The deadline for filing your federal tax return is still weeks away, but there are plenty of reasons to start your taxes well before April 15. If you're owed a refund--and most taxpayers are--you'll get your money that much sooner. Filing early will also reduce the risk that a crook will hijack your refund, because someone can't steal a refund that's already been claimed. And even if you end up owing the IRS, it's better to know that now, when you have time to come up with the money, than at 11 p.m. on April 14.
But perhaps the most compelling reason to start now is that filing early will give you enough time to claim all the tax breaks available to you. The Tax Cuts and Jobs Act, now in its second year, nearly doubled the standard deduction, which for 2019 is $12,200 for single taxpayers and $24,400 for married couples who file jointly. Only about 10% of taxpayers will continue to itemize.
Even if you're sure you'll claim the standard deduction, don't assume you can polish off your return during the Super Bowl halftime. Congress has recently enacted a bevy of tax credits and deductions for non-itemizers. Overlook them and you could end up paying more to the IRS than you should.
The tax code is particularly welcoming for parents, even if they don't itemize. For example, if you became a parent last year, you'll be eligible for a $2,000 tax credit. Unlike a deduction, which reduces the amount of income the government gets to tax, a credit reduces your tax bill dollar for dollar. The credit begins to disappear as income rises above $400,000 on joint returns and above $200,000 on single and head-of-household returns--although there's no limit to how many kids you may claim on a return, as long as they qualify.
You may also qualify for a tax credit that will reduce the cost of child care. If your children are younger than 13, you're eligible for a credit of 20% to 35% for up to $3,000 in child-care expenses for one child or $6,000 for two or more. The percentage decreases as income increases. Eligible expenses include the cost of a nanny, preschool, before- or after-school care, and summer day camp.
See Also: 10 Tax Breaks for the Middle Class
Once the kids start college, make sure you take advantage of tax breaks designed to offset the rising cost of higher education. The American Opportunity tax credit, which you can claim for students who are in their first four years of undergraduate study, is worth up to $2,500 for each qualifying student. You don't have to itemize to claim the credit. Married couples filing jointly with modified adjusted gross income (MAGI) of up to $160,000 can claim the full credit; those with MAGI of up to $180,000 can claim a partial amount.
Unlike the American Opportunity credit, the Lifetime Learning credit isn't limited to undergraduate expenses, and you don't have to be a full-time student to claim it. The credit is worth up to 20% of your out-of-pocket costs for tuition, fees and books, up to a maximum of $2,000. Married couples filing jointly with MAGI of up to $116,000 can claim the full credit; those with MAGI of up to $136,000 can claim a partial credit.
See Also: 20 IRS Audit Red Flags
Non-itemizers may also be eligible for several "above the line" deductions. In addition to lowering your taxes--if you're in the 24% tax bracket, for example, $1,000 in above-the-line deductions will save you $240--these deductions will shrink your adjusted gross income, which could make you eligible for other tax breaks.
One of the most popular above-the-line tax breaks is the deduction for contributions to an IRA. If you're not covered by a retirement plan at work, you can deduct up to $6,000 in contributions to an IRA, or $7,000 if you're 50 or older. Even if you're covered by a workplace plan, you may be eligible to deduct all or a portion of your contributions, depending on your income.
Another above-the-line deduction could provide relief for taxpayers with student loans. You can deduct up to $2,500 in student-loan interest for you, your spouse or a dependent if your MAGI is less than $85,000 ($170,000 if filing a joint return). The deduction starts to phase out at MAGI of $70,000 (for singles) and $140,000 (for joint filers). A former student can claim this deduction even if Mom and Dad are making the payments.
Advice for itemizers
With the larger standard deduction, many taxpayers will be able to do a quick, back-of-the-envelope determination to see whether they'll itemize. Plus, if you claimed the standard deduction last year and your situation hasn't changed, it's unlikely you'll itemize on your 2019 tax returns.
But some taxpayers will still benefit by calculating their taxes both ways to see which delivers the lower bill. (Tax software makes this task pretty easy, as long as you have all the necessary documents.)
Homeowners who have a large mortgage are still good candidates for itemizing. For loans acquired after December 15, 2017, you can deduct interest on a mortgage (or mortgages) of up to $750,000. (For loans taken out before that date, you can deduct interest on mortgage debt of up to $1 million.)
High property taxes could also raise the likelihood that you'll benefit from itemizing. The tax overhaul capped deductions for state and local taxes, but you can still claim a deduction for up to $10,000.
Charitable contributions remain a popular deduction for itemizers, so if you're on the cusp between claiming the standard deduction and itemizing, make sure you get credit for all of your philanthropy in 2019. Gather your receipts and acknowledgments from the charities you supported last year. You can also deduct donations of clothes, books and other noncash items. Use the fair market value of the items--not the amount you paid for them--when calculating how much to deduct. (Some tax software programs provide guidance on valuing your donated items.)
If you had extraordinary medical costs last year, deducting your unreimbursed expenses could push you into the itemizing pool. However, you'll only be allowed to deduct a portion of those expenses. For 2019, you can deduct unreimbursed medical expenses that exceed 7.5% of your adjusted gross income. If your AGI was $50,000, for example, you would only be allowed to deduct the unreimbursed medical expenses that exceeded $3,750. The list of eligible expenses is long, ranging from long-term care to health insurance co-payments to prescription drugs. And if any costs for dental and vision care aren't covered by your insurance, those expenses are also deductible.
Heads-up for retirees
If you're retired, it's even more important to start your tax return early. While you'll probably claim the standard deduction, you could be in for some unpleasant surprises--particularly if you're a new retiree.
See Also: How Retirement Income Is Taxed
The money you've scrupulously saved in your 401(k) or traditional IRA will be taxed when you withdraw it. As is the case for non-retirees, you'll also owe taxes on dividends, interest and capital gains in your taxable accounts. A portion of your Social Security benefits may be taxable, too (see Answers to Your Social Security Questions).
That means it's critical to take advantage of all the tax breaks available to you. To start with, you're eligible for a larger standard deduction once you turn 65. For 2019, you can claim an additional $1,650 for your standard deduction if you're unmarried and not a surviving spouse. If you and your spouse are both 65 or older, you can claim an additional $2,600.
If you reached age 70½ by the end of 2019, you'll have to take required minimum distributions from your tax-deferred accounts and pay taxes on that money (see Ahead for changes to RMD rules). It's too late to do anything about that now, but it's not too soon to look for ways to lower your tax bill in 2020. You can transfer up to $100,000 a year from your traditional IRAs directly to charity. (If you're married, your spouse can transfer an additional $100,000 to charity from his or her IRAs.) The transfer counts toward your required minimum distribution and is excluded from taxable income.
Depending on your income, you may also be able to avoid paying taxes on capital gains from your taxable accounts. If you're a single filer and your 2019 taxable income was less than $39,375 (or $78,750 if you're married and file jointly), you won't owe taxes on gains from stocks or mutual funds you owned for more than a year.
Also note these changes for 2019:
Alimony payments may no longer be deductible. The tax overhaul eliminated the deduction for alimony for divorces finalized or modified on or after January 1, 2019. If your divorce was finalized or modified before December 31, 2018, you can still deduct your payments.
A revamp of the "kiddie" tax was repealed. The tax overhaul changed the way investment income earned by children younger than 19 (or full-time students younger than 24) was taxed. Under the kiddie tax, a child's investment income that exceeds $2,200 was scheduled to be taxed at the rates that trusts and estates are taxed, which can run as high as 37%. After advocates for military families said the change would penalize children of deceased service members, Congress repealed the change. Investment income earned by children will generally be taxed at their parents' tax rate.
The IRS wants to know about your investments in virtual currency. There's a new question at the top of Schedule 1 for Form 1040: "At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?" The IRS wants to make sure you're reporting taxable income you earned from investments in virtual currency, says Andy Phillips of H&R Block's Tax Institute. If you sold a virtual currency for more than you paid for it, you're expected to pay taxes on your profits at capital gains rates, even if you used it to make a purchase.
If you're self-employed
If you work for yourself, either by choice or necessity, the task of preparing your tax return is considerably more complex, even if you didn't earn a lot of money last year. The same goes for people who are independent contractors, a status that's increasingly common in today's workforce.
See Also: 10 Surprising Things That Are Taxable
While employees split the tax for Medicare and Social Security with their employer, people who work for themselves must pay the entire 15.3% tax themselves. That often comes as a shock to newly self-employed workers, says Dina Pyron, of Ernst and Young's TaxChat mobile tax-preparation service. "It's a big chunk of additional tax on top of your income tax," she says.
The good news is that you can deduct half of what you pay in self-employment taxes, even if you don't itemize. And that's just one of a long list of deductions available to those who work for themselves, whether it's a full-time job or a side hustle. All of your business-related expenses--everything from mileage to postage stamps--are deductible (you need to save the receipts). Health insurance premiums are also deductible. And if you use a room or other space in your home or apartment exclusively for business, you can claim a home-office deduction. You can deduct the actual costs, based on a percentage of insurance, utilities and so on, or use a simplified method developed by the IRS: Write off $5 for every square foot that qualifies for the deduction. For example, if you have a 300-square-foot home office (the maximum size allowed for this method), your deduction would be $1,500.
A big money-saver. Once you've tallied up these deductions, it's time to determine whether you're eligible for a new tax break that could save you a lot of money. The new tax law allows eligible self-employed taxpayers to deduct up to 20% of their qualified business income--net income after they've claimed business deductions--before they calculate their tax bill. For example, if you're self-employed and earn $100,000 in qualified business income this year, you could be eligible to deduct $20,000. If you're in the 24% tax bracket, that would reduce your tax bill by $4,800.
The deduction is subject to various limitations if your taxable income is $160,700 or more ($321,400 or more for spouses filing jointly). Above those thresholds, the write-off phases out if you provide personal services, such as financial planning or accounting. But if your income is below the thresholds (which is the case for many people who are newly self-employed or have part-time income) you can claim the full deduction no matter what your business. To help alleviate confusion about this tax break, the IRS is providing a separate form this year (Form 8995 or Form 8995-A) to report qualified business income, along with new guidance, says Christina Taylor, head of operations for Credit Karma Tax.
Last-minute tax savers
You must act before December 31 to lock in most tax-saving financial moves, but there are still a few things you can do between now and April 15 to lower your tax bill.
Contribute to a health savings account. You have until April 15 to set up and fund a health savings account for 2019. To qualify, you must have had an HSA-eligible insurance policy at least since December 1. The policy must have had a deductible of at least $1,350 for individual coverage or $2,700 for family coverage. You can contribute up to $3,500 to an HSA if you had single coverage or $7,000 if you had family coverage. You can contribute an additional $1,000 if you were 55 or older in 2019, or another $2,000 if you were married and both spouses were at least 55. Contributions to an HSA will reduce your adjusted gross income. The money in your account will grow tax-free, and withdrawals used to pay medical expenses are also tax-free.
Stash money in an IRA. You also have until April 15 to contribute to an IRA for 2019. If you're not enrolled in a workplace retirement plan, you can deduct an IRA contribution of up to $6,000, or $7,000 if you were 50 or older in 2019. As with HSAs, contributions to a traditional IRA will reduce your adjusted gross income on a dollar-for-dollar basis, which could also make you eligible for other tax breaks tied to your AGI.
Workers who have a company retirement plan but earn below a certain amount may qualify to deduct all or part of their IRA contributions. For 2019, this deduction phases out for single taxpayers with AGI of between $64,000 and $74,000; for married couples who file jointly, the deduction phases out between $103,000 and $123,000.
If one spouse is covered by a workplace plan but the other is not, the spouse who isn't covered can deduct the maximum contribution, as long as the couple's joint AGI doesn't exceed $193,000. A partial deduction is available if the couple's AGI is between $193,000 and $203,000.
Know what you'll owe
Completing your tax return usually provides a sense of relief, but it can also lead to regrets. Did you owe the IRS more than you expected? Or was your refund so large you almost expect to receive a note from the Treasury Department thanking you for your generous interest-free loan?
In either instance, it's now easier to figure out how much you'll owe the IRS when you file your 2020 tax return. The IRS has overhauled Form W-4--the form you use to tell your employer how much to withhold from your paycheck--to reflect changes in the Tax Cuts and Jobs Act. In the past, your withholding was based on the number of allowances you claimed, and those allowances were based on your personal exemptions. The tax overhaul eliminated personal exemptions, and the calculation that was confusing to many taxpayers no longer applies.
The new W-4 form allows your employer to calculate your withholding based on several factors, including the number of your dependents, family income from other jobs, and deductions you expect to claim when you file your return. The result should be more precise than the old system, says Christina Taylor, head of operations for Credit Karma Tax.
All employees hired in 2020 must use the new W-4, says Alice Jacobsohn, senior manager of government relations for the American Payroll Association. Employees who didn't change jobs aren't required to fill out the new form, but if you're unhappy with the outcome of your 2019 tax return--or your personal situation has changed since you filed your last W-4--you probably should.
If you have only one job, no dependents and claim the standard deduction, all you need to provide is your name, Social Security number and filing status. But if your taxes are more complex--you itemize, for example--you'll need to provide more information. An ideal time to complete this task is right after you've finished your 2019 tax return, because you should have this information at hand.
If you're a two-earner family, the new W-4 does a better job of calculating how much you should have withheld. The form also provides a way to adjust your withholding to reflect income from taxable investments or a side gig. Don't want your employer to know you're moonlighting? Go to www.irs.gov/individuals/tax-withholding-estimator to calculate your withholding. You can enter the result on the "extra withholding" line without revealing any more information about the sources of your income.
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- 10 Tax Breaks for the Middle Class
Copyright 2020 The Kiplinger Washington Editors