Author: Christy Bieber | February 14, 2019
Educate yourself before you file
Almost no one likes doing their taxes. After all, there's a lot of paperwork involved and the threat of an audit hanging over your head if you do things wrong. Plus, the tax code is very long and complicated, and even many tax professionals aren't 100% sure what some of its more obscure provisions actually mean.
The good news is, learning some key facts about taxes can help make filing easier -- and potentially help you keep at least a little more money in your pocket. In fact, here are 40 things you should probably know before you submit your returns for 2019.
1. Tax season starts in January, and doesn't always end April 15
Most people assume April 15 is the deadline for filing taxes each year, but this isn't the case if the 15th falls on a weekend or a holiday. While taxes are due on April 15, 2019 -- which is a Monday -- last year's returns were due on Tuesday April 17, 2018. That's because the 15th fell on a Sunday and the 16th was a legal holiday (Emancipation Day) in Washington D.C.
While taxpayers have until April to file returns, they don't have to wait. The IRS began accepting paper and electronic returns on Jan. 28, 2019. So, taxpayers who are ahead of the game have no reason to delay in submitting their paperwork and claiming their refunds or paying what's due.
2. The U.S. tax system is progressive
In the U.S., taxpayers pay more if they make more. In fact, there are currently seven different tax brackets in the U.S., and the higher your income, the higher your bracket. This type of system is referred to as a progressive tax system. It's an alternative to a flat tax system, where everyone would pay the same amount or would be taxed at the same rate.
The theory behind a progressive tax system is that people who make less spend more of their money on meeting life's basic necessities so they have less money left over to contribute to the common good by paying a high tax bill.
3. Not everyone is required to file a tax return
You may assume you have to file a tax return as soon as you earn your first dollar of income, but that isn't true. You're only required to file a tax return once your income hits a certain threshold.
Your filing status, the income you earn, and the amount of income you've had withheld will all determine if you're required to file with the IRS or not. The IRS Interactive Tax Assistant can help you to determine if filing a return is something you're required to do.
4. You may want to file a tax return even if you don't have to
While you may not be legally required to file a tax return, it can sometimes be a good idea to do so anyway. It may seem crazy to do all this paperwork when the IRS doesn't mandate it, but it could be important if you're entitled to a tax refund.
If you had more money withheld from your paycheck than you owe, you should file a tax return to get that money back. You could also be entitled to get back more money than you paid in federal taxes under some circumstances, such as when you're eligible for the earned income tax credit. You don't want to miss out on getting money you're owed back from the IRS, so get the paperwork done if you find yourself in this situation.
5. Your taxable income is below your gross income
Some taxpayers assume if they make $50,000, they'll be taxed on $50,000 in income -- but this isn't the case. The salary you earn from your employer is called your gross income. You'll need to make adjustments to your income and claim any deductions and credits that you're entitled to claim in order to arrive at your taxable income. Your taxable income determines what your tax bracket is and how much you'll actually owe to the IRS.
6. AGI determines what deductions and credits you're eligible for
Many tax deductions and credits are available only to people whose income falls below a certain threshold. Your Adjustable Gross Income (AGI) is what determines the deductions and credits you can claim.
Your AGI is different from both your taxable income and your gross income. To determine AGI, you add up all your taxable income, including income from your employer, your business, interest on your bank account, and dividends. Then, you make adjustments to this total amount. The adjustments you make include subtracting half of any self-employment taxes you pay, as well as subtracting contributions you've made to IRAs and other eligible tax-advantaged accounts.
After you calculate AGI, you can then use this number to determine other deductions you're entitled to claim. Once you subtract those deductions, you arrive at your taxable income.
7. You're required to pay taxes as you earn income
Under the U.S. tax code, you can't just wait until April to pay what you owe to the IRS. You're required to pay in money as you earn income.
For most people, your employer takes care of this automatically. You fill out forms when you get your job that help your employer to determine an appropriate amount of money to withhold from your paychecks. Your employer collects this money and sends it to the IRS for you.
If you earn income from sources other than an employer, you are responsible for making sure to comply with the rules to pay taxes as it's earned. This means you must make estimated tax payments four times annually. If you don't make your estimated tax payments and pay in at least 90% of the amount you owe in taxes, you could potentially be hit with penalties.
If you're not sure how much income you'll earn over the year or how much your estimated taxes will be, you could avoid penalties by paying in at least 100% (or 110% for higher earners) of taxes shown on your return for the prior year. This is called the safe harbor amount.
8. You're expected to declare all your income
You aren't just taxed on wages that you earn. If you earn money from gambling; interest from savings accounts; returns on investments; cash from selling crafts you make; rent from real estate; or income from any other source, you're expected to declare it. You're even expected to declare cash income you earn.
If the IRS suspects you aren't declaring all your income, this could trigger an audit. They could examine your bank accounts or see if the income you declared is high enough to support your lifestyle. You could end up owing penalties and interest on the taxes you should have paid on any income that went undeclared.
9. Forgiven debt can count as income
Under the U.S. tax code, there are certain things that count as income that you may not consider to be income. One of those things is cancelled debt.
If you have a legal obligation to pay back a debt and the lender forgives the debt or reduces the balance you owe, the forgiven amount can actually count as taxable income. You could receive Form 1099-C, Cancellation of Debt detailing the amount of debt that's been forgiven that you owe taxes on.
There are some limited exceptions to this rule, such as when you have student loan debt forgiven due to participating in qualifying loan forgiveness programs. But in general, most debtors will be obligated to pay taxes on forgiven debt.
This can come as a big financial shock if you had your debt forgiven because you couldn't afford to pay it. It can be an especially big issue if you had a substantial amount of debt forgiven and you're pushed into a higher tax bracket or lose deductions or credits you otherwise could've claimed.
10. Your Social Security benefits might be taxable
Social Security benefits are paid out by the government and are based on the amount of Social Security taxes you paid in over your lifetime. It may come as a surprise that your Social Security benefits could potentially be taxed on both the federal and state level.
Your Social Security benefits are taxed by the federal government only once your income exceeds a certain threshold. And calculating income for purposes of determining if benefits are taxable works differently than most income calculations. Income is determined by adding up half your Social Security benefits and all taxable income from sources other than Social Security. You also have to include certain tax-free income, such as income from interest from municipal bonds.
If your income under this formula exceeds $25,000 as a single filer or $32,000 when married file jointly, you could be taxed on up to 50% of Social Security benefits. If your income exceeds $34,000 as a single filer or $44,000 when married filing jointly, you could be taxed on up to 85% of your benefits.
There are also 13 states that tax Social Security benefits, so you could owe state tax as well if you live in one of them.
11. Some retirement accounts allow you to withdraw money tax-free
While the general rule is that you're taxed on all income, this isn't always true. In fact, if you've invested in certain types of tax-advantaged accounts, you could make tax-free withdrawals.
You can withdraw money tax free from Roth IRAs and Roth 401(k)s, provided you comply with the rules such as waiting until you're old enough and having your account open for a long enough time.
This can provide a major advantage since you'll have income coming in during your senior years that you aren't taxed on. Be aware, however, you won't get up-front tax breaks for investing in these accounts as you do with traditional IRAs and 401(k) accounts.
12. You could be hit with huge tax penalties if you don't withdraw enough from some retirement accounts
If you've got money in retirement accounts that you got tax breaks for investing in, it's very important you understand the rules for withdrawals. That's because with both a 401(k) and an IRA, you're required to take out money once you hit age 70 ½.
The amount you're mandated to take out of your retirement account is called a Required Minimum Distribution (RMD). If you don't follow the rules for RMDs, you could owe a penalty of up to 50% of the amount you should've withdrawn. You definitely don't want to end up with this huge penalty, so study up on the RMD rules.
13. Gifts could trigger taxes -- but only big ones
Did you know that if you give a generous gift to someone, it's possible you could owe taxes on the gift. The good news is, this gift tax applies to very few people. That's because there's both an annual gift tax exclusion and a lifetime gift tax exclusion.
Thanks to the annual gift tax exclusion, you could give up to $15,000 per recipient in 2018 and 2019 without triggering gift taxes. And thanks to the lifetime exclusion, you could give up to $11.2 million in assets away in 2018 and $11.4 million away in 2019 without taxes being triggered. Just be aware that this lifetime exclusion also applies to estate taxes, so if you start giving away really generous gifts during your life, this will reduce the amount you can pass after death without triggering taxes.
14. Opening an account abroad can trigger a whole bunch of complicated tax obligations
While opening offshore bank accounts may seem like something only really rich people do, the reality is there's lots of reasons why you may want to open a bank account in a foreign country. You may have family abroad, for example, or may go live abroad for an extended time and want a bank account in your new locale.
The problem is, having an offshore account -- even if you're living abroad -- can make your taxes much more complicated. You may be required to file a Report of Foreign Bank and Financial Account (FBAR) if your account exceeds $10,000. You also have reporting obligations under the Foreign Account Tax Compliance Act (FACTA).
Be aware you could trigger these reporting requirements just by having signature authority on a foreign account. So if your elderly mom living abroad puts your name on her bank account or your company gives you access to a foreign financial account for business trips, you may have a lot of tax paperwork to do.
The penalties for failure to comply with these rules can be very substantial, so talk to an accountant if you do any banking offshore!
15. Not all income is taxed in the same way
While you're required to pay taxes on all of your income, not all of it is taxed using the same seven tax brackets. When you make a profit from selling certain types of assets, such as stocks and other investments, you pay capital gains taxes instead of standard income taxes.
Making things even more complicated, there are different capital gains rates for long-term investments you hold for a long time compared with investments you hold only for a short time. Your long-term capital gains rate is determined by your income, while short-term capital gains are usually taxed at the same rate as your ordinary income.
The rate you pay on long-term capital gains is typically lower than the rate you pay on your ordinary income, so it can pay to be strategic about when you sell investments at a profit.
16. Filing your taxes early can help prevent identity theft
Did you know identity thieves have taken to submitting tax returns using stolen Social Security numbers to claim refunds they aren't entitled to? If a scammer files a return with your Social Security number before you get a chance to, this can create a huge mess for you.
The IRS provides a step-by-step guide for what to do if you're a victim of tax identity theft, but you'll ideally want to protect yourself before a thief can submit a fraudulent return. One of the best ways to do this is to file your taxes ASAP. If you've already submitted your legitimate forms, the scammer's attempt to submit a return with your info on it will be rejected.
17. It's way faster to get your refund if you e-file your taxes
You have a choice to file your tax returns electronically or to submit a paper return. E-filing is way easier, is preferred by the IRS, and can allow you to get your tax refund much more quickly. This is especially true if you also opt to have your refund directly deposited.
18. Refunds take longer if you claim certain tax breaks
If you claim either the Additional Child Tax Credit or the Earned Income Tax Credit, your entire tax refund could be delayed. That's because the IRS is required to withhold refunds of taxpayers who claim these credits until the middle of February under the Protecting Americans from Tax Hikes Act.
The IRS indicates that taxpayers who use direct deposit and who have no issues with their tax returns will start receiving refunds as early as Feb. 27, 2019 if they've claimed either of these credits.
19. Many tax filers can e-file their taxes for free
Taxpayers with incomes under $66,000 can use a variety of online software programs to e-file their federal taxes at no cost. The IRS even provides a tool to look up e-filing software that allows you to file for free.
Many of the programs that allow you to e-file federal taxes for free will also allow you to file state tax returns without incurring any costs. Just be sure to check the fine print for the software you're considering to confirm you won't have to pay to file with your state.
20. It's also possible for many tax-filers to get in-person help from volunteers at no cost
Taxpayers with incomes under $55,000 could get free help with their tax returns from the Volunteer Income Tax Assistance (VITA) program. Disabled people and those who speak limited English can also get help from VITA while seniors over 60 are eligible for free assistance through the Tax Counseling for the Elderly (TCE) program.
The IRS has tools to help you find free tax help in your area. Taking advantage of these free services can make it much easier to comply with your tax obligations and ensure you're able to claim all the credits and deductions you're entitled to.
21. Your filing status makes a big impact on how you're taxed
When you file your taxes, you'll need to choose whether to file as single; married filing separately; married filing jointly; or head-of-household. You don't want to make the wrong choice, as your filing status affects your tax bracket, deductions and credits you can claim, and even whether you must file at all.
If you're not sure what your filing status is, the interactive tax assistant from the IRS allows you to answer a few simple questions to find out.
22. Your marginal and effective tax rate aren't the same
If you're in the 22% tax bracket, it may sound like you'd pay 22% taxes on the entire amount you earn, but that's not the case. Instead, only income above a certain threshold is taxed at 22%. For example, for single filers, the 22% tax bracket covers income between $38,700.01 and $82,500 for the 2018 tax year. Income below $38,701 is taxed at a lower rate. So if your taxable income is $38,701, you'd only pay 22% tax on your $1 in income within the 22% bracket. The tax rate you pay on each additional dollar of income you earn is called your marginal tax rate. It goes up as your income rises.
Your marginal tax rate is different from your effective tax rate, which is the total amount you actually end up paying relative to total income (not just taxable income). If your total income was $50,000 and you ended up paying $4,000 in total taxes, your effective tax rate would be .08%. The deductions and credits you qualify for will end up affecting your effective tax rate, which is usually much lower than your marginal rate.
23. There are certain deductions you can only claim if you itemize
Taxpayers should try to claim as many deductions as possible to reduce taxable income and cut your total tax bill. To maximize your deductions, you'll need to decide whether to claim the standard deduction or to itemize.
The standard deduction is a set amount you can deduct from your income, and it's determined by your filing status. For example, singles in 2018 could claim a $12,000 standard deduction. If you claim the standard deduction, you can claim some additional deductions, such as the deduction for IRA contributions.
However, there are many deductions you cannot claim if you claim the standard deduction. Among them are the deduction for mortgage interest; for charitable donations; and for state and local taxes.
You'll need to estimate the total amount you could deduct if you itemize your deductions and compare this with the total amount you can deduct if you itemize. Unless you can claim a larger deduction by itemizing, it makes no sense to do so when it's much easier to simply claim the standard deduction.
24. You can contribute to tax-advantaged retirement accounts until tax day
Contributing to a tax-advantaged retirement savings account, such as an IRA, is one of the single best ways to reduce your taxable income. The good news is, it's not too late to get a retirement tax break for 2018.
That's because you can contribute to your retirement account for the prior tax year until taxes are due for that year. So you can take a deduction on your 2018 tax return for IRA contributions as long as those contributions are made by April 15, 2019.
25. Your baby can get you a full year's worth of tax breaks even when born on Dec. 31
Having a baby can entitle you to some generous tax breaks, including the child tax credit. Your child also allows you to become eligible for the Earned Income Tax credit with income at a much higher threshold.
Parents may be excited to discover that their new bundle of joy brings these tax breaks no matter when in the year your child arrives. If your baby just beats the clock and is born at 11:59 on Dec. 31, your child's done you a favor and arrived just in time to save you a fortune in taxes.
26. HSA contributions can provide some of the best tax-saving benefits
It's not just retirement savings accounts that can help you to reduce your taxable income. Contributions to a Health Savings Account can also be deducted from your taxes. You'll need a qualifying high deductible health plan to be eligible to contribute to an HSA, though, and the amount you can contribute depends whether you have an individual or a family plan.
HSAs are actually a great account to help you save because not only can you deduct the funds you contribute, but you also don't pay taxes on withdrawals as long as you use the money for qualifying health expenses when you take it out. This is actually a more generous tax break than for 401(k)s and IRAs, as you're taxed on withdrawals with those accounts.
27. Deductions and credits have very different values
You've probably noticed the terms “deductions” and “credits” in anything you read about taxes -- including these tax facts. Both deductions and credits are important because they provide tax savings. But the amount of tax savings they provide differs greatly.
Deductions allow you to reduce your taxable income. If you make $50,000 and you take a $1,000 deduction, you've reduced your taxable income to $49,000. The savings you realize is determined by how much you would've been taxed if you hadn't taken the deduction. If you're in the 22% tax bracket and you take a $1,000 deduction, you save at most 22% on the $1,000 you're not being taxed on thanks to the deduction. So the $1,000 deduction is actually worth a maximum of $220.
A credit, on the other hand, provides a dollar-for-dollar reduction in taxes owed. If you receive a $1,000 credit, then you subtract $1,000 from the taxes you were supposed to pay. If you were supposed to pay $4,000 in taxes, your taxes will only be $3,000 thanks to your credit. The $1,000 credit saves you a full $1,000 and is much more valuable than the $1,000 deduction.
28. Some credits are refundable, but others aren't
Since a tax credit provides a dollar-for-dollar reduction in what you owe, there are times when a credit could reduce your taxes below $0. If you owed $1,000 in taxes, for example, and were eligible for a $2,000 credit, technically your new tax bill would be -$1,000 and the government should cut you a check for $1,000.
However, it doesn't always work that way. Some credits are fully or partially refundable, which means you do get back money if the credit entitles you to more than the taxes you owe. Others are not refundable, so you can only reduce your taxes down to $0 but won't get a check back in the mail for more than you paid in.
The Child Tax Credit is an example of a partially refundable credit. The credit is worth up to $2,000, $1,400 of which is refundable. If you owed $2,000 in taxes, your Child Tax Credit could reduce your tax bill to $0. If you owed nothing in taxes and claimed the Child Tax Credit, the maximum you'd be able to get back would be the $1,400 refundable portion of the credit.
29. You can deduct some of the state and local taxes you pay from your federal returns
Most taxpayers owe at least some taxes to their local governments. This could be state income tax, sales tax, or real estate tax.
The good news is, when you pay these local taxes, you can deduct up to $10,000 of the amount you paid to your state from your federal taxable income. You do have to itemize to claim this deduction, though. The deduction is commonly called the SALT deduction, which stands for State and Local Tax deduction.
Previously, taxpayers who claimed the SALT deduction could deduct the full amount of state and local taxes paid from their federal taxable income. The Tax Cuts and Jobs Act imposed the $10,000 cap, which has created substantial controversy and which will result in big tax increases for many taxpayers in high tax states -- especially those who own expensive properties.
30. It's easy to get an extension on filing your taxes
If you're feeling overwhelmed by the requirement to file taxes by April 15, there's some good news: getting an extension to file is really easy.
In fact, any taxpayer is entitled to a six-month automatic extension on filing their taxes just by requesting one using Form 4868. You do need to make sure that you submit your request for an extension by the April 15 tax deadline, though.
31. An extension on filing your taxes doesn't provide an extension on paying
While you can get a six-month extension on filing your taxes, you still must pay your taxes by April 15 in order to avoid penalties and interest. If you cannot pay by the 15th, you should contact the IRS to find out about your options for setting up a payment agreement.
32. The penalty for failure to file taxes is far greater than the penalty for failure to pay
When you can't pay your taxes by April 15, you may be tempted to hold off on filing your returns until you have the money to pay what you owe. This is a terrible idea because the penalty for failure to file a return is far greater than the penalty for not paying on time.
The failure to file penalty is 5% of the unpaid tax balance for each partial month you're late on paying, with a maximum penalty of 25% of the unpaid tax balance. The failure to pay penalty, on the other hand, is 0.5% of the unpaid taxes, although the penalty can be reduced to 0.25% if you enter into an installment agreement or increased to 1% if the IRS issues notice of intent to levy.
Obviously, 5% is greater than 0.5% so you should file your taxes on time no matter what.
33. The chances of an audit are very small
Most people are terrified of being audited, but how likely is it that you'll actually end up the subject of an IRS inquiry? Not very.
The IRS audited approximately 0.5% of all returns last year, according to ProPublica. So the chances of actually being audited are very slim.
34. You're most likely to be audited if you claim the Earned Income Tax Credit
ProPublica also found that taxpayers are more likely to be audited if they claim the Earned Income Tax Credit. This credit is typically claimed by people with incomes between $10,000 and $40,000 annually -- so lower income households are actually more likely to be audited than higher income families.
35. Most audits actually aren't a very big deal
When you think of a tax audit, you probably imagine spending hours with a grim-faced IRS agent pouring over every detail of your financial life. In reality, however, this type of in-depth audit is very rare. The majority of audits are done by mail and are simple requests to verify something on your return that catches the eye of the IRS.
A mail audit may question your filing status, inquire about income the IRS thinks you forgot to declare, or ask for more info to prove you're eligible for a certain deduction or credit. Often, you just need to send in a few documents to explain the situation to the IRS or need to make minor adjustments on your return to correct an oversight or mathematical error.
36. The IRS can audit you for past tax returns
The IRS indicates it tries to conduct audits ASAP -- but you could actually end up being audited not just for last year's return but for returns from several years past. In fact, in cases of substantial errors, the IRS can go back six years to audit you.
Because the IRS can question past tax returns, it's a good idea to keep tax paperwork for at least this six year timeline. That way, if the IRS suddenly shows up wanting you to prove you actually made those charitable contributions you claimed in 2014, you'll be prepared and ready.
37. The IRS can pursue civil actions as well as criminal actions
The IRS doesn't have to arrest you for tax evasion to try to recoup money from you if you failed to comply with tax obligations. The IRS has many collections tools in its arsenal, including garnishing your wages and placing liens on property.
Most people who owe back taxes don't ever get hauled into criminal court -- but this doesn't mean that dealing with IRS efforts to collect is fun. If you owe back taxes, you should get expert help figuring out the best course of action to resolve your tax problems.
38. The government could take away your passport if you don't pay your taxes
One of the tools in the IRS' arsenal to help collect taxes is its ability to have the State Department refuse to renew your passport or revoke a passport you already have in effect.
Typically, the State Department only revokes -- or won't renew -- your passport if you're seriously delinquent on your tax obligations. Still the fact that you're at risk of losing your freedom to travel should be reason enough to take action when you have a big unpaid tax bill.
39. It's possible to settle unpaid tax debt for less than the full value
When you have a ton of past tax debt, resolving the problem may seem insurmountable. But the IRS does provide help to taxpayers struggling to pay. One of the options to consider is an Offer in Compromise, which allows you to settle your tax debt for less than the total balance due.
The IRS will agree to an offer in compromise only under limited circumstances when paying the full balance due would create financial hardship. The IRS considers your income, expenses, assets, and ability to pay in determining whether to accept an OIC. And you must be current with all tax filing requirements before you can be considered.
Still, if you owe back taxes and you want to resolve the problem once and for all, negotiating an OIC may be just the solution you need.
40. Getting a tax refund is actually a bad thing
Many taxpayers are excited about tax season because it means it's time to finally claim a much anticipated refund. The reality, however, is getting a refund isn't something to hope for. When you get a refund, it means you've given an interest-free loan to the IRS.
Getting a refund means money you could have used to invest and earn returns, to pay down debt, or to cover emergency costs, was tied up with the IRS. This money wasn't accessible if you needed it during the year, as it would've been had you put it into an emergency fund. Even if you invest it or use it to make a big debt payment at the end of the year, this won't make up for interest paid or lost during the 12 months when you made an interest-free loan to the government.
To avoid getting a big refund so you can put your own money to use, adjust your withholding for next year.
Now you know a ton about taxes
These 40 facts should help you to go into tax season 2019 far more prepared. Hopefully you're less worried about the IRS coming after you and more aware of deductions and credits you can claim to help save you on your tax bill. Now you just need to decide on the right way to file so you can get your taxes in on time.
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