Tax Season 101
An OppLoans Explainer E-book
OppLoans.com
Table of Contents
Introduction
3
Taxes: the basics
Expert Advice
How do taxes work anyway?
Expert Advice
4
5
6
7
Step 1: Preparing to file
What you need to do your taxes
Expert Advice
8
9
Step 2: Select your method of filing
Expert Advice
Self-preparation
Expert Advice
Make a robot do it (err… use tax preparation software)
Hire a human
How much will that tax preparation cost me
10
10
11
11
12
13
14
Step 3: Filing & receiving your return
Maximize your return
Expert Advice
Receiving your tax return
Average tax returns
15
15
17
18
19
Conclusion
Glossary of terms you may encounter
Tax FAQs
Expert Advice
About the experts
Works Cited
20
21
24
26
27
28
Introduction
If you’ve never filed your own taxes before, just the idea of it can seem
scary and overwhelming. There are long, complicated forms to fill out and
terms you may not have ever heard before. What’s a Form 1040? What do
they mean by “a dependent”? What’s the IRS, and why do they get so much
of my money?
Those are all good questions, and ones we’ll answer here. We’ll admit it—
doing your taxes is a little bit of a headache. But like many things, it’s
much easier with help. That’s why we’re here to explain the basics of how
(and why) to do your taxes!
So whether you’re a first-time filer or just want to feel more confident
walking into your accountant’s office, we’re here to help you tackle tax
season 2017 with confidence.
3
Taxes: the basics
The United States uses income taxes to pay for various government
programs—everything from highways to military equipment is supported
by your tax dollars.1 That’s why we pay taxes. When the city fixes a
pothole on your street, or a veteran receives healthcare benefits; those
are your tax dollars at work.
Rather than paying all taxes at once at the end of the year, most people
have small amounts of money taken from each paycheck to go toward
any taxes they might owe.2 Then, in April, we file our “tax return” to make
sure we’re square with the Internal Revenue Service (IRS)—the
government agency responsible for collecting taxes.
So when we talk about “doing your taxes,” we really mean, “settling up
with the IRS.” At the end of the year, sometimes you owe them a little.
Sometimes they owe you a little. Filling out your tax return is how you
figure out who owes whom, and how much.
It’s worth noting that a lot of people—about 45 percent of Americans in
20153—don’t earn enough money to owe any federal income tax. If that’s
you, you still don’t get to relax completely when April rolls around. Even if
you know for sure you won’t owe any taxes, you still need to fill out and
submit a tax return.4
In addition to filing a federal tax return, you may also need to file tax
returns in any states where you earned money. Fortunately, the
mechanics of doing your state taxes are very similar to doing your federal
taxes, so although we’ll mostly be talking about federal taxes here, much
of this advice also applies to state taxes.
While you probably already know this, it’s worth repeating: You really,
really want to settle up with the IRS and your state’s department of
revenue. Not paying your taxes might cause your wages to be
garnished, or in a worst-case scenario, land you in prison.5 Yikes.
4
Expert Advice
Aaron Lesher, CPA with Hurdlr
“Doing your taxes” is a broad term that means
completing and filing your tax return and sending it to
the government. A tax return, in a basic sense, is a form
that states how much money you earned during the
year from your job, business or side gigs. It also lists all
the expenses you incurred during the year that you can
“deduct” from your income. Since taxes are only
calculated on your income minus any eligible
deductions, it’s advantageous to take as many
deductions as you can to reduce your tax bill, whether
you’re an individual or business.”
Larry Ludwig,
Founder and Editor in Chief of
Investor Junkie
“If you don’t file your taxes on time or at all, the IRS can levy
hefty fines and in severe cases, criminal charges. An IRS
audit is definitely an unpleasant experience and you can
help avoid one by filing your taxes accurately and on time
each year. If you make less than $200,000 a year, however,
your audit risk is about 1 percent.”
5
How do taxes work anyway?
How much you pay in taxes is determined by how much money you make.
Generally speaking, the higher your income, the more tax you pay.6 But the
IRS doesn’t simply add up how much you make in a year and call it a day.
The IRS calculates your tax liability (how much you owe) by looking at
your earnings and what are called “tax deductions.” You get deductions for
things like donating to charity, paying interest on a mortgage, and
covering the costs of health care.7 Essentially, your taxable income minus
your deductions determines how much money you’ll owe the government
at the end of the year.
The IRS lets you decide whether you want to itemize your deductions
(meaning list out each individual deduction), or instead take what’s called
the standard deduction ($6,300 for a single adult or $12,600 for married
couples filing together). Whether you itemize or take the standard
deduction will depend on factors like if you have children, own a home, or
have major medical expenses.8
6
Expert Advice
Aaron Lesher, CPA with Hurdlr:
“Since taxes are only calculated on your income minus
any eligible deductions, it’s advantageous to take as
many deductions as you can to reduce your tax bill,
whether you’re an individual or business.”
Ian Atkins, Analyst and staff writer at Fit
Small Business.
“If you want to make sure you're getting the full refund
you're entitled to, don't put off your taxes until the last
minute. Before preparing your taxes (or preparing the
documents for your tax professional), take a couple
hours and review the year. If you're married, do this with
your spouse as you'll undoubtedly remember different
things. Donations, expenses, changes in income
level/sources, major purchases, etc. If you want to make
sure you're not leaving anything on the table, you need
to make sure you're not forgetting any part of the
story.”
7
Step 1: Preparing to file
There’s some light “housekeeping” you’ll need to do before you’re ready
to file your taxes. So get out some file folders, fire up that printer, and get
ready to organize your financial year. It may sound unpleasant, but it’s
necessary. After all, you want to do your taxes correctly so you can get
back the maximum amount you’re owed.
Think of this time spent as an investment. If done right, it will definitely pay
off!
Your tax prep checklist:
q Your personal information like your Social Security number and
birthdates for you, your spouse and any dependents.
q It will be helpful (but not required) to have last year’s tax returns on
hand.
q Your bank account and routing number. If you want your tax return
directly deposited into your account, you’ll need this information.
q Forms W-2 and/or 1099: If you are a full- or part-time employee, you
should get a form called the W-2 from your employer. The W-2 shows
how much you made in the previous year, and how much you’ve
already paid toward your taxes.9 If you work as an independent
contractor, you probably won’t receive a W-2, and will likely get a Form
1099 from each of your clients. Like the W-2, the Form 1099 helps you
determine how much you made in the previous year.10
q Any forms that might help you determine your deductions, such as
receipts from donating to charity or moving expenses.
q Information on any alimony received throughout the year.
q Any childcare cost info like your provider’s name, address and tax ID
number.
q The appropriate tax form for you, either the Form 1040, Form 1040A, or
Form 1040EZ. You can fill these forms out electronically or by hand—
or hire someone else to take care of them for you (more on that
below). 11 Which form you use depends on factors including your income
and whether or not you have dependents (that’s IRS-speak for “kids and
other family members you support financially”).12
q A calendar! Tax returns are typically due April 15. This year (2017), April
15th falls on a Sunday and Monday is Emancipation Day (a legal holiday
observed in Washington DC). So this year, Tax Day is Tuesday, April
18.13
q A strong cup of coffee, if that’s your thing.
8
Expert Advice
Micah Fraim, Certified Public Accountant at
Micah Fraim, CPA
“Before you file, one of the most important steps is to
look at your return from the previous year. This will
serve as a reminder of your situation and what
documents you should be expecting. It's also a great
sanity check to compare to the current year's return and
make sure that there aren't unexpected disparities year
over year.”
Dawn Brolin, Accountant-in-Resident at The
Neat Company
suggests using expense management software to better
prepare for your tax filing. “Expense management
software and applications let individuals use their
smartphones to simply snap a photo of their important
financial documents, like expense receipts and business
invoices, before vital data points, like totals, purchase
dates and vendor names, are seamlessly uploaded to
the cloud, or even accounting software, like QuickBooks
Online or SageOne. Using expense management
software eliminates the monotonous and time
consuming data-entry process, while putting all of your
financial information in one place, where it is easy to
review.”
9
Step 2: Select your method of
filing
Some of us are tech wizards, and some of us
prefer a good old-fashioned pen and paper. Some
of us like to talk things through with others, and
some of us prefer to solve problems on our own.
Whatever your style, there’s a way to do your
taxes that will work for you.
How you choose to do your taxes will depend on
your budget, how busy you are, and how
complicated your tax situation is. The three
options we’ll discuss here are:
•
Filing your taxes yourself
•
Use tax preparation software
•
Hire a professional to file your taxes
Expert Advice
Aaron Lesher, CPA with Hurdlr
“You can do your taxes a couple ways: yourself, with the help of online
software, or in-person with a professional tax preparer. To do taxes
yourself, you can use this [IRS] site to file for free or download fillable
forms, depending on your income level. If you paid more taxes
throughout the year than you owed, the government will send you a
check for the difference, called a refund. In rare cases you might owe
the IRS additional taxes at the end of the year, especially if you
freelance or own your own business.”
10
Expert Advice
,
Larry Ludwig Founder and editor in
chief of Investor Junkie
“Taxes aren't that bad: If you have a W-2 or a 1099, or maybe
one of each, you can complete your taxes on your own. In
fact, I recommend you complete your taxes on your own. It's
important to learn the basics of the tax code and this is
possible when you use an online software like TurboTax or
H&R Block because they actually educate you WHILE you are
filling in the numbers. It's pretty awesome. That said, if you
have a complicated situation at all—use a professional.”
Self-preparation
You know what they say: If you want something done well, you have to do
it yourself. That’s why some people choose to fill out their tax returns on
their own. Everything you need is on the IRS website. You can download
tax forms, print them, fill them out, mail them, and call it a day. If you make
less than $64,000, you can file your tax returns electronically on the IRS
website for free.14
If you make less than $100,000 a year and have no dependents, you may
be able to use a special form called the Form 1040EZ (yes, like “easy”—
someone at the IRS was having some fun that day). The Form 1040EZ is
super quick and, well, easy.15 This might be the tax form of your dreams!
If you’re not eligible for the Form 1040 EZ, don’t worry. You’ll use either the
Form 1040 A or the Form 1040. The IRS even provides a helpful little quiz
to help you determine which form is right for you. All of these forms come
with very detailed instructions on how to fill them out.16
Like the other options we’ve discussed, self-preparation has its pluses and
minuses. Many people find it a little harder than using software or hiring a
tax preparer, and for some, it might take more time. But it’s definitely a
bargain!
11
Make a robot do it (err… use tax
preparation software)
Using tax preparation software is very popular, and a good option for
people with pretty straightforward tax situations. If you have a full- or
part-time job with a W-2, you didn’t win the lottery, you don’t own four
mansions, and you have no offshore bank accounts in the Bahamas,
tax preparation software might be just the thing for you.
Tax preparation software guides you through the process of filling out
your tax return by asking lots of questions, like “Did you buy a house
this year?” The software will have you to transfer information from
your W-2 into the software to determine your income. (It can also
provide guidance on whether it makes most sense for you to take the
standard deduction or to itemize your deductions.) When you’re all
done, many of these programs allow you to file your tax returns
electronically.
Some options to consider include:
•
Turbo Tax—Free option available, paid options range from: $34.99$114.9917
•
H&R Block—Free option available, paid options range from $34.99-$54.9918
•
TaxAct—Free option available, paid options range from $15-$3019
•
Tax Slayer—Free option available, paid options range from $17-$3520
•
eSmart Tax—Free option available, paid options range from $14.95$34.9521
Tax preparation software has its upsides and downsides. On the
upside, it’s often quick and easy to use, provides lots of help and
guidance, and allows you to file electronically. The downsides: It’ll
take a little bit of your time and you may have to pay for the software.
It’s also important to remember that your tax returns contain very
sensitive personal information, such as your social security number.
Hacking and security breaches are always a possibility. (You might
remember, for instance, that TurboTax had a big security breach in
2015.)22
12
Hire a human
If you don’t want to entrust your taxes to a robot, you can always hire
a human tax professional. Companies such as H&R Block and Jackson
Hewitt are chock full of people who are ready and waiting to help you
with your taxes. Although the cost varies from person to person, you
can probably expect to pay somewhere in the neighborhood of $100200 to have your return done at one of these large tax preparation
offices.23
There are different types of tax professionals with different levels of
training and experience.
The more training and experience a tax professional has, the more
their services will cost you.
Different types of tax professionals include:
Tax preparers: Tax preparers are the most inexpensive tax
professionals. This is because they may not have a lot of training. In
most states, they are not required to be licensed. However, if your
tax situation isn’t too complicated, a tax preparer can probably
handle your taxes just fine.
Enrolled agents (EAs): Enrolled Agents are tax professionals who
must be licensed by the IRS. They are allowed to represent you in
the event of a tax audit.
Certified public accountants (CPAs): CPAs have significant training
and specialized expertise. Their services can cost you around
$100/hour.
Tax attorneys: Tax attorneys are the top-of-the-pile tax
professionals. If you have a complicated tax problem (maybe you
do own four mansions and have offshore accounts in the Bahamas)
you might need their services, but it’ll cost you $200-300/hour.
Fortunately, hiring a tax attorney isn’t necessary for most of us.24
There are some pros and cons to hiring someone else to do your
taxes. An experienced tax professional may find ways to save you
money, and will certainly save you some time. Of course, you have to
pay for their services, and you can’t always be sure they have much
more experience with taxes than you do.
13
How much will tax preparation
cost me?
Wondering how much you can expect to pay a professional CPA to
prepare your taxes? Here’s a handy breakdown of average income tax
preparation fees by region assembled by CouponBox.
(Average Income Tax Preparation Fees by Region. (2017, March 16). Retrieved March 30, 2017, from
https://www.couponbox.com/us/blog/average-income-tax-preparation-fees-region/)
14
Step 3: Filing & receiving your
tax return
Maximize your return
You took a deep breath, gathered your tax information and documents,
selected a method of filing and now you’re ready to get it done. Great!
But let’s not forget, filing your taxes isn’t just a legal requirement—it’s also
a process which will likely deliver you a “tax refund”—or check—once the
process is over. You definitely want a refund, but how much can you
expect to get back? Well that depends on you and how you file.
If you want to maximize your tax refund (and, let’s be honest, who
doesn’t?), then follow these steps to make sure you’re getting the most
from your tax refund check. Leave no dollar behind!
1.
Increase withholding throughout the year: Here’s something you
can do all year long to get a bigger refund check after you file.
Whenever you take a new job, you’ll be asked to fill out a W-4 form.
The way you fill this out will determine how many allowances (for
yourself and your family), you’ll claim. (An allowance is an amount
deducted from your taxable income). When you fill this out, drop an
allowance to withhold more income. It will increase the amount held
from each paycheck (which will mean smaller paychecks throughout
the year) but potentially a much larger tax refund in the spring.25 You
can use a withholding calculator to determine which allowance to
claim.
2.
Choose to Itemize instead of standard deduction: The standard IRS
deduction ($6,300 for singles, $12,600 for married couples filing
jointly) will lower your taxes. But selecting to itemize your deductions
will likely increase your tax refund. When you choose to itemize, look
for items like job search expenses, unreimbursed business expenses
and more to increase your refund.26
3.
Understand which exemptions and deductions you are eligible for.
Speaking of itemizing your deductions, there are a surprising number
of items you might not know that you are eligible for. For instance, you
can deduct the costs associated with childcare, elderly parent care,
even friends you are financially supporting (though we don’t
recommend financially supporting your friends). Especially in the
case of supporting elderly parents, they must receive more than half
of their financial support from you.27
4.
Be charitable. Here’s an easy one: give stuff away! Whether it’s
clothes or food, or even big-ticket items like electronics and vehicles,
when you give to qualified charities, those charitable gifts are tax
deductible—making you eligible for a larger refund! You get to feel
good and collect a bigger refund. Win!28
15
5.
Deduct your home office expenses. Do you work from home? Do
you have a home office? If so, those home office expenses can be
deducted! Here’s how:
The IRS offers two methods of calculating home office expenses: The
Standard Method and the Actual Method.
With the standard method, you can deduct auto mileage with the
following formula:
57.5 cents per business mile plus parking and tolls. You can calculate
the expense of a home office at $5 per square foot (at a maximum of
300 per square feet).
The Actual Method is a bit more detail oriented, but it could result in a
somewhat higher tax refund.
Using the actual method, for auto-related expenses, add up all your car
expenses (including gas, maintenance, and insurance) and then
multiply by your business percentage (business miles divided by total
miles for the year).
For example, $10,000 in vehicle expenses / 25,000 miles driven in
2016=40.Take that percent and multiply it by the amount of
relevant expenses you had that year ($10,000), so: $10,00 x .40=
$4,000.29
Calculate your home office deduction using the Actual Method by
adding your home expenses and multiplying it by your home
office square footage divided by total home square footage.30
6.
Deduct medical expenses and use a Flexible Spending Account
(FSA) for medical costs. Did you know you can deduct unreimbursed
medical and dental expenses? And not only that, but also the mileage
to and from your care.31 It’s true! So get that nagging toothache
checked out, your mouth—and your wallet—will thank you.
7.
Refinance your mortgage—Interest on your mortgage is deductible.
If you refinance, you’ll get a tax break. But you should also refinance
to get a better interest rate.32
8.
Contribute to a 401K—When you pay into a 401K, those payments are
“shielded”, meaning you can deduct those payments from your
taxable income. Double win! You pay more into your retirement and
stand to receive a larger tax refund.
9.
Talk to a pro—When you do your taxes, you want to make sure you’re
doing them right and getting back the most cash you can. After all,
you worked hard for that money. If you’re worried that you’re leaving
money on the table, it might be worth it to speak with a professional.
They aren’t free, but you’ll might get peace of mind that you wouldn’t
otherwise.
16
Expert Advice
Ian Atkins, Analyst and staff writer at Fit Small
Business
“Plan ahead. As with anything in life, if you want the best results
possible, you need to plan ahead. Wealthy individuals and families
do not wait until the last minute (or even until tax season) to start
tax planning. They know that with professional guidance and time
to enact a plan, they can save a ton of money. Everyone should be
thinking this way. Your CPA or tax professional is not a magician,
even if it sometimes feels that way. Do them, and yourself, a favor:
talk to them about what you expect for the following year (changes
to income, dependents, major purchases, work arrangements, etc)
and let them help you plan for the coming year. Effective planning
will increase your tax refund more than any trick.”
Dave Du Val, Chief Customer Advocacy
Officer at TaxAudit.com
As you’re filing, always be double checking for errors. As expert
Dave Du Val from TaxAudit.com reminds us, these common tax
filing errors are easy mistakes to make (and avoid).
•
•
•
•
•
•
•
•
•
Wrong or missing Social Security numbers (SSN): Verify all SSNs using each person’s
Social Security card.
Wrong names: The names on the return must match each person’s Social Security card,
including all dependents. Do not use nicknames or married names unless you have
previously changed the name with the Social Security Administration office.
Filing status errors: Check your filing status, especially Head of Household.
Most tax software asks questions to help you determine your status. You can also go to
the Interactive Tax Assistant.
Math errors: There is a benefit to using tax software—the math is done for you. If you are
doing the return by hand, double check all computations on a calculator with a paper
tape. Keep your receipts with a tape showing the name of the deduction for reference in
case you are contacted by the IRS for any reason, as any tax return can be audited even
if it is 100% complete and accurate.
Credit and deduction errors: Be very careful in calculating the Earned Income Credit,
Child Income Credit, and the Child and Dependent Care Credit. Follow the directions,
and review the rules for Qualifying Child, Qualifying Relative, and Qualifying Expenses.
Another problem area is the Standard Deduction for those who do not itemize. If you are
over 65 and\or blind, there is an additional standard deduction amount to add to your
Standard Deduction.
Bank accounts for refunds: The IRS and most state tax agencies offer direct deposit of
refunds. This is the fastest and safest way to receive your refunds, but only if you verify
the bank account information. You certainly don’t want YOUR refund going to MY bank
account.
Forms not signed or dated: An unsigned return is not valid, especially for married
couples where both must sign the forms. This can delay processing while the IRS sends
a form for correct signatures.
Electronic filing PIN numbers: E-filed returns must have a PIN number in lieu of a
signature. If you e-filed last year, use the same PIN number. If you can’t remember it,
you will need your 2015 adjusted gross income as originally filed—not as amended or
corrected by the IRS.
Remember, the Affordable Care Act is alive and well as of today. Make sure your 2016
return reflects all the requirements needed under the ACA (such as having minimum
essential coverage) to show that you have the required health insurance and to avoid
the shared responsibility penalty. Regardless of what Congress does tomorrow or next
month, it will not change what’s required on your 2016 return.
17
Receiving your tax return
Okay, so you’ve taken the plunge and “done” your taxes. If you’re like 83%
of Americans who filed returns, you qualify for a “tax refund.”33 Rather than
owing the IRS more money, the IRS actually owes you. That’s a good thing!
So how exactly will you collect that tax return?
Whether you’ve filed on your own, used an app, or gone with a
professional, there are several different ways you can select to receive
your return.
When you file, you can choose one of the following methods to receive
your refund:
1.
Direct deposit
This is the easiest option for receiving your refund. All you need to do is
provide the account and routing number for your bank account when you
file your return. You can even have them split the refund between
multiple accounts. Once your refund is processed, the IRS will
electronically deposit your funds. That’s it! If you file your return
electronically, using direct deposit can usually get your refund back in 21
days or less. Direct deposit is also available for folks who file paper returns
or who use a tax preparation service.
2.
A prepaid debit card
This option should really only be used by people who do not have a bank
account. Having the IRS load your refund onto a prepaid, reloadable debit
card can be better than having them issue a check due to the high fees
charged by many check-cashing businesses. (Also, just like direct deposit,
this option is much faster than a paper check.) However, many of the
prepaid cards that are offered for tax refunds come with high fees as well,
so be careful and make sure that the card you’re choosing is the best one
available to you. A lot of cards are offered by tax preparation services
specifically for these purposes, but folks who already have a prepaid debit
card can have their refund deposited on that card by providing the
account and routing numbers on their return.
18
3.
Paper check
For those who like to do things old-school, you can always have the IRS
cut you a paper check, which they then mail to you. Some of the issues
with this option include the check getting lost in the mail or the check
getting lost, stolen or destroyed once you’ve received it. In addition to
those risks, this method is also much slower than direct deposit or using a
prepaid debit card. With those other options, it usually takes 21 days or
less for your refund to arrive. With a paper check, it can take between 4-6
weeks. However, if you have a bank account and do not want to do direct
deposit, paper checks are a better option than a prepaid card, due to the
fact that no fees will be involved with the check.
4.
Purchase US savings bonds
This is the least-known tax refund option. It’s also fairly new, having only
been around since 2010. By filling out IRS Form 8888, you can use your
refund to purchase up to $5,000 in US savings bonds. These are low-risk
products designed for long-term investment—maturing after 30 years.
You can use any portion of your tax refund to purchase a savings bond, so
long as it is in an increment of $50. Any amount that is left over will then
be sent to you via paper check or direct deposited into your bank account.
Average tax refund
So how much are you getting? Well, that definitely depends. But we can
tell you that the national tax average is $2,860. Check out this breakdown
of average Federal Tax Returns by state courtesy of Couponbox.
(Average Income Tax Preparation Fees by Region. (2017, March 16). Retrieved March 30, 2017, from
https://www.couponbox.com/us/blog/average-income-tax-preparation-fees-region/)
19
Conclusion
Whichever method of tax preparation you choose, know that it’s
important to get your taxes done. If you have a single source of
income and no dependents, then your taxes might be simple enough
to complete on your own. If you’ve never “done” your taxes before,
maybe a face to face session with a professional is right for you.
If you need more help, though, you’re not alone.
Many public libraries offer classes and other kinds of tax preparation
assistance. There’s also tons of help online: Tax preparation
companies like H&R Block and Turbo Tax put plenty of information
and advice on their sites. And although it’s not as exciting a read as
Fifty Shades of Grey, the IRS website does have all the tax information
you could ever desire.
Finally, don’t forget: April 18 is the big day. Good luck and happy
taxing!
20
Glossary of terms you may
encounter
Filing Status— Your filing status really describes your marital status, and it
impacts everything from the type of form you’ll need to fill out to the tax
credits and deductions you’ll be eligible for to the rate at which you’ll be
taxed.34 There are five different filing statuses, as outlined below:
21
Tax Brackets— If you’ve ever filled out an income questionnaire, survey or
census, you’ve likely ticked a box next to your salary range to indicate
your annual income. Marginal tax brackets (usually just shortened to “tax
brackets”) are a very similar concept.
You can think of tax brackets as a series of income “buckets.” The bucket
your annual income falls into—combined with your filing status (married
filing jointly, single or head of household) determines the percentage, or
tax rate, at which you’ll be taxed.
If your salary falls into the lowest tax bracket, you’ll be taxed at the lowest
tax rate; if you fall into the highest tax bracket, theoretically, you’ll be
charged at the highest tax rate. And if your annual income falls below a
certain amount (depending on your filing status) you’ll be exempted from
paying any taxes at all—though you’ll still have to fill out and submit your
tax forms to the IRS.35 According to the IRS, the 2016 tax brackets break
down as follows:36
22
Tax Liability—“Tax liability” is just another way of saying “how much you
owe in taxes.” You could think of your tax liability as…
Tax Season—Traditionally, tax season— the time of year when business
and individuals are required to complete and submit their previous year’s
tax returns to the Internal Revenue Service, or IRS—falls between January
1st and April 15th of each year.37 In 2017, tax season began on January 23rd
and ends on April 18th—the official deadline for submitting your tax return.
38
Personal Tax Exemption—Like a standard tax deduction, a personal tax
exemption is a fixed amount you can claim to lower your taxable income.
For 2016, the personal exemption amount is $4,050.39
A good way to think about exemptions is “number of people you’re
supporting financially”—what the IRS calls a “dependent.” The first
dependent you should claim? Yourself! If no one else can claim you as a
dependent on their tax returns, then US Tax Codes allow you to claim
yourself.
Additionally, you can claim your children, grandchildren, stepchildren,
foster children and, if you’re filing a joint return, your spouse. It’s important
to note that each of these individuals must meet qualifying criteria,
including age, and, if they are working, income level, but this list is a great
starting place to look for additional savings.
23
Tax FAQs
Q: What’s the difference between Federal Income Taxes and State
Income Taxes?
A: US law dictates that both individuals and businesses must pay annual
taxes on earned income to the federal government. In 2016, the federal
government received $3.13 trillion dollars in revenues, $1.3 trillion of which
came come individual income taxes—the largest single source of this
revenue.40 These tax dollars are used to support a wide variety of
government programs and initiatives—everything from the military and
federal and welfare programs to highways and disaster relief.41
State taxes are a little bit of a different story. Since state taxes are
governed by the states themselves, they vary from state to state. And
while many states follow a model that looks quite similar to federal taxes,
some states really go their own way. Pennsylvania, for example, imposes a
flat tax—meaning everyone pays the same amount, instead of being taxed
according to income—while some states impose no state taxes at all!42
Q: What’s the difference between “taxable income and “non-taxable
income”?
A: Generally, you can assume all income is taxable unless it’s explicitly
designated as tax-exempt by the IRS. Taxable income includes all the
usual suspects—all wages, tips, bonuses, investment income—but also a
few surprises. For example, even bartering—what the IRS defines as “an
exchange of property or services” (that is, a non-monetary exchange) is
considered taxable income.43 If you’re not sure, check out the IRS taxable
income page for more information.
Non-taxable income, then, would be items like inheritances, cash rebates,
received welfare and child support payments.44
24
Q: What is the difference in a “tax credit” and “tax deduction?”
A: Both tax credits and tax deductions can help you reduce your overall
tax liability (the amount you owe in taxes), but they work a little differently.
According to the IRS, a tax credit “provide[s] a dollar-for-dollar reduction
of your income tax liability.”
By comparison, a tax deduction lowers your taxable income by allowing
you to deduct a percentage of qualifying expenditures you made during
the previous year. Donating to a charity, paying interest on a mortgage, or
healthcare costs that exceed 10% of your AGI (adjusted gross income) are
all qualifying tax deductions.
So what’s the difference? A tax deduction is affected by your tax rate. This
means that you’ll only be able to subtract a percentage of the overall
deduction (the same percentage at which all your income is taxed) from
your overall tax liability. Here’s the example the IRS gives: if you fall into
the 25% tax bracket, a $1,000 tax deduction will only net you $250 dollars
in savings, while a $1,000 tax credit means $1,000 saved. For a complete
list of qualifying deductions, visit the IRS website.
OK—so what’s the difference between a “tax deduction” and a
“standard deduction?”
The IRS gives you a choice between itemizing (adding up) your list of tax
deductions from the previous year, or taking a standard deduction.
A standard deduction is a deduction amount that’s pre-set each year by
the IRS; standard deductions vary based on filing status and tax bracket.
It’s important to note that you can’t claim both a standard deduction and
your itemized list of deductions, so you’ll want to pick the option that
saves you the most money. For many people, the standard deduction is
the higher amount. However, if you’ve had large medical bills or made
large contributions to tax-deductible organizations, for example, you
might come out better itemizing your deductions.45
25
Expert Advice
Ian Atkins, Analyst and staff writer at Fit Small
Business
“Is it more effective to itemize or accept the standard
deductions? The answer to that depends. It helps to start by
seeing what the standard deductions will be (see below for
2016). If you have a lot of mortgage interest, make significant
charitable contributions, have significant out of pocket
medical expenses, have qualified job expenses that weren't
reimbursed to you, or have significant state & local income or
sales tax you may want to consider itemized deductions.”
26
About The Experts
Ian Atkins (@FitSmallBiz) is an analyst and staff writer for Fit Small
Business. He covers small business finance with a focus on traditional
and alternative small business lending. Ian has over 9 years working in
personal and small business finance.
Dawn Brolin (@dawnbrolin) Accountant-in-Residence at The Neat
Company, In addition to her roll at Neat, Dawn is a CPA and the CEO of
Powerful Accounting, an accounting firm that uses a tech-first
approach to better serve their clients.
Steve Cuffari (@Couponbox) is a writer and researcher born and raised
in NYC, who currently lives in Berlin. He now works at Couponbox.com,
a website dedicated to savings, where you can see his articles and
infographics on the blog and press page. His work has been featured
on Forbes, GoDaddy and Foxsports. He can also be found roaming
Twitter and his fiction site.
Dave Duval, Chief Customer Advocacy Officer at TaxAudit.com. Dave
is a taxpayer advocate, tax expert, and a tax educator as he travels
around the country helping educate tax professionals. He also serves
as a source for tax writers at publications like CNN, CNBC, MotleyFool,
FoxBusiness, and many more.
Micah Fraim (@MFraim89) Micah Fraim, CPA owns an award-winning
accounting practice, has an Amazon bestselling book, and experience
as a business analyst in the marketing department of a Fortune 500
company. As such, he brings a broader perspective than most any
other accountant. For years he's helped my clients find money that
others have missed and helped them make maneuvers others had not
thought of. He's been featured on Forbes, MarketWatch, Time and you
can learn more about his work at FraimCPA.com.
Aaron Lesher, CPA. Aaron is a part of the Customer Success and
Growth team at Hurdlr. He's passionate about helping entrepreneurs
achieve more financial success. Before joining Hurdlr, Aaron audited
Fortune 500 clients at a Big 4 accounting firm. To make sure you know
exactly how much in business taxes you owe and maximize your
deductions, download Hurdlr today.
Larry Ludwig (@IvestorJunkie) founder and editor in chief of Investor
Junkie. He graduated from Clemson University with a bachelor of
science in computers and a minor in business. Back in the ’90s, he
helped create some of the first financial websites for firms like Chase,
T. Rowe Price, and ING Bank, and later went on to work for Nomura
Securities. He’s had a passion about investing since he was 20 years
old and has owned multiple businesses for over 15 years.
27
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30