Before tax season swings into high gear, now is the perfect time to start preparing. Giving yourself plenty of time to gather necessary documents and investigate possible deductions and credits is the best way to avoid errors and minimize your tax burden.
Here are some helpful tax preparation tips you can put to use today:
- Organize all necessary tax documents.
The sooner you can start gathering and organizing your financial documents, the better. Many of the forms you'll need will be mailed to you or sent to you electronically. As you receive them, it's a smart idea to store them all in a centralized folder or digital file. That way you can easily locate them when it's time to sit down and prepare your taxes.
Here are some of the tax documents you may need:
• Last year's tax returns
• W-2 forms from your employer
• 1099 forms listing any other sources of income you may have received throughout the year (this may include unemployment benefits, interest income, or dividends from investments)
- Determine if itemizing deductions makes sense.
Most U.S. taxpayers take what is called a "standard deduction" on their taxes. This is a dollar amount that reduces your taxable income and will vary based on your filing status. However, if you had a lot of tax-deductible expenses during the year, you may be able to reduce your taxable income further by itemizing your deductions. Unfortunately, the only way to know whether the standard deduction or itemized deductions could save you more money is to add up your eligible expenses to see if they're greater than the standard deduction.
Eligible tax-deductible expenses may include:
• State and local income or sales taxes
• Personal property taxes
• Mortgage interest payments
• Disaster losses
• Charitable donations
• Qualified medical expenses
• Qualified business expenses
• Qualified education-related expenses
You can calculate your itemized deductions using the 2022 Schedule A Form 1040. If the amount you come up with is less than the standard deduction, you should stick with the standard deduction.
- Determine if you qualify for any tax credits.
While tax deductions help reduce your taxable income, tax credits can reduce your tax liability dollar-for-dollar. It's a good idea to review which tax credits you may be eligible for.
Here are some of the common tax credits available for the 2022 tax year:
• Child/dependent care credit: Eligible taxpayers could receive a credit of up to $3,000 for one qualifying dependent, or up to $6,000 for two or more qualifying dependents.
• Earned income tax credit: Also referred to as the EITC, this tax credit has specific eligibility requirements. The exact credit amount for qualifying taxpayers will also vary based on income, marital status, and number of dependents.
• Retirement savings contribution credit: Eligible taxpayers can receive a credit for making contributions to an IRA or employer-sponsored retirement plan such as a 401k.
• American opportunity tax credit: The AOTC allows eligible college students or their parents to receive a tax credit of up to $2,500 for qualifying college expenses such as tuition, books, and school fees.
• Solar tax credit: Taxpayers who have installed a residential solar energy system could be eligible for a tax credit of up to 30% of the cost.
- Save receipts and documents.
As you gather your tax documents and proof of qualified expenses, it's important to organize them and keep them on file. The IRS recommends keeping copies of your tax returns and supporting documents for at least three years after you file. While it is unlikely that you will be audited by the IRS, you'll want you tax information easily accessible if it does happen. During an audit you'll be asked to prove your income and any deductions or credits that you claimed, and having all of your documents on hand will make the process much easier and less stressful.
- Double-check your returns and verify bank information before filing.
Before submitting your tax returns, it is extremely important to double-check them for errors. Ensure your name is spelled correctly and that your social security number was entered correctly. If you're filing jointly or claiming dependents, you'll want to make sure their information is correct as well. It's also critical that you verify any bank account information listed on your return. If you have a closed bank account or switched banks since you last filed your taxes, you could have an outdated account number or routing number listed. Having incorrect bank details on your return could cause major issues with your tax payment or your tax refund.
After your taxes are done, there are a couple of additional things you should do to make next year's tax prep even smoother.
Here are some post-tax tips to consider:
- Ensure your tax withholding is adequate.
Throughout the year, as you have taxes withheld from your paychecks, it's hard to know whether the amount being withheld is correct. Oftentimes, taxpayers don't realize there is a problem with their withholdings until they do their taxes. Ideally, your withholdings should be large enough to cover your expected tax obligation, but not so large that you overpay and need a refund during tax time.
Many taxpayers are surprised to learn that a $0 tax refund is what you should aim for. A $0 tax refund means you've had exactly the right amount of taxes withheld and haven't overpaid the government. At the same time, you've met your tax obligation and don't owe any additional money in taxes. While getting your tax withholdings 100% perfect is no easy feat, you can make some changes to come as close as possible.
If you find yourself owing taxes, you should consider having more money withheld from your paychecks moving forward. Not only will this help you to avoid a big bill at tax time, but it can prevent you from having to pay a penalty as well. Taxpayers that don't have enough money withheld could be subject to an underpayment penalty.
Likewise, if you find that you're getting a huge tax refund this year, you should consider adjusting your withholdings so you're not overpaying. Afterall, it's your money and you could be putting it to use earning interest in a high-yield CD or savings account, instead of loaning it to the government for free.
- Consider maxing out your retirement contributions.
One way to reduce your taxable income for next year is to put more money into your retirement accounts. For 2023, the max amount you can contribute to your 401K is $22,500, and you can contribute up to $6,500 in an IRA account. While contributing the maximum amount to your eligible retirement accounts can help to reduce your tax obligation, you should be sure to evaluate your entire financial situation and non-retirement goals before deciding if it's the right move for you. It's also always wise to consult with a tax professional or investment advisor before making any major investment changes.
There's no denying that tax season can be overwhelming and confusing. Thankfully though, there are things you can do now to help get organized and make the process a bit less stressful.