With tax time fast approaching, here is a checklist – along with my comments – of the information and documents you need to collect.
Personal info: The legal names, dates of birth, and social security numbers of everyone in the family.
Status: Married couples have to file as “married.” Single people file as “single” or “head of household,” which is tax talk for single parent. Married people can file separately, but they usually lose more than they gain.
Comment: It might make sense to file separately if you have high medical or work expenses. Planning a wedding date carefully can provide great savings. Also, if a couple is going to separate, the timing can make a difference.
Children: You get a tax deduction for each child and a $1,000 tax credit for those who are under 17! To qualify as a deduction, children must be under 19 (under 24, if students). You can deduct older relatives if you support them, but the rules and income tests get more complicated.
Comment: You can blow a very valuable deduction for children if you run afoul of the rules. Check the definition of student and the cap on the student’s income.
Income: 1) Collect all forms: W2, 1099-MISC, and 1099 for interest and dividends. Other items needed are 1099s for unemployment, social security, and pensions. You also have to claim income from prizes, gambling, bartering, fellowships, and even jury pay. If you get a 1099-c for cancelled debt then you might have to pay taxes on it. You might have to claim your refund from state taxes received for last year’s tax filing! Use the worksheet to determine if you do.
Comments: Sorry, folks, you need to report all of your income, even if you do not get a 1099. For instance, independent contractors must report income for jobs less than $600, even though the employer does not.
If you sold stocks (or they became worthless), you need to know their original cost. Sometimes, that can get very complicated.
Very important: Once you get a W2, your income is pretty much cast in stone. Make sure that you keep your W2 as low as possible, by maxing out on pretax items at the beginning of the year. These include fringe benefits and other items that the employer can pay for that do not count as part of your income.
Note that, if you collect on a lawsuit for non-physical damages, you have a complicated situation regarding how to address the third that the lawyer gets.
If you have a business or rental real estate, you need to keep careful records of your income and expenses.
Comment: If you are starting a business, get advice on “business entity” choice and recordkeeping skills.
Deductions: Your income is reduced for various expenses, such as teacher expenses, moving costs, student loan interest, deposits into health savings accounts, some medical expenses, real estate taxes, mortgage interest, mortgage “points,” and, of course, charity. Did you refinance? If so, you had better review the settlement sheet for possible interest points and real estate taxes.
Pensions: This is the ultimate of all tax deductions. Money that you contribute to a 401k at your job or to an IRA is not taxed. Moreover, your employer may match your contribution. It is extremely worthwhile to budget well in your everyday living expenses, so that you will have the funds to participate in this one.
In addition, you can deduct miscellaneous expenses (mostly investing and job expenses) to the extent that they exceed two percent of your income. These could include investment advisory fees, malpractice insurance, licenses, tools, uniforms, travel and car, supplies, equipment (e.g., computers), education, entertainment, business gifts, cell phone, dues and subscriptions, insurance, and even the cost of a home office. Also in this category are job hunting expenses and tax preparation fees (money well spent and my favorite deduction).
You can deduct your gambling losses, and they are not subject to the two percent limitation.
Comments: Your job expenses are much more valuable if paid by your employer. If you are paying them, you are losing out. Medical expenses should be addressed through HSA and flex plans.
In general, expenses that are itemized deductions should be timed to maximize the tax savings. Some people can save a lot with a strategy called bunching, which essentially means you give all your charity every other year, and in the non-charity year, you claim the standard deduction. It is a little fancy footwork but might be worth it. And do not overlook the donations to Goodwill.
Tax credits: Low earners can claim the earned income credit (the greatest money grab since the Communist Revolution.)
Comment: If your investment income exceeds $3,200 you blew it big time.
If any dependents are in college, you can get a valuable tax credit. The more valuable one, called the American opportunity tax credit, is limited to four years.
Comment: Planning can be critical here, as you are juggling various expenses and various years. It is very easy to literally blow a few thousand dollars.
Daycare: This credit can save you $1,700 a year. To max it, you need two children being watched, up to but not including kindergarten (unless you have renamed kindergarten as pre-1A, in which case kindergarten does count.) Day camp counts but sleep-away camp does not. You must provide the provider’s name, address, and ID number.
Comments: Here, too, you are juggling kids, years, and date cut-offs. Be cognizant of your $6,000 maximum per year so you do not waste this one.
Other: If you pay more than $1,900 a year to any one household worker, such as nannies and cleaners, you may have to make the person an employee. This involves paying additional taxes and filing several forms. This is a headache (and mostly observed in the breach). You might want to consider arranging your affairs so you are not in violation of this tax rule.
A Word about State Taxes
Maryland follows the federal definitions of income and deductions but adds a few of its own. The State allows deductions for part of your pensions and social security, and credits for long term care insurance, continuing education for public school teachers, and its own earned income credit and dependent care credit. The State also allows deductions for money put into Maryland college funds.
Folks, all these details of tax planning are important, for two reasons: First, doing it correctly keeps your taxes down. Second, keeping a low income might increase your eligibility to government handout programs. With Obamacare being linked to your income, this is all the more important. Hopefully with a little planning you will not have to pay any more than you have to.
