below a certain income, you could qualify for the Earned Income Tax Credit. It has the potential to wipe out your tax bill completely! If you make less than $20,000, you could qualify. Read about the EITC.
8. I never remember what W-4 withholdings actually mean during tax time. 0? 2? What is that?
They're technically called "allowances," but we know what you're talking about. W-4 allowances are kind of similar to exemptions, but they're not exactly the same. You might have more or fewer allowances than exemptions, depending on your situation. But the short answer is this: the more allowances you have, the less money is withheld from your paycheck in anticipation of paying taxes.
You want to get an accurate number for this by correctly filling out your W-4. If you don't withhold enough, you'll have to scramble to pay your tax bill in April, instead of getting a refund. If you withhold too much, you'll get a huge refund. That's cool, until you remember you could have paid off your debt faster or invested that money.
9. I can't afford to pay my taxes this year. What do I do?
First stop worrying — you're not going to jail. You have several options:
- Put it on a credit card (for smaller amounts)
- Take out a personal loan from a bank or credit union
- Set up an installment plan with the IRS.
- Seek relief from the IRS for the bill
Find out which option is best for you by reading our post on paying a difficult tax bill.
10. Will I get audited? What happens if I do?
The short answer: probably not. If you make less than $200,000, there's a 1 in 98 chance you could be audited, according to 2011 figures. This number might even go down in 2013, with IRS budget cuts due to the sequester.
You're more likely to get audited if you do something that the IRS considers evidence that you're trying to game the system, like taking really big deductions on a very low income or putting in nice, neat round numbers that all end in 00. Learn the most common audit triggers and how to avoid them.
But if you do get audited, it might not be so bad. Most likely, it will be conducted by mail (only about one in five audits involve your showing up in person or an auditor showing up to your business or home), and the IRS will just ask for back-up documentation. That's why you should be very organized and keep your documentation for deductions, retirement contributions, HSA distributions, and anything else you claim around for several years, in case the IRS asks for proof.
11. I realized after I filed that I made a mistake. What do I do?
Cop to it. The longer you wait, the more you'll owe in interest and penalties if the IRS finds out. You'll need to fill out a new 1040 with the corrected information, and a 1040x form. We explain how to do all that, plus when and how you should file an amended return, in our post on fixing a tax mistake.
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