Don't look now, but tax season is getting closer. It's not something most of us enjoy thinking about or dealing with -- indeed, 16% of respondents to an AARP survey said they'd rather spend a night at the airport than prepare their taxes, while 36% would just as soon visit the DMV.
If you approach tax season prepared, though, and you're able to shrink your tax bill via some savvy moves, then maybe it won't be so bad. Here are five valuable tax tips you can use in 2020 and in the years ahead.
Tip No. 1: Be organized
It's a little late to do a great job with this tip, but it's not too late. Ideally, have a folder or box where you place tax-related receipts and documents throughout the year. (After all, you might spend some money on a tax-deductible medical expense in May -- and you don't want to forget about it.) Once you're sitting down to prepare your return, all the papers you need will be in one place. Even if you're using a tax professional to prepare your tax return, it will be very helpful to be able to hand over all your necessary documentation instead of having to hunt for it.
Tip No. 2: Take advantage of IRAs and 401(k)s
It's vital for most of us to be saving and investing for retirement, and it's very helpful to do so using tax-advantaged accounts such as IRAs and 401(k)s.
There are two main kinds of IRAs and 401(k)s: traditional and Roth. Traditional accounts offer an up-front tax break: You contribute money on a pre-tax basis, thereby reducing your taxable income for the year of the contribution. If you contribute, say, $5,000, you deduct that from your taxable income and avoid paying taxes on it. With a 24% tax bracket, you could shrink your tax bill by $1,200.
Roth accounts offer a back-end tax break: You contribute money on an after-tax basis, so your taxable income isn't reduced and your tax bill for the year of contribution doesn't shrink. But, if you follow the rules, when you withdraw money from the account in retirement, it will be tax-free income.
Tip No. 3: Keep up with changes to tax laws
Next, it's important to keep up with developments in tax law. Otherwise, you might not realize that the amount you can contribute to various accounts has changed or that certain deductions are no longer allowed. Some years offer more changes than others -- the Tax Cuts and Jobs Act of 2017 ushered in lots of change, such as doubling the standard deduction and reducing various tax rates -- rules that are in effect now, for your 2019 tax return that you'll prepare in 2020 and for future years.
Here are three changes that take place for tax year 2019:
- Alimony payments from divorce or separation agreements made or changed in 2019 or later will not be deductible.
- The penalty if you don't have health insurance (and didn't receive an exemption) has been eliminated.
- The threshold for deducting qualifying medical and dental expenses has risen from 7.5% of your adjusted gross income (AGI) to 10%, making it harder to deduct those expenses. So, if your AGI is $60,000, you could only deduct those qualifying expenses that exceed $6,000. Expenses of $7,000? You can deduct $1,000. Expenses of $4,000? You're out of luck. (Remember, though, that the standard deduction is now much higher than it was in recent years, so many more people should simply take that instead of itemizing.)
Tip No. 4: Be thorough and report all your income
It can be tempting or easy to omit some income when preparing your taxes -- if only because you forgot some income. That can be a costly blunder, however, and one that can be prevented if you're organized and keep good records of all your earnings. You might have a small job on the side, for example, or you may be earning a little extra income making and selling things online.
Many sources of income will send you end-of-year documents, such as the W-2 form from your employer or 1099 forms from your bank and/or brokerage detailing income from sources such as dividends or interest. That information also makes its way to the Internal Revenue Service, which is expecting you to report it. Failure to do so will likely be noticed.
For less-formal income you receive, it may be your responsibility to keep track of it and ensure that you have sufficient funds on hand to pay your tax bill come April. Those who earn significant sums on the side may need to pay quarterly estimated taxes to the government as well -- that's when you pay your taxes in installments throughout the year, as many self-employed folks do. The many people who just file and pay taxes once a year can do so because their employers have been withholding taxes throughout the year -- they have, therefore, been paying throughout the year, too.
Tip No. 5: Consider hiring a tax pro
Finally, because tax laws are so complicated and subject to change, consider not preparing your tax return on your own. If your situation is very simple, such as if you're single, with no dependents, no investments, and no income other than a salary, you could do well to use a tax preparation software package.
But those with more complicated financial lives should consider using a good tax pro's services. After all, he or she spends a lot of time keeping up with tax laws and knows about available strategies that can minimize your taxes. But don't just sign up with a stranger at a kiosk you run across -- ask for strong recommendations from friends or family or look into nearby enrolled agents (those who are authorized to represent you before the IRS) and interview a few before selecting who to hire.
Taxes aren't exciting, but it's well worth your time to read up on tax basics, including deductions and credits available to you that can shrink your tax bill.