The dread that surrounds the issue of taxes can be attributed primarily to taxpayers' fear of the unknown. A surprising number remain confused about basic tax knowledge, preferring instead to transfer full ownership of their returns to a seasoned professional or computer system.
TUTORIAL: Personal Income Tax Guide
If tax season had you tied up in knots this year, you're probably glad it's over - but you can prevent the same thing from occurring again next April. Learn to master these fundamentals of filing your tax return and you'll reduce your stress come tax season.
Back to Basics
Citizens are required to report and pay taxes on all income they have earned over the year. Gifts, such as inheritances or scholarships, are not considered part of this category. The U.S. tax system is progressive, which means the more income you earn, the more taxes you pay. Your total earned income is known as gross income.
Throughout the year, your employer deducts a set amount from each paycheck for tax payments, a process known as withholding. When you file a tax claim, you must calculate how much you have already paid through these installments. If you've paid more than you owe, you're entitled to a tax refund. If you haven't paid enough, you owe the balance to the government by the deadline, which is usually April 15 of each year.
Tax benefits reduce your overall payment. If you put money into an IRA or pension fund, for example, the balance is tax-sheltered. (For related reading, see Tax-Saving Advice For IRA Holders.)
Never Too Early for Next Year
It's never too early to start thinking about next year's claim. To start, implement a filing system. It's as easy as grabbing a file folder and labeling the tax year. Every time you receive receipts, medical bills or other relevant paperwork, throw it in the file. Come next April, you'll be grateful that your papers are all in one place. Also, invest extra money in a tax-sheltered location, such as a retirement savings plan. (For related reading, see Money Saving Year-End Tax Tips.)
If you have significantly overpaid or underpaid this year, take a hard look at your financial habits. A costly tax payment might mean you need to raise your tax payments throughout the year; consider asking your employer to pay more money from your wages toward taxes. A hefty refund could be an indication to put that extra money you've been paying to the government elsewhere, such as an investment. Look at the end of last year's tax season as an opportunity to maximize your savings throughout the coming year. (To answer more of your tax questions, read Common Tax Questions Answered.)
File Taxes in Seven Steps
1. Contrary to popular belief, not everyone needs to file taxes. Generally, you must file if your gross income exceeds the minimum level set by the government. Further exceptions are listed on the IRS website.
Your tax bracket depends on your income level, which in turn determines the tax percentage you'll pay. Your filing status is based on your family situation, and will fall under one of five headings: single, married and filing jointly, married and filing separately, head of household and widowed. Tax payments are based on these two variables, and each carries its own deductions and exemptions.
One more factor you might have to consider is extensions. It may be that circumstances prevent you from filing your tax return by the deadline. The IRS grants six-month extensions to those who apply in a timely manner. Keep in mind, however, that this only allows additional time to file your tax claim; you still have to pay the estimated amount due by the deadline. Extension forms can be downloaded from the IRS website.
2. Next are receipts, such as W-2s, last year's tax return amount and all other related paperwork. You also need the proper tax forms for this year, which can be downloaded online.
3. Calculate your gross income (all the money you earned the previous year), then, figure out your adjusted gross income (AGI) by deducting earnings that are non-taxable, such as IRA contributions. (For more, read IRA Contributions: Deductions and Tax Credits.)
4. To reduce your tax payment further, decide whether it's most advantageous to opt for itemized or standard deductions.
Itemized deductions are any items found on a government-determined list of allowable deductions; a few examples are charitable contributions, accumulated interest on investments or career-based travel expenses. The alternative is a standard deduction, a dollar amount set by the government, which varies based on your filing status. Opt for whichever will reduce your taxable income the most.
Once you've figured out the total for your itemized or standard deductions, subtract this amount from your AGI. The government also offers personal exemptions up to a preset amount. Personal exemptions cover you and your qualifying dependents, and are based on how much you earn.
If you're not sure whether you qualify, check the IRS website, answer a few simple questions and you'll find out if you can claim this exemption. Subtract your personal exemptions amount from the sum total of your previous calculations. This is your taxable income, or the final amount on which you will be taxed.
5. Calculate your total tax payment by multiplying your taxable income figure by the tax rate that matches your income bracket. The tax you've already paid through your paychecks is indicated on the W-2. Subtract your tax payment from this figure. This calculation determines whether you have over or under paid. You could be penalized if you've underpaid by a significant amount, but in most cases you'll either pay what's due or claim a refund if you're entitled.
6. You may also be able to claim tax credits against your income, such as child credits or retirement savings. Tax credits are a real bonus, because unlike deductions, which merely reduce your taxable income, credits decrease your overall tax payment on a dollar-for-dollar basis. (Learn how by reading, Give Your Taxes Some Credit.)
7. You can file your taxes either through the mail or online. Fill out the appropriate forms and send them off.
The IRS prefers e-filing. If you're claiming a refund, you'll receive it faster by filing online. Each person who e-files also receives confirmation that the IRS has begun to process the forms. To e-file, your taxes need to have been completed through tax software or by a professional. A few other restrictions can be found on the IRS website.
If your tax return is fairly straightforward, you might choose to go with paper-based filing. Make sure to triple-check your calculations before you send in the forms, and verify that your Social Security Number (SSN) and full name are on every page. You can send your payment along with the return, or pay online.
Alternatively, you might hire an accountant to handle your taxes, especially if they are particularly complex. Be sure to check your accountant's credentials; if your claim is filed incorrectly, only you will be held responsible.
The Bottom Line
Although tax season is dreaded by many, it's an unavoidable fact of life and needs to be faced head-on. After all, it's your hard-earned money that you're forced to part with each April. Once you've successfully mastered the basics of taxes, you're set for life. Each year you can smartly and efficiently complete and file your tax return, and be secure in the knowledge that you are truly the master of your money.
For a comprehensive look into your taxes, see our Income Tax Guide.