With tax season fast approaching, we wanted to help you to make sure you have your affairs in order to ensure you are paying the correct taxes.
Any time you make money or spend money, Uncle Sam seems to be waiting nearby to take his cut. Taxes take a bite out of every paycheck you earn, every investment you sell and every penny of interest you receive. Despite facing taxes on all sorts of financial activities, almost 80 percent of taxpayers in the U.S. get tax refunds at the end of the year. Following a few basic tax tips can help you maximize your tax breaks to cut your tax bill and ensure you get the biggest refund possible.
1. Choose the Right Filing Status
Your tax filing status is one of the most important factors in determining the amount of tax you owe. The IRS recognizes five filing statuses: single, head of a household, married filing jointly, married filing separately and qualifying widow(er) with dependent child. If you are married, filing jointly is almost always the way to go since joint filers face more favorable tax brackets and deduction rules than separate filers. If you aren’t married, filing as a head of a household instead can yield major tax savings if you quality. To be a head of a household you must have paid for more than half the cost of maintaining a home for yourself and qualifying person–a dependent child or family member.
2. Compare your Standard and Itemized Deductions
The IRS lets you claim a standard deduction that exempts a portion of your income from taxation. If you claim the standard deduction, you can’t claim any of the various itemized deductions the government offers, which include things like property taxes, charitable contributions, business expenses and home mortgage interest. If the sum of your itemized deductions is less than your standard deduction you are better off claiming the standard deduction. The standard deduction is $6,300 for single filers and $12,600 for joint filers in 2015.
3. File and Pay on Time
No matter what filing status you choose and which tax deductions you claim, it is important to pay any tax you owe and file your return by the filing deadline of April 15. Failure to pay taxes on time can lead to a tax penalty of 0.5 percent of the unpaid amount per month it remains unpaid. The penalty for filing late is 5 percent of the taxes you owe per month. You can apply for a 6-month extension of time to file if you think you won’t be able to file your return on time.
4. Save for Retirement
Putting cash aside for retirement is one of the best ways to cut your tax bill in the short term and the long run. Money you set aside in retirement plan like a 401(k) or tax deductible individual retirement account is not subject to income tax and account earnings are tax deferred. Tax deferral means you don’t pay taxes on your savings, even investment gains, until you make withdrawals. Delaying taxes can save you thousands of dollars because it lets your nest egg grow faster and you may face a lower tax bracket during retirement.
5. Claim Dependents
Each dependent you claim on your tax return grants you a tax exemption of $3,950, subject to certain limitations for higher income taxpayers. A dependent can be either a qualifying child or a qualifying relative. A qualifying child is a child under the age of 19, a student under the age of 24 or a totally disabled person of any age that lived with you for more than half the year and did not provide more than half of his own support for the year. Qualifying relatives include children, siblings, parents and grandparents of any age who live with you, have a gross income under the exemption amount ($3,950) and for whom you provided more than half of their support for the year.
6. Claim Above-the-line Deductions
The IRS lets you claim certain adjustments to income, commonly called above-the-line deductions, whether you choose to take the standard deduction or not. Common above-the-line deductions include self-employment taxes paid, alimony paid, IRA and health savings account contributions, up to $2,500 of student loan interest paid and $4,000 of student tuition and fees paid. Deductions for student expenses are subject to certain income restrictions and other limitations.
7. Invest Long-Term
When you sell an investment like a stock holding, you have to pay capital gains tax on your profit. The amount of capital gains tax you pay depends on how long you held the investment: if sell an investment within a year or less you pay capital gains tax at your normal income tax rate which can be as high as 39.6 percent. If you hold an investment longer than a year, you won’t pay more than 20 percent in capital gains tax; low and middle income taxpayers generally face long-term capital gains rates of 0 or 15 percent.
8. Don’t Flip your House
The tax benefits of holding investments long term extend to the sale of your home. If you live in and own a home for at least two of the past five years before selling it, you can exclude $250,000 of the capital gains you make from taxation as a single person or $500,000 as a joint filer. If you buy a home and sell it before living in it two years, you’ll pay capital gains tax on any profit you make from the sale.
9. Investigate State Tax Deductions
State governments offer an array of tax deductions that are separate from those offered by the IRS. You may be eligible for various state tax deductions, such as deductions for charitable giving, even if you did not itemize your federal tax return.
10. Consider Off-Brand Tax Software
TurboTax and H&R Block are the giants of the tax filing software industry, but other tax filing software packages may be cheaper for your particular filing situation. Products like TaxAct, TaxSlayer and TaxHawk may provide all the functionality you need at a fraction of the cost of the big name brands.
Taxes are one of the largest annual expenses the average person faces and while you can’t avoid paying taxes altogether, a little bit of knowledge and wise decision making can significantly cut your tax bill. If you go back and discover a costly mistake or tax break you missed on a past return all is not lost: you can file an amended tax return within 3 years of the original return to correct errors and the government will send you any additional refund you are due.