It’s the time we’ve all been waiting for with eager expectation. Yes, it’s more exciting than Christmas, New Years, or Valentine’s Day. It’s Tax Season! It is likely that you have just begun receiving tax documents in the mail, so I wanted to give you five things to keep in mind as you navigate tax season. These tips are not necessarily for helping you get the most deductions or avoid an audit. Rather, these pointers will help you breeze through tax season without stress or panic.
1) Start with a Review
As I am a financial planner, it may not come as a surprise that I would put an emphasis on making a plan before you begin. This is a great way to start your tax season right because you won’t have to do as much recalling and researching as you are going through TurboTax or gathering documents for your CPA. Start with a Word document, Excel worksheet, or just a piece of paper.
Make a list of various sources of income you have had over the previous year as well as other tax-related deductions for which you might qualify. NO NUMBERS. At this time, don’t gather specifics. This list will simply serve to indicate which forms you need to gather. Many tax forms come in the mail, but some are kept online in a web-portal or vault. The list will remind you to check online if you don’t see something that you expect by mail.
Here are some ideas that you might include on your list: Income from jobs, side hustles, banks, investment companies, retirement accounts (if you took a distribution), mortgage information, taxes paid (state, local, sales, and property), student loan information, college expenses, charitable donations, healthcare expenses, real estate rental information.
Keep this list handy as you move through tax season, checking off items and adding items as you go.
2) Stay Organized
Now that you are more aware of the documents you’ll need, bear in mind the importance of keeping everything organized. To some people, this is natural. What else would you do other than being organized? But to those who are a little more liberal in your organization, I would encourage you to set up some organization since you will need to be able to easily access this information for years to come. Applying for a mortgage? They will probably ask for one or two recent tax returns. Audited by the IRS? Legally, there’s no limit on how far back they can audit you. Practically, they may go back up to six years. It is important to keep your returns, documentation, and records.
I recommend a cloud-based system like Dropbox or Google-Drive to store your documents. If the security of these cloud storage systems scare you, there are several encryption tools you can use to supplement your system.
A perk to storing documents digitally rather than on paper is that you can create sub-folders to further organize and access your data. For example, you can create a folder called “Taxes” which opens and displays folders for “Federal”, “State”, and ”Property” You can open those and have each year broken out, and in the specific year’s folder, you can separate the final returns from the documents that support your return.
3) Don’t Procrastinate
You are not alone if you procrastinate filing your taxes. You have the ability to file your return at the start of February, but many people wait until they are dangerously close to the dreaded April 15th, Tax Day.
If you are using a CPA, give them your documentation sooner rather than later. You are likely to get more dedicated time from the CPA. If you file sooner, you’re also more likely to receive your refund more quickly from the IRS. Filing early protects you from tax fraud. If someone is trying to use your identity to file a tax return that you have already filed, the IRS will have a red tag on the fraud.
4) Pretend You are Being Audited Now
If you are filing on your own, through TurboTax or other software, I would prepare as if you were currently being audited. Getting audited is relatively rare (0.5% of returns), but should your return be the lucky one selected for an audit, you better be ready to back up every item listed on your return. Filing your taxes is on the honor system until you get audited, at which point you are guilty until proven innocent. Each deduction that you take needs to have a receipt or some proof of purchase (or donation).
Each time that you enter a deduction on your return, put the matching documentation into your tax data folder. If you make a calculation that you used for your return, save an excel folder with that calculation. If there is a chance that one year from now you could look at a number that was used in your taxes and say, “How did I get to that?” or “Where did that come from?” then type up a note explaining what you are doing and save it. This way, should an auditor come, you will not have any trouble explaining things, because you have documentation AND explanation for each part of your tax return.
5) You Have Time
Finally, if life happens, and you find yourself running up to the April 15th deadline unprepared, you still have a back up solution. ALL taxpayers can extend their tax return to October 15th. You will need to file an extension and pay your best estimate of the taxes that would be due if you were to file in April. If you end up paying too little, you may end up owing penalties and interest when you finalize your return in October.
This is a great option for some taxpayers that may not have all the correct tax information available until late in the tax season. It is not as great for taxpayers that might expect to receive a tax refund because it means you must wait longer to receive your money. Also, the government will not pay you interest for it. Despite the inconveniences of a tax extension, it can be a relief in an emergency.
You can file your taxes each year, pay what your accountant or turbotax says that you need to pay, and repeat the process each year… Or you can take a little more proactive approach. You can make tax projections, time your deductions in appropriate years, make wise decisions when it comes to investment income and gains, and navigate the most beneficial retirement accounts to contribute to. These are all things that a Financial Planning firm like Flourish FP would be happy to help you with.
Feel free to contact us if you would be interested in a consultation or keep perusing around some of our other articles.