Complete Guide to Taxes
There are probably a hundred other things you'd rather be doing or thinking about than your taxes. However, filing taxes is one of those responsibilities you need to comply with, or else you'll find yourself in trouble.
Understanding the process of doing your taxes can be overwhelming. So, this guide will walk you through how to tackle your tax return and give you a head start on the documents you'll need and how to take advantage of tax-saving opportunities.
Who Has to File Income Taxes?
Generally, the requirement to file a tax return will depend on your income, tax filing status, age, and if someone is claiming you as a dependent on their tax return. But even if you're exempt, you might want to file your return anyway.
When you file your taxes each year, the Internal Revenue Service (IRS) and other taxing authorities will have a limited time to audit you. Otherwise, not filing a tax return will give them an indefinite amount of time to check back and hit you with an audit.
Filing your taxes might also qualify you for a tax refund, especially if:
- You're an employee and have income tax withholding from your paychecks.
- You're a business owner making estimated tax payments.
- You're eligible for tax credits, such as the child tax credit.
What Are the Different Tax Brackets?
Currently, there are seven federal tax brackets imposed by the IRS. The rates range from 10% to 37%. The U.S. tax system is progressive, which means taxpayers in the lower brackets pay lower rates, and those in the higher brackets pay higher rates.
However, if you have a higher income and land in the highest tax bracket, that doesn't mean you pay the 37% tax rate for every dollar you've earned. You are charged at multiple rates as your income increases. Similarly, the dollar range for each bracket varies for single filers, married people filing together, married people filing separately, and head of household filers.
You can also reduce your tax liability if you qualify for tax credits, tax deductions, or income and investment losses. Ultimately, your tax rate will depend on your taxable income and filing status. This IRS publication has additional information for 2021's marginal income tax rates.
What Paperwork Do You Need?
As a small business owner, your tax filing process can get a little complicated. You'll want to keep track of the following documents throughout the year so that they're on hand for tax season.
- Income tax forms, e.g., W-2, W-9, 1099-NEC
- Other proofs of income, e.g., interest statements for investments
- Retirement account contributions
- Receipts for charitable donations
- Receipts and bills for unreimbursed medical expenses
- Child care expenses
- Interest paid on student loans
- Interest paid on mortgage payments
- Property taxes and other state and local taxes paid
- Tuition fees and other eligible educational expenses
- Mileage and other work-related expenses
Below is an overview of the basic information and common documents you'll encounter.
Social Security Number
To file your taxes, you'll need your Social Security number (SSN), your spouse's SSN if you're filing together, and the SSN of your child or eligible dependent.
Employers use Form W-2 (Wage and Tax Statement) to report an employee's income from the previous year. The form also details how much tax the employer withheld and other information, such as how much you contributed to your retirement plan during the year and how much your employer paid for your health insurance.
Whether you work for a person or a company, they're obligated to send you a copy of your W-2 by the end of January or send you instructions on where or how you can get it. You'll receive a W-2 from every employer from which you've earned at least $600.
Suppose you're a self-employed individual working in the capacity of a consultant, independent contractor, or freelancer. In that case, your clients will request Form W-9 to verify your identity and obtain your taxpayer identification number (TIN). This form records your acknowledgment that you aren't subject to backup withholding. You'll be responsible for your own taxes and contributions to Medicare and Social Security.
The 1099 forms report the various kinds of incomes that taxpayers receive. You may receive one or more of these forms. Here are the most common Form 1099s:
- 1099-NEC : This is a new form the IRS wants businesses to use to report amounts they've paid to people who worked for them but aren't classified as employees. If you're a freelancer or self-employed, you'll receive a 1099-NEC from anyone who's paid you at least $600.
- 1099-INT : You'll receive a 1099-INT from your bank or any financial institution where you earned at least $10 in interest.
- 1099-G : If you received unemployment compensation within the year, state, local, or federal government tax refunds, or taxable grants — among other government payments — you'll see these amounts on your 1099-G form.
- 1099-MISC : This form is used for any other income that doesn't fit into the other 1099 forms. This includes prizes and awards valued at $600 or more.
If you're currently paying off student loans, you'll receive Form 1098-E from each of your lenders. The form will detail the amount of interest you paid for the year. Interest paid on student loans is tax-deductible depending on eligibility and requirements.
Property Tax and Mortgage
Homeowners who take out a mortgage or home equity loan can claim the interest paid on the loan as an itemized deduction. You can find the amount of your deductible interest on Form 1098 that your mortgage lender sends you every year.
What Deductions or Credits Can You Take?
If you earn money from employment or running your own business, you pay income tax to tax authorities like the IRS. But you don't pay taxes for every dollar you earn because the IRS allows for deductions and tax credits that decrease your taxable income or reduce your tax liability dollar for dollar. Every year, you can choose to apply a standard deduction or itemize your deductions to lower your taxable income.
The standard deduction is an amount set by the IRS, modified every year for inflation. You can use it to reduce your taxable income, which subsequently helps to lower your tax bill. The standard deduction you can claim depends on your filing status, age, and whether you're disabled or claimed as a dependent by someone.
If you don't have many qualifying deductions to itemize, you can choose to use the standard deduction amount to lower your taxable income. It's also easier because you don't have to keep track of eligible expenses you incur during the tax year.
The standard deductions for 2021 are as follows:
- $12,550 for single taxpayers
- $12,550 for married taxpayers filing separately
- $18,800 for heads of households
- $25,100 for married taxpayers filing jointly
- $25,100 for qualifying widow(er)s
When the federal government enacted the Tax Cuts and Jobs Act (TCJA) in 2017, it eliminated personal exemptions. This change made deductions the only way for most taxpayers to reduce their taxable incomes. If you're in the higher income tax bracket and have significant qualifying expenses, itemized deductions could be the better route for you.
Take advantage of these benefits of itemized deductions:
- Your itemized deductions amount could equal more than the standard deduction amount.
- You can qualify for several possible deductions.
Some allowable deductions may be subject to limits, meaning you may not be able to claim all your charitable donations this year. And you'll have to be meticulous with your record-keeping because you'll need to justify your deductions to the IRS. Save your receipts and proof of payments, such as bank statements, medical bills, insurance bills, and tax receipts for qualifying charitable contributions.
Some examples of itemized deductions are:
- Medical and dental expenses
- Property, state, and local income taxes
- Home mortgage interest expenses
- Charitable donations
- Investment interest expenses
A tax credit is the amount of money you can deduct directly from what you owe in taxes. The amounts vary, depending on the nature of the credit and who can claim them. There are three tax credits classifications:
- Nonrefundable tax credits only refund the amount you owe, and any remaining amount is not paid out. However, they're only valid in the year of reporting, which means any unused amount is lost and can't be carried over to the next tax year. Nonrefundable tax credits include the Child and Dependent Care Credit, the Saver's Tax Credit for funding retirement accounts, and the Mortgage Interest Credit.
- Refundable tax credits are also used to reduce your tax liability. But the good news is that if you have unused refundable tax credits, you'll get the amount as a refund. The Earned Income Tax Credit (EITC) and the Premium Tax Credit are examples of refundable tax credits.
- Partially refundable tax credits can be used to reduce your taxable income and lower the amount you owe in taxes. If your tax debt reaches $0 without using the entire credit, the remainder may be refunded to you. The Child Tax Credit is classified as this type of tax credit.
How Do You File Your Taxes?
There are three main ways to file your tax return:
IRS Free File
The IRS Free File provides two ways for taxpayers to prepare and e-file their federal income tax for free.
- For taxpayers with an adjusted gross income (AGI) of $72,000 or less: The IRS has partnered with 10 tax filing companies, such as H&R Block and TaxSlayer, to provide free online tax preparation and filing options to individuals with an AGI of $72,000 or less. This option offers guided tax preparation, which is great for beginners. It can also be used to file state taxes.
- For taxpayers with an AGI above $72,000: Taxpayers can use the fillable electronic forms and e-file their tax returns. However, if you choose this option, you need to know how to prepare your tax return because it only offers basic calculations with limited guidance. You'll also have to prepare your state tax filing separately.
Use a Tax Software
Tax preparation software offers a bit more guidance and helps you figure out any deductions or credits you might qualify for. If you have a simple return and not itemizing your deductions, there is usually a free option from most providers. Otherwise, you may need to pay for access and file a return with tax software, such as TurboTax.
Hire an Accountant
Suppose you have a complex tax situation or are a new business owner wondering what you can and can't take as a deduction, and the guidance offered by tax preparation software is not enough. In that case, you may want to hire an accountant. Get referrals for trustworthy accountants from family and friends or other business owners. The IRS has a directory of certified tax preparers and tax professionals in your area that you can check, as well.
What If You Miss the Deadline?
Income tax returns are due on April 15 each year, and it's highly recommended that you file as early as you can. If you missed the deadline but are getting a refund, you won't incur any penalties.
If you missed the deadline and have a tax liability, you're advised to file your return as soon as possible to avoid penalties and interest. If you need more time to complete your return, you may ask for an extension by filing Form 4868 (Application for Automatic Extension of Time to File U.S. Individual Income Tax Return). But even if you ask for an extension, you're still expected to calculate and pay your tax liability, or you'll owe interest.
Will You Get a Refund or Owe on Your Tax Return?
After you've entered all the relevant information about your income, deductions, and tax credits on your United States Individual Income Tax Return (IRS Form 1040 ), line 34 will show your refund. If you owe tax, you'll find it in line 37. You can receive your refund through direct deposit in your bank account or by mailed check.
If you owe taxes, you can pay through online payments, wire transfers, and even cash through your state's Department of Revenue. You can use Direct Pay to make a direct debit from your bank account. You may pay through credit card, as well.
If you're one of the millions of Americans currently working in the gig economy, Skynova's invoice software can help you track and manage your invoices. You'll find that this tool is invaluable in helping you keep track of your self-employment income and how much you owe in taxes each month.