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.
Are You Ready to Take the Plunge?
I firmly believe every ambitious person needs at least some portion of their net worth invested in the stock market. Investing in America’s top companies is perhaps the best way to grow your wealth.
Look at it this way. From 1968 through 2018, the S&P 500 returned 11.26% annually. This means an investor who put $100 to work in an index comprising of the 500 largest American companies a little more than 50 years ago is sitting on an investment worth more than $12,000 today. This required absolutely no work except setting up the investment and opening up some account statements a few times a year.
Betting on American business has been a winning strategy since 1776, and I don’t see that changing any time soon. Despite events like The Great Recession, the dot com bust, and even the granddaddy of them all, The Great Depression, America industry has shrugged off adversity to soar ever higher.
The best way to get exposure to the American economy is to buy stocks. Here’s everything you’ll know to get started.
Safe or Risky?
The first question you want to ask yourself is what kind of investor you are. You can either pick and choose individual companies or invest in many different companies at once through special products called exchange traded funds (ETFs).
Let’s start out with choosing your own stocks. It isn’t enough to listen to your neighbor or trust your gut when choosing companies to invest in. You must do the research before buying, and much of that time spent will be trying to understand a company’s accounting, its value compared to other stocks, and its future prospects.
This is not an obligation to take lightly. It takes years of study to become a good stock analyst. Some folks who invest in stocks for a living don’t do any better than the stock market as a whole. But others manage to do quite well despite having no formal training. Picking your own stocks can be a profitable endeavor if you’re willing to put in the work.
Most people don’t have much interest in researching individual stocks, so they should stick to buying a basket of different names through an ETF. An ETF gives an investor access to hundreds of different stocks through one security that trades on the stock exchange.It’s a simple way to build a diverse portfolio without going to all the work of picking and choosing individual stocks.
Popular ETFs include ones that own all 500 (505, actually. It’s complicated.) S&P 500 stocks, worldwide ETFs that own large American and international companies, and more niche ETFs like funds that invest in smaller companies or ones that focus on something specific like dividends.
Some investors like the challenge of picking their own stocks. Others think the practice is foolish and smart people shouldn’t even bother trying. There is no right or wrong answer to this debate; the secret is picking the strategy that’s right for you. The important thing is getting your capital to grow. The rest is just details.
Once you’ve decided what kind of investor you want to be, the next step is setting up a brokerage account.
If you want to invest primarily in ETFs, you can either choose a self-directed account or work with a financial advisor. A good advisor can be useful. They will help you choose ETFs that meet your risk tolerance, help with rebalancing the portfolio, and even do the work of buying and selling the funds for you. But be warned; these services are not free. You’ll pay for them through higher fund fees.
Doing all the work yourself might seem daunting, but it really isn’t so bad. You’ll need to do three steps before you can invest in the stock market:
- Open a brokerage account
- Fund that account
- Tell the brokerage what you want to buy
The first step is opening the account. If you’re looking for the easiest way to do so, I’d recommend seeing if your bank also offers an online brokerage. Many of the big banks do. The bank will share your information with the brokerage, making the account setup much easier.
If you have to open an account from scratch, don’t sweat it. It’s not a hard process, but it is a little tedious. Expect to spend an hour or two filling out forms telling the brokerage who you are, how much you have to invest, and so on.
Once the account is open, you’ll have to fund it. Your brokerage will give instructions on how to do this. The easiest way is to add your brokerage account as a payee in your bank account and transfer money just like paying any other bill. It’s the quickest way to transfer money over; but be warned, it still might take a couple of days to show up in your account.
We’re now to the moment of truth. It’s time to actually buy stocks.
The basic steps are the same no matter what you’re buying. You’ll need to tell your brokerage what stock (or ETF) you’re buying, how many shares, and whether you’re okay to pay the going price (this is a market order) or if you want to hold out for a specific price (a limit order).
You’ll also want to make sure you build a diversified portfolio if picking individual stocks. It’s irresponsible to put all of your dollars into one or two stocks. Pros say you need at least five stocks to be somewhat diversified, with an ideal portfolio of 15 to 20 different companies spread among different industries.
If you don’t have much to invest today, it might not make sense to build a diverse portfolio right now. That’s fine! Just commit to putting more cash in regularly and diversify with additional stocks over time.
The Bottom Line
Every American who is trying to save for retirement should be in the stock market. You’re missing out on fantastic potential long-term returns by avoiding it.
The market seems complex, but it’s really not. If you commit to it, your cash can be invested in America’s top companies in no time, slowly making you rich. There is no better way to passively grow your capital than the stock market. So what are you waiting for?