Tips for tax season

Many people have the perception that their tax bill each year is chiseled into stone and an unchangeable result of their financial situation.  But the reality is that there is many things you can do each year to optimize your taxes, especially if you have a complex investment portfolio with both taxable accounts and tax-sheltered retirement accounts.

Tip #1: Always contribute to your retirement accounts.

It’s very easy to forget to make your IRA each contribution each year, but make sure at a minimum you make your $6,000 contribution (under 50) or $7,000 contribution (over 50) by the deadline of April 15th 2020 (for 2019 contributions).  Ideally, this should be done with “new money” if you can afford it, but you can also shift funds from your taxable brokerage account as well.  To receive the full IRA deduction for 2019 contributions, you must have adjusted gross income of $64,000 or less if you’re single, or $103,000 or less if you’re married.  However, there is a “phase out” zone for incomes higher than that, so it’s still beneficial to make those contributions if you’re income is higher. Alternatively, if you earn $122,000 or less a year if you are single or $193,000 if you’re married, you can opt for a Roth IRA contribution.  This won’t reduce your taxable income, but you’ll be able to withdraw from your Roth tax-free in retirement.

Tip #2: Don’t forget about your 1099 forms.

I’ve noticed that many people overlook their brokerage account paperwork when doing their taxes, or when delivering their paperwork to their CPA.  It’s extremely important that you report your dividends, interest, and capital gains in your taxable accounts, because not reporting it is a likely path to an IRS audit.  Most brokerage companies host their 1099 forms online by February 15th each year:

1099-MISC: This form is used to report miscellaneous income you've received, usually because of freelance or self-employment. Companies are required to issue a 1099-MISC if they pay you $600 or more over a given tax year.

1099-INT: This form is used to report interest income you receive, such as that from a savings account at a bank, treasury bills, notes, or bonds.  This interest is taxed as ordinary income.

1099-DIV: This form is used to report dividends and distributions from investments, including capitals gains if you had stocks or funds that were bought and sold during the tax year.  Some dividends are taxed at different rates (e.g., qualified vs non-qualified dividends) and this form typically differentiates those different rates.

1099-C: This form is used to report debt that has been cancelled by a lender, which is considered income by the IRS.

1099-R: This form lists distributions from retirement accounts such as IRAs, 401(k)’s, 403(b)’s pensions, and annuities. You should receive a 1099-R if you have been paid $10 or more from a given plan or account. You'll also be issued a 1099-R if you roll a retirement plan into another tax-advantaged account (such as rolling a 401(k) into an IRA). Unless you have a Roth IRA or Roth 401(k), you're required by the IRS to pay taxes on your retirement plan distributions, and those withdrawals are treated as ordinary income.

1099-S: This form lists taxable income from the proceeds of real estate transactions, such as the sale of a house. When you sell your property, you're allowed to exclude up to $250,000 in gains if you’re single, and up to $500,000 in gains as a married joint filer, provided you meet certain criteria. The 1099-S will tell you what real estate income you're required to report to the IRS and pay taxes on.

Though there are other types of 1099 forms in addition to those listed above, these ones tend to be the most common for the majority of people.

Tip #3: Itemize your deductions

It’s easier to take the standard deduction, and awfully tempting since the new tax code has raised the deduction to $12,200 for single filers, and $24,400 for those that are married and filing jointly.  However, there is still a large segment of the population that would benefit from itemizing their deductions, so it’s worth the effort to work through calculating your itemized costs.  In particular, families that own expensive homes in high tax areas, have paid a large amount of medical and dental bills, own a lot of real estate, or have made large donations to charity are likely to come out ahead by itemizing.

Some of the most common itemized deductions are:

·         Home mortgage interest.

·         Property, state, and local income taxes.

·         Investment interest expense.

·         Medical expenses.

·         Charitable contributions.

·         Miscellaneous deductions.

Tip #4: Always file electronically

Firstly, if you’re expecting a tax refund, why wouldn’t you want access to your funds earlier?  The IRS processes electronically filed returns 3-6 weeks faster than paper returns.  Anyone with a simple understanding of the time-value of money knows that the earlier you get access to money, the higher its future value is (i.e., it can start earning interest earlier).  Even if you don’t expect a refund, it’s still best to file electronically because (according to Turbo Tax), less than 1% of electronically filed returns have errors, whereas nearly 20% of paper returns have errors (or more commonly omissions). There is also better records (digital receipts) for filers to prove when and where they filed their returns.  If your return is lost by the postal service, you might not be able to prove it arrived to the IRS in a timely manner, and would therefore incur additional interest and penalties for late filing.

Tip #5: Communicate with your dependents near tax time

Make sure to record the Taxpayer Identification Numbers (usually Social Security Numbers) for your children and any other dependents on your return.   This is important because the IRS won’t allow any dependent credits that you might be entitled to, such as the Child Tax Credit.  A child can only be a claimed as a dependent by one parent, unless you’re married and filing jointly. If you’re a single filer, this requires that the child doesn't provide more than half of their own financial support and resides with you for more than half the tax year. This only applies to dependents under the age of 19, or under the age of 24 if they are attending school in a full time capacity.  Therefore, it’s extremely important that you communicate with your spouse (or ex-spouse if you’re divorced) to coordinate who is claiming the dependent, and even more importantly if the dependent should claim themselves.