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.
Know Where You Are So You Can Get to Where You Want to Be
Financial success normally drills down to one’s personal net worth. Although this is not the only measure of success, nor the most important, it is worth knowing as you progress through your career.
Personal net worth is a measurement of your current financial situation and will allow you to understand if you have enough money to pay off your bills, make certain investments and have enough for a comfortable retirement.
Calculating Your Net Worth
In order to calculate your net worth, you will need to have a good understanding of all your assets and liabilities.
Assets are things that you own that have a monetary value. Assets can range from cash to material possessions. The most common assets include any checking and savings bank accounts, stocks, vehicles and real estate. Essentially, if you can trade in something you own for money, then it is a financial asset.
An individual's net worth is a combination of your liabilities against your assets.
Net worth = assets (what you own) – liabilities (what you owe)
The result will immediately inform you of your financial health and if you have more money than you owe or vice versa.
In the beginning, it is completely normal to have more liabilities than assets. This is nothing to be concerned about, as liabilities can be managed with different payment schedules. For example, a credit card bill may need to be paid off monthly, however, a student loan can be paid off over 30 to 40 years with low-interest rates.
Having a positive net worth should be your ultimate financial goal, which is very achievable as you can control both how much you own (earn) and how much you owe (spend).
In order to measure your net worth, it may be helpful to understand where you are in comparison to the average American.
Good Net Worth Financial Targets
Normally, we all start out in the red (owing more money than we have) due to student loans.
When you start your first job, it’ll be important to start thinking about how to save and build your net worth while paying off your monthly bills consisting of student loan payments, rent and credit card bills.
- Control your credit card debt — don’t spend more than you make
- Build good credit — this will help you secure low-interest loans down the road
- Start putting money away toward retirement — ideally in an investment plan. There are employer investment plans and private investment plans available. It may be wise to consult a financial advisor to understand which option is best for you.
At this point in your life, it would be wise to have some savings.
This would be a good time to look into purchasing your first home. It is not expected to have enough savings to buy a home in cash; however, you should have enough to put a down payment on a home. Your credit should also be in good shape, making it easier to secure a mortgage with low interest rates.
Buying real estate is normally a smart way to spend your money since the value tends to increase over time instead of decrease, as opposed to other major purchases such as cars.
This means that the amount you spend now to buy a house can be less than what you will one day sell it for, resulting in a capital gain and more income, thus net worth down the road.
Real estate will only add to your net worth as you pay off the mortgage (reduce the liability portion) and start to own your home (increase the asset portion).
If you are not looking to purchase a home, then think about other investments you might make with your savings, which is more profitable than just collecting bank interest rates.
Your 40s & Beyond
This is when most lives diverge and there is no good benchmark to measure yourself against. Some will have families, resulting in higher liabilities due to having to pay off additional student loans for their children, while others may be focused on solely building net worth through higher risk, higher reward investments.
The important thing to focus on during the second half of your life is having a positive net worth. In addition to having a diverse range of assets from cash to real estate, you should look to continue investing in retirement accounts.
Importance of Net Worth
Your own net worth is not necessarily something you advertise or share. Instead, it’s something to track your own progress against your own financial milestones and targets.
What is important to note is that it is not easy to calculate an individual's net worth from first impressions. You may look at a former colleague who has multiple homes and luxury cars and think that they have a very high net worth. However, remember that net worth is a combination of both assets and liabilities. It may be very well that this same person is up to their neck in outstanding loans, thus canceling out the value of these assets.
In the end, the importance of an individual's net worth is relative. Each individual will have different net worth goals based on their desired lifestyle. What's important is that you have a good handle on your net worth to understand your own financial health.
Look to have good financial health by having a positive net worth. Ensure you have enough to pay off your bills and enough saved away for emergencies and retirement.