Nobody likes filing taxes. But thinking ahead and getting your documents lined up reduce the stress of the process. Here are some key ways to prepare yourself for tax season, and get you ready to sit down to your own tax prep software or deliver an organized package to your tax preparer.
1. Download a 2016 tax year organizer. There are many available online. Mine is here. This will be your guide and checklist, and will help you see what you still need, and tell you when you’re done. Follow this guide. Every accountant has a horror story about someone who, in the attempt to save themselves time, doesn’t read the organizer carefully, and causes no less than six follow up phone calls to chase down the information. Believe me when I tell you that a busy accountant in the heat of tax season will charge you extra for that kind of hand-holding. If you want to save yourself time (and money) on the tax process, have these materials fully prepared before heading to your accountant.
2. Put your receipts, 1099-MISCs, W-2s and all your other tax documents in a folder. This can be virtual or manilla. But keep in mind that there is a lot of sensitive personal information in your tax documentation – so wherever you are storing your documents online, be sure you’re using a high security password. Never email sensitive information – you can grant access to your accountant through your secure system (Dropbox, Google Drive, etc.), or you can use theirs. As your various tax statements arrive in the mail, drop them or scan them into this folder.
3. Ask yourself if your address has changed this year or last. If it has, immediately call your employer, bank, taxing authority or anyone who will be issuing you a tax document – and make sure they have your current address on file. Outdated or incorrect mailing addresses are the chief culprit for missing documents. You should, by law, receive all of your 1099-MISCs and W-2s by January 31. If you don’t, call the sender.
4. Ask yourself if you’ve had a baby in 2016. (This won’t be difficult to answer.) If you have, and haven’t yet received their social security card, check in with the Social Security Administration. New legislation means you can no longer amend a prior year return to receive the Earned Income Tax Credit for years that your child didn’t have a social security number.
5. Save yourself some time on medical expense calculations by knowing you probably can’t take any deduction. Generally, medical expenses can be deducted only by those who itemize deductions and are older or who had a catastrophic health event. So unless one of those situations apply to you, you don’t need to bother tallying up your medical expenses for 2016.
(More specifically, you can’t take any deduction if you take the Standard Deduction, or if your medical expenses were under 10% of your adjusted gross income (AGI), or 7.5% if you are 65 and older. For a 35 year old with an adjusted gross income of $50,000, this means you can only deduct your medical expenses over $5,000 (10% of $50,000). So if you had $6,000 in medical expenses, you can deduct $1000 of them ($6,000 – $5,000).)
6. Tally up your total income and expenses in each category from your freelancing/arts business. For many of the arts workers reading this, you will be filing a Schedule C for your freelance income or your arts business. Organizing for your Schedule C means you have to finish your bookkeeping for 2016. If you use bookkeeping software, run a Profit and Loss report for 2016, and include that with your tax documents. But you’re not done there. In all cases, you will need to gather and tally up the total amounts for your income, including your 1099s (and please note which income items you received/are providing 1099s for, and which you are not – you don’t want your tax preparer double-counting your income). List the total amounts for each of these expense categories:
- asset purchases (such as phones, computers, or equipment)
- contract labor
- dues or subscriptions
- insurance premiums (including health)
- legal and accounting fees
- professional development
- taxes and licenses
- telephone & internet
- website hosting
- for home office, provide:
- total square footage of your home and
- the square footage of your office space
- Please indicate the date you began using your home office for business
- If you use your vehicle for business purposes:
- indicate the date you began using your vehicle in your business, and
- either: a) the total actual expenses, such as gas, repairs, lease payments, etc.,
- or b) both total miles and business miles driven this year
Let me take a moment to clarify a common misconception. While you definitely want a clear and detailed breakdown of your expenses for your own books, you do not need to lay out more detail than this in order to do your tax return. Your books are for your records and for the health of your business. If you are audited, you will need to show them to the IRS. But for the purposes of preparing your taxes, you need only the totals in each category. Taxes are the cliff notes of your financial picture – they should accurately capture all of the plot points. But the subtler details will remain in your books.
7. Don’t show me, or any other accountant, your receipts. While the law requires you to maintain all your receipts, your accountant will burn you in effigy if you actually bring them in. They stay in your records. Your accountant will likely have you sign paperwork testifying that you have all the receipts to back up your claims. She, or your spreadsheet, in the case of TurboTax, wants to see only the category totals in order to prepare your tax return.
8. Note any estimated tax payments you made throughout the year. List these by quarter. You want to make sure you’ve been properly credited for any tax payments you’ve already made.
9. Consider maxing out your retirement savings plans to reduce that taxable income. The contribution limit to a traditional individual retirement account (IRA) for tax year 2016 remains at $5,500. If you’re over 50, there is an additional catch-up contribution allowed of $1000. You don’t need to contribute to your IRA until April 18 for it to count in 2016. For the average taxpayer, putting money in a traditional IRA is their greatest point of leverage in tax savings (as well as retirement saving). So give it some thought before you’re in a tax-deadline panic.
Here’s a grossly simplified* illustration: Let’s say your adjusted gross income is all from self-employment income and is $100,000. Your federal tax rate is 25%, your state tax rate is 5%, and your self-employment tax is the standard 15.3%. You will pay
$100,000 x 45.3% = $45,300 in tax.
Now let’s say you max out your traditional IRA with a $5,500 contribution. You will pay 45.3% tax on $94,500 (that’s $100,000 – 5,500, because the contribution lowers your taxable income dollar for dollar). So that’s:
$94,500 x 45.3% =$42,808.50 in tax.
You saved $2,491.5 in taxes.
So effectively, while you contributed, on paper, $5,500 to your traditional IRA, you only had to use $3,008.50 of your money to do it. The government has given you $2,491.5 extra dollars to grow (with compound interest!) in your retirement fund.
*I’ve eliminated the standard deduction, the personal exemption, the deduction for half of your self-employment income, the presence of different rates for capital gains, assuming there’s no income from sources not subject to self-employment tax, and making up a totally theoretical 5% state tax rate, as well as nixing the substantial complexity of the graduated income tax system. So like I said – grossly simplified.
10. Disclose all money in foreign bank accounts during 2016. The law has tightened up on offshore accounts, and failure to disclose yours comes with a severe penalty. If you had any money in a foreign bank account in 2016, you’ll need to provide the foreign bank account information – location, name of bank, account number, peak value of account during the year. The “nonwillfulness” penalty (“Whoops! I genuinely didn’t realize I was required to report this!”), is up to $10,000, but the “willfulness” penalty (“I was trying to hide the fact that I have an overseas bank account by not reporting it!”) has a ceiling of $100,000 or 50% of the balance in the account at the time of the violation, whichever is greater.
11. Finally, remember that finishing up your 2016 bookkeeping and gathering your tax materials takes some effort. Accountants get busier with every passing week of the tax season. And gathering your materials may reveal other errands – like chasing down a missing 1099 or opening a new IRA account. So reduce your stress by setting aside some time, and getting things together as early as you’re able. You’ll feel better that you did.
DISCLAIMER: True tax advice is a two-way conversation, and your accountant needs to hear your full situation to apply the rules correctly in your case. This post is meant for general information only. Please don’t act on this alone.