2020 may not have been like any other year, but getting ready for your 2020 taxes is going to be substantially similar to years past. We’ll break the process into 5 steps.
Step 1: Gather your documents. This step is simple for some folks but incredibly time consuming for others. The first thing you should start doing is compiling all of the tax information that is mailed or e-mailed to you in one physical/or digital place.
If you’re a technologically oriented person who likes to take advantage of the convenience of your digital devices, scan the physical documents that you receive and preserve the digital copies. I’d further suggest password protecting any PDFs that contain sensitive information like Social Security Numbers and bank account numbers. I may be a bit over-cautious, but I would suggest considering storing this information on a removable USB device as well, to keep it disconnected from the internet.
If you’re a bit more old fashioned, print out any tax documentation that you receive electronically and add it to a folder or secure storage location in your home.
Unfortunately most people find that their tax documents come in at various times during the first few months of a new year, so it’s important to stay organized and stay on top of storing this information as it comes in. The list of potential documents is a bit too long to go through here, but basically, if it has the word tax on it or if it is related to income or (potentially deductible) expenses, then you should save it. Additionally, you should add a copy of your prior year return to your tax documents, as your prior year return can potentially have a significant impact on your current year return (i.e. loss carryforwards).
Regarding potentially deductible expenses, for most people, people who don’t run their own business or manage their own rental properties, you’re going to find that you will be taking the standard deduction and that much of the information you previously needed to itemize your deductions won’t be required. The reason for this is two-fold. First, the standard deduction was doubled during 2017 making it a much more attractive option for many people. The second, and perhaps even more impactful change, was the SALT (state and local tax) limitation of $10,000 that was imposed on the deductible amount of taxes paid to your state or local government. Previously, if you paid $12,000 in state income tax through your employment income and $6,000 in property taxes, you would have had an $18,000 deduction to add to your schedule A (the schedule for itemized deductions). During 2020, those same expenses will only result in a $10,000 deduction through your schedule A.
If you know that your itemized deductions won’t exceed the standard deduction (Single/Married Filing Separately: $12,400; Married Filing Jointly: $24,800; Head of Household:$18,650) then you won’t need the documents with those expenses for your tax filings.
Step 2: Deciding if and how you want to prepare your tax filings yourself or if you want to hire a professional tax preparer is an important step. Preparing and filing your own returns has never been easier. There are a variety of software options that can accommodate most individuals’ situations.
The most noteworthy option is the IRS free file (https://www.irs.gov/filing/free-file-do-your-federal-taxes-for-free). If you have $72,000 in income or less, you will be eligible to file for free through the above link. If you have more income than that, you will still have some viable options, most commonly TurboTax software and H&R Block software, but there are a variety of other online return preparation options. Because the information that you are providing is incredibly sensitive (i.e. your Social Security Number) you want to make sure that you choose a reputable provider for your return, so spend a few moments and research the software//website that you are considering using. Additionally, you should be aware that their pricing might not be as straightforward as it seems at first glance. Very often these software providers will charge you additional amounts for each state return that you need to file, or will try to sell you ‘audit protection’ which, if you ever need it, you will regret having paid for the second rate audit support that you will receive for the audit protection fee. Anyone including audit protection for a nominal flat fee can’t be expected to provide you with the extensive service that is required to bring most audits to a satisfactory conclusion. It’s also worth mentioning that the percentage of people that are audited annually is very very small, and these companies are relying on people buying this ‘audit protection’ and never needing it.
If you are considering hiring a professional to help you with your return, you should spend some time confirming that they are actually credentialed preparers (for example, you can navigate to https://www.jud.ct.gov/attorneyfirminquiry/AttorneyFirmInquiry.aspx to check the status of Connecticut Attorneys and also review if they have a record of grievances resulting in disciplinary action). It’s also worthwhile to confirm that they are keeping up-to-date with changing laws and recent court decisions. Perhaps check their website to see if they maintain a blog where they select some of the more interesting recent developments to discuss (alright alright… maybe you won’t think the developments are interesting, but we do). Lastly, talk to them. You need a preparer that will be accessible, will be able to respond to questions and concerns that you have, and who will timely handle your return and any other tax matters that you bring to them. If it takes a preparer a few days to follow up with you when you are considering hiring them, how long do you think it might take once they’ve already received your payment? I’ve heard too many stories of unsatisfied people that were not provided enough time to review their tax returns, and who had their correspondence and any questions they had for their preparer ignored.
I don’t want to get preachy here, but I’m going to for just a moment (sorry?). It’s important that you understand how taxes work and that you understand your tax return. It could have a very large impact on the actual profitability of your investments. If you end up paying an additional 10%-30% on investments because you didn’t hold them long enough to receive long-term capital gains treatment, that’s a lesson you need to learn in order to maximize the income from future investments. The unfortunate truth is that your investment advisors don’t care about tax efficiency at all, and they will give you inaccurate information too often. They care about the bottom line performance of the investment, but you should be concerned with the amount of profit you have AFTER you pay your taxes on an investment.
Another and equally important reason to work with a tax professional is that that person will now be familiar with your situation, and when that situation changes, or if you are considering an important change (maybe becoming self-employed, moving to another state, working for a company in another state, working remotely) you can pick up the phone/open an e-mail, reach out to your tax professional and get some front-end advice that can save you from very real problems down the road. The easiest example of this is the individual who becomes self-employed but doesn’t realize that they need to pay self-employment tax on all of their self-employment income. Learning that you need to pay an extra 15.3% on your net self employment income after you’ve already spent that money… can leave you in an impossible situation.
Step 3: Determining if you need or want an extension is a step that individuals often procrastinate or skip entirely until immediately before the filing deadline. If you’re not sure if you’re going to want an extension, it may be worthwhile to go ahead and file for extension anyway. Filing for extension has never been easier than it is currently. You can login//create an account on the IRS’ website, open their payment portal (https://www.irs.gov/payments) complete the requested information indicating the correct tax year and that this is a payment for an extension, make as much of a payment as you’d like (people who don’t think that they will owe the IRS but still wish to use this method to secure an extension, will typically make payments around $20).
To briefly expand on extensions, your personal tax return (if you live within the United States) is due April 15th and you can file for an automatic extension (which means your extension will be accepted automatically if properly filed) until October 15th. The extension to file your tax return IS NOT an extension to pay your taxes. Any taxes that you owe for the prior year are due by April 15th and any amounts that aren’t paid by April 15th will result in failure to pay penalties. This means that if you are filing for an extension, you should liberally estimate amounts that you may owe, and err on the side of overpaying if you are financially capable of overpaying. Any amounts you pay with an extension will be fully credited on your tax return and any amount you have overpaid will be refunded to you.
These failure-to-pay penalties are much much less than the failure to file penalties, so if you know you are a procrastinator, maybe go ahead and get that extension filed sooner rather than later.
Step 4: Review and understand your return. Whether you’ve prepared your return yourself or hired a preparer, you want to be able to look through your return and have a rough understanding of why you are paying the amount of tax you are paying. You also want to be able to confirm that all of your income has been included on that return. You are responsible for your return, if you receive incorrect advice from a preparer, that can aid an argument to remove future penalties, but if you blatantly omitted income or made a different ‘obvious’ error, you will be responsible for all of the interest and penalties resulting from that error. Please be aware that when you sign your return, you are swearing that you’ve accurately provided all of the relevant information.
Step 5: File your return. This should be the easiest step. Tax professionals will almost always electronically file your return (and receive confirmation that the return has been accepted) and any reputable tax software will also provide you with the ability to electronically file your return as well. Electronically filed returns are processed faster (faster refunds) and create a clear paper trail that the return was timely filed. If, for any reason, you decide to mail a return (or anything for that matter) to the IRS, you should send the mailing with tracking and preserve a record of the date that the item was postmarked.
This blog post may have gotten a bit long winded in the middle, but any of you that stuck it out until the end, thank you, and I don’t doubt that you are the type of person that will take your tax filing responsibilities seriously and that will have advance notice of the tax consequences headed your way in the future.