Dec. 25 and April 15 are two of the most memorable dates on the American calendar. The first is the eagerly anticipated culmination of a joyful season of celebration, gift-giving, and general goodwill. The second date — the day we must file income tax returns — is a day of dread, stress, anger, and fear for many people.
Even though nearly 3 out of every 4 filers receive a tax refund, nobody likes income tax time. However, there are ways to make tax season less hectic and easier to endure.
How to File Your Income Tax Form With Less Stress
Trying to make sense of a rat’s nest of paper receipts, canceled checks, brokerage statements, and other miscellaneous bits of information is frustrating and time-consuming. The confusion adds time for you and unnecessary expense if you’re using a professional tax preparer.
It also increases the probability of incorrectly calculating your tax liability. If you pay too little, you may be subject to a tax audit and additional penalties. If you pay too much, you’re effectively giving the government a donation. Avoid such troubles by following these tips.
1. Collect Pertinent Income & Expense Information
Around the end of January each year, people like employers, vendors, and financial institutions prepare and forward various tax forms and information pertinent to your filing.
Create a set of files — whether that’s a large multi-pocket accordion file, a group of large manila envelopes, or a digital filing system on your hard drive — to sort and separate the data into one of the following categories:
This information includes your legal name and the legal names of your spouse and all dependents. You also need their Social Security numbers and dates of birth.
I also keep my primary bank information — account number and bank account routing number — so I can request a direct deposit refund if circumstances warrant.
Common forms include W-2s from employers; 1099 forms for other types of income, such as self-employment, investments, and retirement distributions; and K-1s for any partnerships in which you participate.
Keep a separate folder for security transactions so you can quickly determine holding periods from buy and sell dates to ensure you qualify for capital gains treatment wherever possible.
Personal Expenses (Deductions)
You will receive Form 5498 for IRA and health savings accounts contributions from vendors and Form 1098 for home mortgage interest deductions.
But you must collect most of the information documenting allowable tax deductions, such as business expenses, from other financial documents, such as check registers, canceled checks, bank statements, and credit card statements.
Download and print summaries of the prior year’s transactions for each credit card, and review each transaction to determine whether it may be deductible. I use a highlighter to mark the transactions that may affect my filing for easy identification later. You can use a similar culling process for canceled checks.
If you own a small business, perform freelancing jobs, or have other side income, you need to keep your business income and expense items separate from your personal information.
2. Review Tax Filings From Previous Years
For most people, the changes from one tax year to the next are relatively slight. Previous federal tax returns are excellent reminders of areas you can easily overlook, such as interest or dividends, capital loss carry-forward balances, and infrequently used tax deductions.
I keep paper and scanned copies of past years’ returns in addition to four spreadsheets detailing my income and expenses for each year. One spreadsheet contains the information from Form 1040, while the others have previously filed data for Schedules A, C, and D. That allows me to quickly check whether I’ve overlooked an income or expense item, as well as the year-to-year changes in amounts.
For example, if I received dividends from one security holding or interest from a particular bank in prior years but the amount is missing or substantially changed for the current year, I know to check for the reason behind the omission, increase, or decrease before completing my tax filing.
3. Fund IRAs & SEPs to Allowable Limits
If you participate in an employer-sponsored qualified retirement plan, such as an individual 401(k) plan or 403(b) retirement plan, the deadline for contributions is Dec. 31. However, you can still fund an individual retirement account (IRA) until April 15.
For 2020 tax returns, the contribution limit is $6,000, or $7,000 if you’re 50 or older. So if you’ve contributed less than that amount, you have until April 15, 2021, to invest money on a tax-sheltered basis for 2020.
If some or all your income comes from self-employment, you can set up a simplified employee pension (SEP) IRA up until the due date of your tax return, including extensions, and contribute up to 25% of your self-employment income.
If you have the opportunity to choose between paying income taxes or funding your retirement, it should be an easy decision.
While Roth IRA contributions are not deductible, traditional IRA and SEP contributions are fully deductible, depending upon your income, filing status, and participation in an employer plan. Income within a retirement plan — whether IRA, SEP, or 401(k) — remains untaxed until you withdraw it.
Pro tip: If you have a 401(k) or IRA, sign up for a free portfolio analysis from Blooom. Simply connect your account to quickly see how you’re doing, including risk, diversification, and fees.
4. Automate or Outsource Tax Calculation & Filing
While the IRS has made an effort to simplify tax forms and reduce the time and complexity of filing a tax return, it remains a daunting task, especially since it occurs only once per year and is often stressful.
The IRS even offers free tax filing software for taxpayers with an adjusted gross income of $72,000 or less. To determine whether you’re eligible for the free software, check last year’s return for your adjusted gross income, which appears on line 82 of the 2019 version of Form 1040.
For those with incomes greater than $72,000, the IRS provides free fillable forms for electronic filing. However, these forms offer only basic guidance, so you must know how to do your taxes yourself.
Most of the filing programs allow you to keep track of any refund due and select your preferred payment method — direct deposit, paper check, or holding and applying the refund for the coming tax year.
When deciding whether to use a tax expert versus a software program or a software program for tax prep, consider your income, the complexity of your return, unusual events that significantly affect your income or expenses, and your concern about a tax audit.
In my experience, there isn’t a big difference between the better software programs and the typical paid preparer at a walk-in tax preparation office.
Modern tax software is highly sophisticated and leads you through a series of detailed questions to verify amounts and the appropriate tax treatments. The typical storefront preparer is a seasonal, part-time employee whose training in tax preparation may be limited to a few hours of company-offered instruction.
In either case, the quality of the work depends upon the information you provide them as a result of your diligence and earlier preparation.
You should consult a certified public accountant or another experienced tax professional (rather than a tax preparer or DIY) before filing taxes this year if you:
- Have a gross income greater than $150,000
- Participate in complex investments that have tax preference or are managed through partnerships or private businesses
- Experienced a significant change in either income or expense during the previous year or a life-changing event such as the death of a spouse or partner, a divorce, marriage, bankruptcy, a change in the number or status of your dependents, or retirement
- Started or closed a full- or part-time business, purchased or sold a home, rented a home or room, or received or paid significant fines or penalties related to a lawsuit during the tax year
- Are concerned that tax filing will trigger IRS scrutiny and a possible audit
- Have concerns about completing your own tax calculations accurately and entirely
If any of those describe you, the cost of advice from a certified public accountant or tax attorney will be worth the peace of mind.
5. Do (a Little) Research
Since tax laws and interpretations are continually changing, you should attempt to be as informed as possible. Even if you use a tax advisor, it’s wise to understand the tax issues and treatments that affect you as thoroughly as possible so you can make the best decisions.
It’s not difficult to spend an hour or two online researching specific taxable situations or relative conditions.
For example, entering the words “freelance income tax” in a search engine reveals numerous sources about the tax treatment and filing of freelance income. A search of the words “home rental income tax” delivers a similar number of sources about the treatment of home rental income.
You can never know too much about income taxes. It’s your money you get to keep by minimizing your tax liability.
6. File Early
There are three good reasons to complete your filing as early as possible:
- Information Is Readily Available. Employers, vendors, and financial institutions are legally obligated to mail the required W-2s and 1099-Rs by Jan. 31. Complete your taxes as soon as you have all the necessary information to prevent confusion, tension, and misplacing tax documents.
- Filing Is Inevitable. Filing your taxes is something you must do every year, so why procrastinate? Getting it behind you gives you time to focus on other things.
- You Can Invest Your Tax Refund as Soon as Possible. Your money won’t earn interest in the government’s till. File your return now and invest the refund to get the most out of your money.
The one reason to delay filing until April 15 is because you owe taxes. If you have tax liabilities, the best approach is to complete the calculations and fill out all the required forms but delay the actual filing until April 15.
You won’t be charged any penalty or interest if you file and remit any unpaid balance at that time.
Note: For 2020 tax returns (those filed in 2021), the tax deadline has been extended from April 15 to May 17, 2021.
7. Prepare for Next Year’s Tax Filing
While it’s too late to affect your tax bill for this year, it is not too early to begin planning and making changes that can reduce your liability for the upcoming year.
If you have a significant amount of unpaid taxes at the end of the year, an unusually large tax refund due, or anticipate a substantial change in income during the current year, you can adjust your withholding so your employer withholds more money from your paychecks during the year or has more money distributed to you each pay period.
Some people prefer to get a larger refund check rather than a small increase in take-home income every pay period because they’re less tempted to spend the money and more likely to save it.
If your employer offers flexible spending accounts for health care, child care, or commuting expenses, take advantage of them early in the year. That allows you to pay those expenses with pretax dollars rather than after-tax dollars.
Maintain your filing system for the current year year-round, storing receipts and other information that will be useful in filing income taxes next year. And remain diligent about keeping up with any news about investments or changes that might affect you tax-wise. Forewarned is forearmed.
Preparing for and paying taxes doesn’t have to be a hassle. Follow these tips, and you can spend the tax filing deadline doing something more enjoyable than waiting in traffic in front of the post office or trying to e-file your tax return.
Or if you’re looking for something more productive, take some time to spring clean your finances, create a new budget, or declutter your home and donate your old stuff to charity. That could even help you get a tax break for charitable donations on next year’s tax return.