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Grab your sharpened No. 2s. Tax season is upon us!
OK, we’re kidding about the No. 2s. (We recommend you e-file.) But the sentiment still stands: let’s face our taxes head on and get them out of the way.
Wouldn’t it be great to enter March with your tax refund in hand?
Whether you are a parent, a student, a home owner, or even all three, we took the tax code and made it understandable. After all, straightforward financial advice is our main goal, even when it comes to deductions and credits.
To get you started, we’ve created a trusty cheat sheet with the top 10 things you must know going into tax season.
1. It’s Best if You E-File
E-filing can save trees, time, and money for the IRS and for you. If you use tax software, the forms you need will be built right in, and if you’re owed a refund, you’ll get it faster. And through a special LearnVest partnership, you can get H&R Block’s basic federal filing package (normally about $20) for free just by signing up for our Ace Your Taxes Boot Camp.
However, there are a few instances in which you must file a paper return. If you need to file a paper return, check out our guide to IRS forms, which will tell you which ones you need for your specific tax situation. Then, read our instructions on how to file. Note that tax refunds this year will be delayed an extra week or two, so prepare yourself.
Read on for more.
2. If You Get One Thing Right, Make It Your Filing Status
Filing status is important because it can determine how much you pay (or save) in taxes. Also, if you get it wrong, it will definitely stick you with a dreaded audit. (Find out what else will get you audited.)
Your filing status basically expresses how you wish to be treated by the IRS, and can determine which deductions and credits you are allowed to take, which forms you should fill out, and more. To make sure you get it right, check out our handy flow chart.
3. The Magic Number Is Your Adjusted Gross Income
As you do your taxes, you’ll see a lot of instructions like, “If your AGI is less than $100,000,″ or “Up to 10 percent of your AGI.”
Here’s how AGI works: We report our income, but then the government subtracts certain expenses, such as education tuitions or IRA contributions, to determine our adjusted gross income or AGI. Our AGI, in turn, determines what credits and deductions we might be eligible for and how big they are. After taking these additional deductions, credits, and exemptions (all of which are described below), we arrive at our taxable income.
Learn to fill out your 1040 and figure out your AGI here.
4. Exemptions Are a Quick Way to Lower Your Tax Bill
Did you know that you get a sort of tax discount just for the fact that you are a contributing member of society, that you’re married, or that you have children? These discounts are called exemptions, and they reduce the income amount you will be taxed on — by $3,700 each in 2011.
This is a simplified example, but say you make $50,000 and you fall into the 25 percent tax bracket. If you can claim one exemption, you’ll pay $925 less in taxes (because 25 percent of $3,700 is $925). Find out more about each exemption and when you can take it.
5. A $1,000 Credit Equals $1,000 in Savings
Unlike exemptions in the example above, which lower the amount of income you are taxed on, credits directly reduce the amount of taxes you owe. So if you owe $3,000 in taxes, a credit will be subtracted from that. To put it another way, if you receive a $1,000 credit, that means you will pay $1,000 less in taxes. It’s sweet and simple — a rarity in the tax code.
Read about credits to find out if you can claim any of the most common ones.
6. Itemizing Your Deductions Could Save You Thousands
One big decision you’ll have to make is about itemizing, and you have two choices. You could:
a. Take the standard deduction. If your taxes are simple, the government won’t make you go through a complicated process to get the deductions you deserve. Instead, you can use the standard deduction, which — like the exemptions we mentioned above — reduces the amount of income you will be taxed on. Most taxpayers take the standard deduction, which is worth anywhere from $5,800 to $11,600.
b. Itemize your deductions. Itemizing your deductions means listing out each deduction you qualify for. People do this when the sum of all their deductions is greater than the standard amount. Some things people might itemize include medical expenses, large charitable donations, and mortgage interest payments.
The standard vs. itemized decision is really a question of money and time. For some people, taking the time to itemize could save them hundreds or thousands of dollars in taxes. But if you don’t need to itemize, then doing so could take up your time without any financial benefit.
Find out whether you should itemize.
7. Audits Aren’t the End of the World
Yes, they are frustrating. But being notified of an audit won’t bring your financial world crashing down. In order to quickly process millions of tax returns, the IRS has certain flags that will automatically trigger an audit. That doesn’t necessarily mean you’ve done something wrong, just that your return has something that might signify you’re trying to defraud the IRS or that you made more than just a simple math mistake somewhere. (The IRS will correct basic math mistakes for you.)
If you did everything correctly on your return, you should be able to prove that you are paying all of your taxes. The IRS will agree with you and leave your return the same, and the audit will be over without any fines or (heaven forbid) jail time. Phew! If you made a mistake, you may have to pay more in taxes, interest, or a penalty.
Find out the top IRS audit triggers, and how to make sure you don’t get in trouble for them.
8. You Can File an Extension For Paperwork, But Not For Payment
If you just won’t be able to file your taxes on time, the IRS understands. (Their reputation for fierceness is a bit overblown.) You can file an extension for the paperwork, which we tell you how to do here.
But, if you get an extension, you can’t put off paying the taxes you owe. You must pay what you estimate you owe. If you just don’t have the cash to pay your tax bill, there are plenty of options, ranging from using your credit card (only for low tax bills!) to setting up a payment plan. Find out what to do if you can’t pay.
9. Sometimes You Just Need an Accountant
We love DIY projects here at LearnVest. And when it comes to taxes, some people absolutely can do their taxes themselves. But some people need the help of a professional to puzzle through the tax code.
Some situations in which you should consider hiring an accountant include:
- Taking complex deductions
- Making noncash contributions to charity
- Being self-employed or owning your own business
- Having a big life change like buying a house or having a baby
- Trading in investments frequently
If you’re still not sure, let our quiz tell you in our free Ace Your Taxes Boot Camp.
10. Do Not Get a Rapid Refund
If you work with a tax preparer, you might be offered a rapid or instant refund. Do not take it.
While it may seem like you are just getting your tax refund faster, this “refund anticipation loan,” as it’s called, is actually a short-term loan — one that likely has a predatory interest rate that will take a big chunk out of your refund; think $50 or more! Read more about rapid refunds.
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