It’s tax time. Here’s what you should know before you file them
Americans face a rite of passage around the time they become adults: The need to start filing income-tax returns, both at the federal level and with most states.
With tax season upon us, here are some basic tips to help guide you through the process:
How to file a return
There’s no set answer to this. You can research and prepare your own tax return, pay a professional to do it or find a volunteer group for free assistance.
The Internal Revenue Service suggests looking into its Free File program. To get started with this, visit IRS.gov/freefile to see the choices. Also, check out IRS.gov/vita to see if you qualify for the IRS-supervised Volunteer Income Tax Assistance program, which offers free preparation, mainly for moderate-income people. Whether using tax software or working with a person, you will be prompted to answer questions about income, expenses and so on, guiding you through the process.
Most states, including California, require residents to submit state returns, though they generally aren’t as complex and often use Adjusted Gross Income, which you just calculated on your federal return, as a starting point.
Which documents to collect
Most people start to receive various tax forms in the mail or electronically this time of year. These include W-2 statements from employers showing your job income for the prior year and the amount of taxes withheld. You might also receive other forms such as various versions of Form 1099 that show interest received, dividends and so on.
It’s important to include relevant information from these forms on your tax returns accurately, as IRS computers will be receiving copies of the same forms.
A mathematical or inputting mistake can subject you to an audit. However, most audits aren't in-person, middle-of-the-night interrogations but, rather, letters you receive from the IRS asking you to clarify or support some item. In recent years, the IRS has examined well under 1% of individual returns.
Heeding deadlines is important
The IRS will start accepting electronically filed tax returns Jan. 29 and you have until April 15 to submit yours. Or, you can receive an automatic extension taking you to Oct. 15 by filing form 4868.
For taxpayers who expect to receive refunds, filing early is best as they can receive their money faster. If you file and then spot an error, you can and should file an amended return. The IRS will assess a penalty for filing a tax return late starting at 5% of the unpaid tax amount, capping at 25%.
What to know about income and assets
One important point you will learn about the tax code is that income — essentially cash inflows to you from work, investments and so on — is typically taxable.
In contrast, the value of assets you own might not be taxed until you sell them, if at all. Suppose you buy a stock today and don't sell it for 30 years. In case that, you wouldn't be taxed on the gain until that time, though dividends or other income received in the meantime generally are taxable.
There's a special benefit available to homeowners. If your home rises in value over time, you won't be taxed on the profit, known as a capital gain, until you sell. Even then, you can exclude up to $250,000 in gains if you are single and $500,000 if married and filing a joint return.
How to distinguish deductions from credits
The tax code basically reimburses you for certain expenses that you make, or it gives you a tax break based on eligibility factors such as your age, income or number of children.
Deductions are expenses that you paid that reduce your taxable income. Common examples include state taxes that you paid, mortgage interest on your home, property taxes and donations to charities.
You can itemize or list these deductions separately, or you can take what's called the standard deduction instead. The standard deduction for 2023 was $13,850 for singles and $27,700 for married couples. If you had deductible expenses above those amounts, you probably will want to itemize, though that entails more work. Nearly nine in 10 taxpayers now take the standard deduction.
Unlike both types of deductions, credits reduce your tax bill and thus are more valuable than deductions, which reduce taxable income. One popular credit is for child and dependent care.
Watch out for criminals
When filing a tax return and at other times of the year, it's important to safeguard your information from crooks.
Identify theft is a growing problem and one that can compromise your personal information with repurcussions that include delayed refunds. That means you should keep your Social Security number away from prying eyes and keep copies of your tax return, paper or electronic, in a safe place.