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.
How to Structure Your Business
When you launch your business, you face many decisions, but none is more important than how you structure your company. If you alone are the business owner, you can set the company up as a sole proprietorship with minimum preparation.
If you and at least one other person are owners, you can create a partnership structure. Both are unincorporated, pass-through structures and therefore pay no corporate income tax. The IRS considers a sole proprietorship and a partnership as no different from the individual owner(s). However, limited liability structures are available for those who want to establish a separate entity, and we’ll touch on this at the end of the article.
Read on to learn the pros and cons of setting a company up as sole proprietor vs partnership.
In a sole proprietorship, the owner runs the business, without partners (other than a spouse). You can start a sole proprietorship without filing any papers or taking any legal steps. However, your local government might require you to secure a business license and permits to operate.
For example, if you started business as a plumber or electrician, you would probably need to obtain the proper license. You have the option to Do Business As (DBA) a trade name, which is easy to do online. But a DBA doesn’t separate the owner from the business.
As the owner, you are personally liable for all debts and tax payments. In fact, the IRS considers your sole proprietorship to be a disregarded entity, and you file your business income and losses as part of your personal return. The business files no separate tax return. In other words, the sole proprietorship is a pass-through entity because income, expenses and the obligation to pay taxes flow directly to you, the owner.
You must pay self-employment taxes (for Social Security and Medicare) as part of your quarterly estimated payments to the IRS. The sole proprietorship provides your personal assets no protection from liabilities arising from debts, legal actions and other causes.
You can dissolve a sole proprietorship any time by informing the federal, state and local taxing authorities that you no longer run the business. As the sole proprietor, you have exclusive control over how you run the business. You make the management decisions, and when you die, the company dies with you.
Sole Proprietorship Pros and Cons
The advantages of a sole proprietorship are:
- It’s easy and quick to launch, with few, if any, forms to complete.
You have total control over the business, including all the money earned by the business.
- As the sole manager, you can quickly respond to problems and opportunities.
- You have less involvement with the government, and you don’t have to keep any special incorporation records or minutes of annual meetings.
You don’t file a separate tax return and you don’t have to prepare financial reports such as a balance sheet.
The disadvantages of a sole proprietorship are:
- The business owner is liable for all business obligations and debts. The liability extends to your personal assets (except for a 401(k) and, partially, an IRA). You may need to secure additional insurance coverage against physical loss or personal injury.
- If the owner dies, becomes incapacitated or physically impaired, the business may have to terminate.
- It can be difficult to raise financing because the owner has fewer assets.
- You call all the shots, which means you could make a bad decision that kills or hurts the company.
- Your business might seem less professional than do other company structures.
A partnership is a business owned by two or more individuals. To establish one, you first register the partnership with your local Secretary of State. You must also give the business a name or use a partnership name consisting of the partners’ last names. You can also register a DBA if you want to operate under a different name.
You then obtain any necessary permits and licenses. These vary by state, locality and industry. You might also create a partnership agreement, which although not legally required, is a good idea. A partnership agreement lays out the responsibilities of each partner, how decisions are made, how profits are divided, how disputes are resolved, and how to change or dissolve the partnership.
Like a sole proprietorship, a partnership is a pass-through entity that pays no income taxes on its own. However, the IRS requires partnerships to annually file Form 1065, which reports the partnership’s income, gains, losses, credits, deductions and so forth.
Partnership Pros and Cons
The advantages of a partnership are:
- The company can survive the death or departure of a partner.
- It can be easier to raise financing because multiple owners have a greater number of assets.
- Decision-making is shared, meaning that mistakes might not be attributed to a single person.
- Your business will appear more professional.
The disadvantages of a partnership are:
- It requires more paperwork to establish a partnership and report annually to the IRS.
- The partners are liable for all business obligations and debts. The liability extends to their personal assets. This can make it harder to secure loans or attract investors.
- Control is shared among the partners, which can slow down decision-making.
- It can take longer to respond to opportunities and challenges.
- You face more government involvement.
- You must file an annual tax information.
Limited Liability Alternatives
A sole proprietor can limit personal liability by setting up a Limited Liability Company (LLC), a Chapter S corporation or Chapter C corporation. An LLC is a pass-through entity for tax purposes. It is set up as a sole proprietorship if there is only one owner. Otherwise, it is treated as a partnership. A Chapter S corporation is also a pass-through entity, but a Chapter C corporation files its own return and pays income taxes on its profits.
Partnerships can obtain liability protection by structuring themselves as limited partnerships or limited liability partnerships. In a limited partnership, the general partners have 100% liability for the company, but limited partners are liable for only their capital contributions. In a limited liability partnership, all partners have limited liability.