By the time the clock strikes 12 tonight, another tax season will be over. Some will be able to put the agony past them entirely, while others will resign themselves to filing for an extension and taking up the battle again within the next few months.
But whether you expect a refund or wrote the IRS a check, and regardless of whether you filed months ago or just got around to doing it today, your tax return can give you a valuable glimpse into your finances and what you can do to improve them. Let's take a look at three lessons that your tax return is begging to teach you.
1. Not all income is created equal.
When a dollar goes into your bank account, you don't really care where it comes from. You can spend it just as easily whether you got it from your paycheck, your investments, or found it on the street.
But to the IRS, it makes a huge difference where you got your income. On the earnings side, if you're an employee, then you just pay your ordinary tax rate on your wages, and you're done. But if you're self-employed, then you get to tack on extra self-employment taxes that can run as high as 15.3%.
With investment income, the rules are even more varied. Interest income gets an ordinary-rate hit, unless you invest in municipal bonds, which are tax-free. Some dividends get favorable tax treatment, while others don't, and some capital gains get taxed at a lower rate, while others get charged at ordinary income rates.
Keeping it all straight can be tough, especially when rules change all the time. But unless you know the tax impact of your investments, you won't accurately assess your true returns -- and that could lead you to make mistakes with your investing.
2. Where'd all your investment income go?
If you rely on your investments to make ends meet, then you'll probably notice a disturbing trend: Your interest income has probably just about evaporated. With interest rates near all-time lows, it's gotten increasingly hard in recent years to squeeze income from bonds, bank CDs, and other traditional fixed-income sources. As Wells Fargo's
Many investors have moved into dividend stocks to try to make up for the income shortfall, and so you may have seen your dividend income go up. Blue-chip stocks have boosted their dividend payouts substantially -- so much, in fact, that many of them have dividend yields that exceed the yields on their bonds. In fact, among the stocks in the Dow Jones Industrials, Merck
In this environment, going with dividend stocks over bonds may seem like a no-brainer. But just remember that stocks carry risks that bonds don't -- and an abrupt fall in the stock market could leave you saddled with losses you can ill afford to suffer.
3. The more you keep off your tax return, the better.
I'm not advocating cheating on your taxes. But if you have retirement accounts, then you have a potentially major source of income that you can legitimately shelter from tax.
I'm a huge fan of IRAs, 401(k) plans, and other methods of getting tax deferrals. They definitely help you save on taxes, but even more important is the simplicity they bring to tax preparation. Not only do you not have to worry about income your retirement account assets generate, but you can also buy and sell at will without worrying about the tax consequences of capital gains and losses. That's a benefit that too few people take advantage of -- yet it can make a world of difference to your long-term financial success.
Barring a last-minute IRA contribution, it's too late to change anything that will show up on your 2011 tax return. But going forward, be aware of the impact that your investment strategies have on your taxes -- and try to make the most of your tax-saving opportunities.
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