4 Steps to Prepare for Tax Season
A new year is wonderful because it signifies a fresh start. Clean slate. Endless opportunities.
Then reality sets in. Tax documents appear in your physical mailbox and email inbox. If you’ve worked with a tax preparer in the past, you may receive an engagement letter this month. Know that you are not the only one who is anxious about this upcoming tax season. Below are four strategies to ease your tax season anxiety.
1. Decide Early if You’ll Outsource
Do you have a pretty straightforward tax situation? For families with one or two W-2s and few expenses, you may save money by self-preparing. Yet, as parents, time is one of our most valuable resources. Federal Form 1040-EZ is simple, but anything more complex should be processed through a tax preparation program like TurboTax.
For about 10 years, I used TurboTax to self-prepare my taxes. It took me a full day to enter all the info and finalize the tax returns -- even as a CPA. Navigating the software and e-filing took extra time.
Honestly assess who is best suited to handle your taxes. Here are some triggers for more complex tax situations:
Earned wages in multiple states
Moved to a new state
Operated or started a small business
Bought and/or sold a home
Inherited a large amount of money
Married someone with significant student loan debt
Owned investment property or an outside business interest
Bought, sold, or exchanged cryptocurrency
Work with a tax professional who has successfully navigated these issues with other clients and could represent you if you’re ever audited.
2. Assess the Team
Suppose you’re going to hire an outside tax preparer. Recognize that not all tax preparers are created equal. Cost does not necessarily equal value.
Here’s a bit of alphabet soup. Enrolled Agents, or EAs, go through specialized tax training for individuals and are typically more affordable than Certified Public Accountants (CPAs). However, the EA’s breadth of knowledge is usually limited to tax. CPAs may have a broad range of expertise. Some CPAs focus on audit or tax issues, while others specialize in forensic accounting and personal financial planning.
Always inquire about your potential tax preparer’s area of expertise.
3. Get Organized
If you hire a tax preparer, use their tax organizer as a guide. Many tax preparers expect tax items to be orderly and may charge more if your items are disorganized.
If you are self-preparing, pull out your prior year’s income tax returns and familiarize yourself. As you receive new physical tax documents, consider sorting them into file folders. I separate tax info into four manila file folders: 1) Income, 2) Expenses, 3) Business Activity, and 4) Other Tax Items.
Income
W-2s, 1099s, pension income, Social Security reports, and investment statements showing interest, dividends, and capital gains go into the Income folder.
Expense
The Expense folder is critical, especially if you’re itemizing deductions. Gather Form 1098 if you have a mortgage, real estate and personal property tax receipts, and charitable contributions. Include medical expenses in this folder if they exceed 7.5% of Adjusted Gross Income, or AGI.
My husband and I have several charitable contributions, so we create a one-page summary in Excel with the name of the charitable institution, transaction date, and dollar amount given. We separate cash from non-cash donations. In the non-cash contribution section, identify what was given (i.e. stock, household goods) along with the estimated cost basis and fair market value. A nice rule of thumb for thrift-shop donations to determine cost basis is to multiply the fair market value by three. For example, $200 FMV * 3 = $600 cost basis.
Business Activity
Single member LLCs taxed as sole proprietorships don’t have a separate business tax filing. Therefore, all of the Business Activity should run through your personal tax return (Federal Form 1040) on Schedule C. However, not every company is taxed in this manner. If your company’s tax status is a partnership or S Corporation, a separate tax return is required and the filing deadline is earlier — March 15th.
It’s best to keep track of business finances year-round through a third-party accounting software like QuickBooks Online. Then, you can use the Income Statement to populate Schedule C in the tax program. Strongly consider having your taxes professionally prepared if you are a small business owner, unless you have deep knowledge of the tax code. Self-preparing means you may miss out on important deductions such as home office, auto, or qualified business income deduction (up to 20% of income).
Other Tax Items
The Other folder is reserved for items that do not fit in the Income, Expense, or Business Activity folder. Quarterly estimated tax payment receipts and support for federal and state tax credits go into this folder. For instance, my family used to incur daycare and after-school costs that exceeded the $5,000 dependent care FSA threshold so we kept the receipts in this folder. We also had 529 plan contributions that were eligible for a Missouri state income tax credit when we lived in Missouri. Year-end 529 plan account statements were necessary to determine the total contributions.
In theory, each document you save should tie to a corresponding line on the federal and/or state income tax return.
4. Be Cognizant of Timing
The deadline for filing your 2023 U.S. personal federal tax return is Monday, April 15, 2024. Although this deadline can be extended to October 15th, you are responsible for paying tax by April 15th.
Partnerships and S Corporations have an even earlier tax filing deadline – March 15th! Begin your search now if you want to hire an outside tax preparer. Several tax advisors internally adhere to an earlier deadline for new client relationships.
Be realistic. If you drop off your tax items to an outside preparer in early April, don’t expect your taxes to be filed by the April 15th deadline. Tax preparers are extremely busy this time of year – many working 50, 60 or 70 hours a week. They may need a few weeks to finalize your tax return.
Self-preparers shouldn’t wait until the last minute, either. Start working on your taxes as soon as possible so you can fill in gaps and review the draft tax returns with a fresh set of eyes. Once your tax returns are electronically sent or mailed to the IRS and state government authorities, they are final. Subsequent changes could require an amendment, and that may be costly.
If you are seriously stressed and the tax deadline is a few days away, a timely-filed extension request could be your saving grace. Just remember that you do not get an extension of time to pay the tax. And don’t delay if you’re expecting a refund. The sooner you file for a refund, the more money in your pocket. Being proactive pays off.
At WorthyNest®, we guide parents through important financial decisions using a values-based approach. Contact us to explore an ongoing one-on-one relationship. We do not accept “tax preparation” only clients at this time.