It's Not Fun, but It Has to be Done Benjamin Franklin wrote a 1789 letter that states, “But in this world nothing can be said to be certain, except death and taxes.” Even at the United States’ early beginnings, federal taxes were a necessary evil to fund various public projects and administrative costs. Today, federal taxes serve much of the same purpose. While virtually no one likes to prepare and file their taxes, it is a necessity if you want to avoid fines and further hassle. It is no secret that preparing and filing your taxes is notoriously complicated. Many people lament that it should not be so difficult to pay the government. However, some of the complications allow people to save money if they discover specific tax benefits. Knowing how to file your own taxes may be a good option if your tax situation is relatively straightforward, or if you are willing to learn the process. Why Do You Need to File Your Taxes Every Year? The short answer is that federal law requires that most individuals file taxes annually. Income taxes are assessed every year based on your income earned during that period. You then pay a percentage of that income to the government, less any deductions, adjustments, or credits that you qualify to receive. If you do not file (and pay) your taxes, then you may be assessed penalties and interest. The Internal Revenue Service (IRS) can even go as far as garnishing your wages and repossessing your property if you do not file and pay as required. The Benefits of Filing Your Own Taxes If you are one of the 43% of Americans that are doing your own taxes, you are certainly not alone. Roughly 53 million people prepared and filed their own taxes in 2018. There are many benefits to filing your own taxes, including: Saving money: Hiring a tax professional is expensive, and many people can prepare and file their returns on their own, completely free of charge. Control: Some people like knowing the exact information that is included in their return and being able to control the data, and for some, knowing precisely how the numbers work out, is comforting. Gain helpful information: When you prepare your taxes, you can see what items saved you money this year or which issues you should address so you can save money next year. While filing your own taxes is complicated, it can be beneficial under the right circumstances. There are several programs online that walk you through the process to help ensure you are taking advantage of all of your available deductions and credits. The Drawbacks of Filing Your Own Taxes In addition to the benefits, there are also some disadvantages to filing your own taxes. These include: Time and effort: Preparing and filing your taxes takes time and work You have to sift through financial information and deal with concepts that you may not understand well. The process can be frustrating and take a considerable amount of time. Error risk: If you do not completely understand how your taxes work, you run the risk of making a mistake because of misconceptions. If that happens, it could lead to underpayment and audits down the road. Questions: Even if you use a tax preparation software, you may still have questions that will remain unanswered unless you do significant research or reach out to a tax professional. For some people, the risk of having a substantial error that triggers the IRS’s attention is enough to scare them away from preparing their own taxes. Preparing for Filing Your Taxes When you begin work on your taxes, you should have information gathered throughout the year. Some of the most common items that you will need include: Social Security numbers for you, your spouse, and any dependents Information about wages, such as W2s or 1099s Investment income information Documents that represent any other source of income Information regarding adjustments to income, such as student loan interest paid, IRA contributions, and health savings account contributions, just to name a few Information regarding potential credits, including, for example, child care expenses, education expenses, or retirement savings contributions Data about any tax payments that you may have made throughout the year Keeping good records will help make tax preparation easier at the beginning of the year. [youmaylike] The Basics About What You Can Claim When Filing You must pay income taxes on all your income earned throughout the year. However, that income is reduced by a few things. The further you can reduce your taxable income, the less you tax you will pay. There are three general categories of tax reduction methods: Standard or Itemized Deductions Everyone can claim either the standard or itemized deductions. Standard deductions are a set amount that is based on your filing status. Itemized deductions are based on actual expenses that you incurred throughout the year. You can choose to use the higher deduction. The higher the deduction, the less tax you will have to pay on your income because your income decreases on paper. Itemized deductions include things like medical expenses, state and local tax payments, and home mortgage interest deductions. Itemized deductions will only decrease your income by a certain percentage, or up to a specific point. Adjustments Some adjustments to your income may also be available. These include things like paying student loan interest or alimony. Adjustments are more valuable compared to deductions because they decrease your income dollar for dollar. Credits A credit decreases your taxable income as well. Some credits are refundable while others are not. For example, you get a child tax credit simply for having children that qualify for that credit, but that credit will not be paid out to you if you do not have any tax obligations. On the other hand, the Earned Income Credit, which is available for low-income filers, will be refunded to you even if you do not owe any taxes. There are a wide variety of deductions and credits available. Take a look at the federal forms and related schedules to determine whether you might qualify for any of these. How to File Your Own Taxes If You Live Overseas If you earned income in the United States as a U.S. citizen or resident alien, you likely need to pay taxes on that income. This is true even if you live overseas. You can still choose to e-file or mail your tax return to the IRS once you have it prepared, just as if you physically lived in the United States. In some cases, you will be taxed on the income that you earned throughout the world. However, you may be able to deduct a portion or all of the revenue that was not made in the United States in some circumstances. Filing Online The IRS offers an online filing option that is free for individuals that have an adjusted gross income below a specific threshold. Generally, your income must be below $66,000 to qualify for this service. You can also file online by using a commercial tax preparation software. Examples of this type of software include: H&R Block TurboTax TaxCut TaxSlayer There are many programs available that will file your taxes for you, often for a fee. Knowing how to file your own taxes can be a great way to save money, but it can be tricky as well. If you want to file your taxes yourself, be sure to read the form instructions thoroughly and get familiar with various tax saving opportunities before you begin preparing your return.
Saving for Further Education
Putting a child, or even yourself, through college has become increasingly financially burdensome as tuition costs continue to outpace incomes. If you or your child are planning to pursue higher education, there is financial help outside of scholarships and loans available. One popular option is the 529 savings plan. This is a savings plan packed with tax advantages that encourage people to save for their educations. Let's take a look at the 529 college savings plan.
Sponsored by states, state agencies and/or education institutions, the plans have the blessings of the IRS whose Section 529 code authorizes them.
Here, we’ll go over the basics of 529 plans to help you determine if they are right for you.
529 College Plans in a Nutshell
529 plans can be used to save for certain educational expenses for any student. These educational expenses include:
- Room and board.
- Mandatory fees.
You can invest in any state 529 plan that has approved them, and that’s most of them. The plans cover costs at any college as long as it qualifies under the plan’s rules. You could reside in Georgia, invest in a Colorado plan and send your child to a post-secondary institution in California.
SavingForCollege.com notes: "In most plans, your choice of college is not affected by the state that sponsored your 529 college savings plan. You can use your 529 plan at more than 6,000 U.S. colleges and universities and more than 400 foreign colleges and universities."
To find out if your preferred institution is eligible under the 529 rules, visit its website.
529 savings plans come in two forms: a prepaid tuition plan and an education savings plan. Every state and the District of Columbia sponsor at least one of them.
Let’s start with the prepaid plan.
These plans allow people to set up specific accounts they can use to prepay all or part of their tuition costs. Funds in these accounts can cover the costs of in-state tuition, or be converted to cover tuition and other costs at out-of-state colleges and universities.
Prepaid tuition plans have some caveats. These include:
- Residency requirements.
- Restriction on where the credits can be redeemed.
- What the credits can cover, which is usually tuition and mandatory fees.
If, for some reason, your child doesn’t attend a participating college or university, the prepaid tuition plan may pay less than expected, according to the U.S. Securities and Exchange Commission (SEC). It oversees and regulates securities, such as stocks and bonds.
The SEC states that only a small amount could be paid based on the original investment.
When considering a prepaid tuition plan, you should understand the restrictions and limitations of the plan, including the extent to which your money is guaranteed and what happens to your money if the beneficiary doesn’t attend a participating college or university, according to the SEC.
Education Savings Plan
Next, we will discuss education savings plans. Like prepaid accounts, they allow people to open investment accounts to save for their children’s futures. The plans cover the same things as prepaid plans.
However, education savings plans are not limited to covering higher education costs. They can also cover tuition for elementary schooling, such as private schools.
An additional feature of education savings plans is that they can be used to pay up to $10,000 per year per beneficiary for tuition at any public, private or religious elementary or secondary school.
The SEC also points out that savers using this plan can choose from a range of investment portfolio options, which often include mutual funds and ETFs.
It states: "If you are using a 529 account to pay for elementary or secondary school tuition, you may have a shorter time horizon for your money to grow. You also may not feel comfortable taking on riskier or more volatile investments if you plan on withdrawing the money soon. Because of these things, you may consider different investment options depending on when you plan to use the money that is invested."
All education savings plans are sponsored by state governments, but only a few have residency requirements for the saver and/or beneficiary. State governments do not guarantee investments in education savings plans.
Understand that investing in an education savings plan doesn’t qualify for federal guarantees. As with most investments, investments in education savings plans may not make any money and could lose some or all of the money invested, the SEC also points out.
You could be one of those fortunate 529 savers who still have money in their account after your student graduates.
Be forewarned that if you use the money for purposes other than paying for qualified higher education expenses or tuition for elementary or secondary school, you could be hit with a penalty. Specifically, the earnings portion of any non-qualified withdrawals will be subject to federal income tax as well as a 10% penalty, according to the SEC.
Also, understand you could face penalties for failing to use the money in your 529 account for qualified higher education expenses and/or tuition. This applies regardless of the plan you choose.
Withdrawals can be subject to state income tax if you claimed a deduction or credit for your contributions. If a scholarship was accepted, you may have to pay taxes on any income earned.
In its bulletin, “Investor Bulletin: 10 Questions to Consider Before Opening a 529 Account,” the SEC states: "You may be able to avoid paying any penalties and taxes if you change the beneficiary of the 529 account or transfer the assets to another 529 account, in both instances to a person in the same family. Or you could keep the savings in the 529 account if your student is considering graduate school. Make sure you understand the tax implications of investing in a 529 account and consider whether to consult a tax adviser."
Time Is of the Essence
No matter which type of 529 plan you choose, you should start saving as soon as possible.
One of the benefits of 529 plans relates to the earnings potential that grows over time.
The SEC states: "The longer the money is invested, the more time it has to grow and the greater your tax benefits. You will lose some of these potential benefits if you withdraw money from a 529 plan account within a short period after it is contributed."