This post is part of the TaxACT #DIYtaxes blog tour which shares stories and tips about doing your own taxes and how it makes you smarter about the overall health of your finances. Do your own taxes today at TaxACT. You got this.
For the past approximately five years I’ve done my taxes myself. I haven’t paid a tax adviser or even looked into their services. After all, I feel like taxes should be easy enough for the average person to do it, let alone a personal finance blogger.
One issue with my taxes the past few years is that they have become increasingly complicated. I got married. My wife has, at times, held multiple jobs. We bought a house. We rent out part of our house. I made money freelance writing and off of blog advertising.
Regardless of how complicated taxes get, though, I will always do them myself. The lessons I’ve learned through doing my own taxes were extremely valuable. That doesn’t mean the lessons weren’t painful at times, though.
Painful tax lessons
Doing your own taxes forces you to look at the details of your finances and how they relate to your taxes. Here are some things we (painfully) learned while doing our taxes.
- Don’t trust your employer to withhold enough
As I mentioned earlier, at one point my wife had a couple of part-time jobs. Unfortunately that meant each employer withheld little – or nothing – for taxes. They assumed the income she received was her only income.
Even if your employer withholds money for your taxes it doesn’t mean they are withholding the right amount for your financial situation. By doing our own taxes we learned that we need to voluntarily withhold more and keep a closer eye on our withholding amount throughout the year.
- Self-employed income can be painful come tax time
The first seven months of taking blogging seriously resulted in virtually no income. It’s tough to get a blog established and even tougher to monetize it. My second year of blogging, though, I made a decent amount of money through advertising. Doing my own taxes showed me just how painful it can be if you don’t plan properly for self-employed/business income.
First of all, as I explain in my post how to calculate quarterly estimated taxes, self-employed income is taxed at a higher rate than income from an employer. Additionally, there is no one setting money aside for taxes unless you take the initiative and do it yourself.
If you misjudge how much you need to set aside for self-employed/business income you can be in a difficult spot when you find out how much you owe.
Despite learning these painful lessons that come with a lack of understanding and poor tax planning, the best way to learn and become better prepared for taxes is to do them yourself.
How doing your own taxes can benefit you
One thing is undeniable: doing your own taxes can benefit you. Here’s all the ways that you will (potentially) benefit from doing your own taxes:
- Truly understand tax deductions and credits – When I didn’t do my own taxes I didn’t have a good understanding of tax deductions and credits. For example I was unaware that there was a relatively low cap on the student loan interest deduction until I actually did my taxes myself.
- Understand how financial moves impact your taxable income – While everyone probably has a general idea of how much they make on a yearly basis, until you do your taxes yourself you will never know all the gives and takes that can impact how much you pay in taxes.
A good example is an employee stock purchase plan. Cashing out an employee stock purchase plan can result in a relatively large tax bill because typically employees receive large gains from these plans. Conversely, contributing to an HSA or other tax-advantaged account can lower your taxable income.
- Know what to look for in the future – Doing your own taxes allows you to plan better next year. For example, it became painfully obvious to my wife and I that we should have checked how much her two part-time jobs were treating her income from a tax standpoint. Additionally I now have a general idea of how much we should have withheld from our paychecks and can do a quick calculation every few months to make sure we are on track.
One thing I haven’t mentioned yet is just how easy it is to do your own taxes. Sure it takes some time and effort to do taxes yourself, but the software available today makes it easy for anyone to prepare their taxes themselves. After all, even if you had someone prepare your tax return for you you’d still have to do all the work of gathering the appropriate documentation.
Do you prepare your own taxes? If so, how have you benefited from preparing your own taxes?
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I couldn’t agree more. I’ve learned so much about all the deductions and I’ve prepared myself that our taxes will get worse in a few years. Next year we might not get the full student loan interest deduction. Soon after that, the childcare credit we get will go away as my eldest starts school. We will have to start withholding more verrrrry soon.
We always do our own taxes too. This year was more complicated thanks to our self-employed/freelance income, but, totally possible to do ourselves. We’re good about keeping records and spreadsheets throughout the year, so at least it’s easy to assemble all of our paperwork. We used TaxAct for the first time this year and were very pleased with it and the fact that it’s less expensive!
It’s great to do your own taxes and see how it all works out. Also, many tax software packages have online and phone support to help when you run into problems. I think that if you have some really complicated tax events happening, it might be a good idea to consult with a professional. Even just to ask that specific question.
Up until a few years ago I always did our own taxes as well. I learned quite a bit doing them and enjoyed doing them – dorky I know. ;) But, we ended up hiring a CPA 3 years ago as the business just introduced too many things I could confidently do and still maximize our tax situation from both a personal and business standpoint. There just became too many moving pieces that it made sense for us to hire it out.
When I first started working my dad made me do my taxes by hand (no software). Fortunately, my taxes were simple back then. My dad still does it by hand. Software is a life saver and makes it pretty simple. While taxes can be complicated, I find it intriguing and want to have a better understanding so I can save on taxes. I took a class to get a better understanding and also considered working part-time as a tax preparer at one point. I do think taxes can get complicated though when you have your own business and other investments. It might make sense to get some tax advice, but I agree with you that I’d try to do it myself for the most part.
As someone else who rents out part of your house, how do you handle the depreciation calculations? Square footage percentage?
Anything you can share about how you calculated the cost basis of your house? (In my case, we did our best to calculate the value of the land from the appraisal & tax docs, and subtracted it from the price we paid.)
The partial-home rental is the most confusing part of doing my own taxes each year, and would love to hear how another financial blogger is handling it. I’ve done my best, but it doesn’t fit in neatly into the TaxAct’s rental-income forms.
My kind of post! Definitely don’t trust that your employer is withholding the appropriate amount. In fact, I’d say be very skeptical of it.
I think it’s admirable how you continue to do your own taxes even though it can be complicated at times. I didn’t do my own taxes this year and felt silly about it afterward because my taxes are not really that complicated at this point in my life. I’m looking forward to following suit and taking care of them myself next year though.
DonebyForty I actually just wrote a post about partial-home rental as it affects your taxes on my blog! Feel free to check it out, and I hope it addresses your question!
http://www.currentoncurrency.com/keep-the-taxman-away-from-your-rental-profits/
I know it isn’t a huge deal that I’m doing my own taxes right now since it’s pretty straightforward, but I’m planning on sticking to doing my own taxes even when things start to get more complicated. I couldn’t agree more with everything you said on this post.
Anum
Thanks for sharing the article, but I didn’t see any references to depreciation or cost basis, specifically as it applies to long term renters. If you rent out a space in your house, might you share how you tackle those items?
DonebyForty If I’m not mistaken I emailed back and forth with my Dad about the depreciation of the rental property square footage but decided against taking that approach (honestly can’t even remember any details of our conversation, but I know we landed on NOT depreciating anything). I depreciate improvements to the space, though, such as the appliances we bought or the new exterior door we had installed. I calculate other expenses based on whatever seems reasonable. For trash I assign 1/3 of the bill to our rental unit expenses because there are three people living in the home (me, my wife, and the renter). For cable I do the same thing thing since 3 people are consuming it. For heat/utilities I believe I went with square footage.
I’ve thought about writing a post about this but wasn’t sure it would be applicable to enough of the readers. Might be a good idea now that you mention it, though.
indebtedmom Great point. It’s important to be aware of how changes throughout the year will impact your taxes. While my wife’s masters program isn’t cheap we did start getting some nice deductions and credits from it. I typically err on the side of NOT getting deductions/credits, but sometimes you can adjust your behavior to take advantage of them.
Mrs. Frugalwoods The best thing you can do with taxes is keep good records. I am with you on using spreadsheets to track everything throughout the year. With that being said, I end up doing more reconciling later in the year than I should!
houseoftre Yes, sometimes it makes sense to consult a professional. It’s nice that the various companies have that support you referenced because it makes it even EASIER to do taxes yourself. If anything too complicated comes up the support is one phone call or click away.
FrugalRules For you it was probably a time-saving exercise too. By hiring out accounting you freed up more time to devote to your business. I see nothing wrong with that.
Andrew LivingRichCheaply Thankfully I’ve never had to do my taxes by hand. My Dad uses software now but also does them by hand just to “make sure” they are correct.
Mark@BareBudgetGuy We made the mistake of not withholding enough too many times for us to ever rely on it. Now both my wife and I voluntarily have extra taken out (plus quarterly taxes!). We figure worst case scenario we get a small return, best case we get a big one. We aren’t complaining.
Chonce Best of luck doing your taxes yourself next year, I think you’ll find it really easy to use the software. As long as you have all your forms and information ready to go, it really isn’t that difficult.
Anum Thanks and glad you agree! I think there is a lot of value to be had in the knowledge you gain by doing your own taxes and seeing how things actually shake out.
I actually still do my own taxes and I love it because every time I go through the process I learn something new that helps me change my behaviors throughout the year. For example, there are certain business write offs that are better than others so I look to maximize those and minimize the others as I make business expense decisions.
DonebyForty
To determine how much of the depreciation is attributed to your rental property you have to determine the percentage of your home that you rent out. This would be done by using square footage. So just take the square footage of the rental space divided by the square footage of the whole home. You can use this percentage to deduct expenses related the the rental of that space as well. For example – if you pay homeowner’s insurance you can deduct the percentage that would go towards insuring the rental space.
I was wondering if this is your first year renting out the property? If so, then you have to calculate our deductions based on the Modified Accelerated Cost Recovery System (MACRS). Then under MACRS you use the General Depreciation System (GDS) or the Alternative Depreciation System (ADS), but usually people use the GDS unless required to use the ADS by law or if they elect to (once you elect to use the ADS you cannot switch). ADS recovery periods are longer than GDS recovery periods. For a residential rental properties the GDS recovery period is 27.5 years and the ADS recovery period is 40 years.
For residential rental property you have to use the mid-month convention. This way, you treat all property placed in service or disposed of at the mid-point of the month. For a residential rental property you then use the straight line method and the mid month convention. If this is the first year that you claim depreciation for the property, then you can only claim for the number of months the property is in use.
The MACRS gives you a fixed percentage deduction each year via a table. I think you were trying to determine the depreciation based on the change in value of the house? Unfortunately, that is not how the IRS calculates depreciation. So, to determine your depreciation you have to know the unadjusted cost basis of the house (how much the house would sell for if you sold it right now), times the depreciation percentage, times the percentage of your house that you are renting out. So say your house is worth $300,000 right now, 10% is being used as rental space, and your depreciation value (taken from the table) is 3.458%, the equation would look like this:
300,000 x (.1) x (.03458) = 1037.4 as a deduction for depreciation for the rental space in your home. Look at the table (Table A-6 from the link) and match up what year into renting you are and what month of that year you placed it into service. I know the tax code is confusing and convoluted, but I hope this helped somewhat. Let me know if you need any clarification.
http://www.irs.gov/publications/p946/ar02.html#en_US_2013_publink1000270861
Anum and DC
Thanks for that confirmation. The square foot percentage is exactly the process we’re using, so it’s great to hear your explanation.
DC: regarding depreciation of your rental space (or, not taking it), I believe you may owe back the deprecation when you sell regardless of whether you take it or not. Obviously, probably a question for a tax professional rather than an amateur blogger. But worth looking in to. If you’re going to have to pay it back to the government later, you might as well get the benefit now.
I used to do our taxes by hand. I inevitably had to redo them a few times when I found mistakes. Then I found out TaxAct does federal taxes for free and does free e-file. (I swear, I’m not being paid by them!)
I had to plug in all the numbers to use that, so it made sense to just skip that first part this year. It was wonderfully easy.
The biggest part of being self-employed is definitely making sure you cover FICA and estimate your overall tax amounts. I’m a contract worker, but I get paid regularly at the same rate. So it’s easier for me to forecast what we need to put away each year.
Just remember that as long as you pay at least as much in taxes as you did the year before, you won’t be charged late fees for underpayment.
I have never done my own taxes, but I do have to rustle up the documents and make sure that I am tracking all of the correct info, like medical travel.
We’re pretty solid in that most years I just contribute to my RRSPs until my tax return is basically zero (the blogging income puts me in a paying situation), which is where a bunch of our savings would go anyway.
DonebyForty Anum That would make no sense, though. So I would get zero benefit but all the negatives? It has to be one or the other, not either-or.
DC @ Young Adult Money
The IRS has no problem making a one sided deal. For example, you pay interest if you underpay throughout the year…you don’t get any interest for overpaying.
Here’s a good article on how you will owe on the depreciation even if you don’t take it. A snippet:
“What if you take other home office deductions and skip the depreciation? Nancy Mathis, an I.R.S. spokeswoman, says that will not help. “Even if you don’t take this depreciation, it will be treated as if you did when it comes times for calculating the basis of the home sale and capital gains exclusion.” The I.R.S. will not say why it makes that assumption, but accountants surmise it is because the government cannot keep track of home-office owners who might depreciate some years and then stop right before selling in hopes of avoiding the extra tax.”
http://www.nytimes.com/2006/01/14/business/14money.html?pagewanted=all&_r=0
DonebyForty DC @ Young Adult Money Woah you may be on to something…I need to run this by a tax accountant for sure. We missed out on only two years of this, but I’m curious what happens if you convert the “rental” portion of the house into a “regular” part of the house? Like if I decide I don’t want to rent it anymore.
DC @ Young Adult Money
Probably another good question for your accountant, but (I think) it used to be that you just had to live in your house for 2 out of the past 5 years from the point you sold for it to be considered a “personal residence”. But as I understand it, that tax law has changed…and it’s not immediately clear to me how depreciation and/or a split of renting+personal use plays in to that.
Which all goes to say, and trying to bring this back to your original blog post: some people have situations that are way too complicated to safely DIY our taxes.
DonebyForty DC @ Young Adult Money Hmmm yeah it really is too complicated in some situations. Can’t believe I will need to amend my return this year and last year…it’s not a huge deal just a bit annoying. Taxes are such a waste of time.
blonde_finance Great point, Shannon. I also have learned a lot doing my own taxes the past few years. It’s not “fun” per se, but worth the time investment.
AbigailP Good point about paying in at least as much as you did the prior year. I will actually probably have to amend this year and last year’s returns. Not amused about it, but I think I missed the depreciation portion of my rental income (see thread lower in the comments). I’m glad TaxAct worked so well for you!
DC @ Young Adult Money
On the plus side, you may be in for some good money when you take the depreciation. Good luck. And if you talk to a professional, lemme know what you learn!
moneypropeller Good way to avoid tax liabilities. The way I avoid having to pay in is just paying a lot more than I think I need to. I ended up with a big return this year and some people do not advise that, but the year before we paid in a ton and it was NOT a good feeling.
DonebyForty DC @ Young Adult Money Yeah it should help us out from a tax perspective. The amendment process just sounds super annoying. A company that pays me for affiliate ads also slightly messed up a 1099 and sent me an amended one. Looks like I would have had to file an amendment anyway. And yes, I will definitely let you know! I owe you for bringing this up, btw…
I’ve been a little lazy in the past and had one of our trusted advisors do my taxes, but I’ve committed to doing my own this year. I know it’s not hard, so there’s no excuse not to do it, especially if you’re someone who understands the financials and doesn’t have a complex tax return to file!
Self-employed income is so incredibly painful around tax time! We do our own taxes as well, and I find that I learn something new about the process every year. Although it’s not a fun process, it’s truly not that difficult. Perhaps annoying at times, but I enjoy the learning part of it.
DonebyForty Anum
DonebyForty Anum I agree with this blog post, DIY on sites like TaxAct are great for simple lower income tax situations. However, this comment chain is a great example of how DIY can cost you if you have any complexities in your tax situation. Glad you see the Irony DC @ Young Adult Money
Jason@Islands of Investing I think some returns can get complex and having an adviser in those situations is really beneficial. For a large majority of people, though, tax returns are relatively simple.
Christina@EmbracingSimple I agree – taxes are NOT fun! I really dislike how complicated self-employed income can be, but honestly a lot of it comes down to good records (which is another annoying aspect of self-employed income haha).
The “know what to look for” is crucial – I’m not a fan of all the “last minute tax tips” articles because it feeds into what people shouldn’t be doing – waiting until the last minute!