Taxes aren’t everyone’s favorite topic, but they are an important one when it comes to personal finance.
With taxes due by end-of-day tomorrow, it seemed like an appropriate time for one more tax post.
Today we are looking ahead to next year by discussing 4 ways to be better prepared for taxes.
I don’t know about you, but it seems like every year there are a number of things I could have done differently throughout the year to make tax prep less of a headache.
IMPORTANT: If you HAVEN’T filed yet – You can e-file a tax extension by April 15th to avoid late fees. If you don’t file for an extension, you need to get your taxes sent as soon as possible, as you may be imposed a failure to file penalty of up to 5 percent per month or part of the month, of the taxes due, up to a maximum of 25 percent of the total tax due.
1) Keep Good Records
When it comes to taxes, you can’t keep too detailed of records. The tax code is incredibly complicated. Even relatively simple tax returns typically require a number of documents from various companies and financial institutions.
If you have side income or plan on writing expenses off of income you’ve made, you need to keep good records of your expenses. If you are audited, you need to be able to support the amount you wrote-off in business expenses. For example, my wife and I rent out a basement apartment. There are many expenses that can be written-off, all the way down to paint and rollers. If we don’t save receipts from these purchases, though, it becomes difficult or impossible to prove to the IRS that we actually spent money on these expenses, let alone the exact amount and date of transaction.
I personally reconcile my small business financials once a month. This helps me make sure I have all my supporting documents in-line and allows me to have full documentation of my revenue, expense, and ultimately the income I made that past month. I scan copies of checks I deposit and take screenshots of quarterly estimated taxes submitted.
One tax item that requires documentation is charitable donations. Keep excellent records of your charitable donations, including how much you donated and on what dates. If you donate household goods such as clothes or furniture to a store like Goodwill, be sure to get a receipt from the organization. Additionally you will want to take pictures of what you donated, since there is no other way to prove exactly what you donated. Finally, you can calculate your tax write-off by listing out the amount the store will sell the items for (i.e. $2 for shirts, $3 for pants, etc.). Bottom line: the better records you keep the less of a headache you’ll have come tax time.
2) Contribute to Tax Advantaged Accounts
Contributing to tax-advantaged retirement and health care accounts can lower your taxable income. These include:
- 401(k) and 403(b)
- Roth IRA
- HSA
While most people are aware that contributing to a 401(k) or a Roth IRA will benefit you come tax time, most don’t realize that money you put in an HSA is treated as pre-tax income and, in turn, lowers your taxable income. Money put into an HSA but not spent on health-care expenses are treated similar to a Roth IRA, creating a secondary retirement account.
It’s much easier to contribute throughout the year instead of a lump sum amount towards the end of the year, so taking the time to plan ahead can save you money come tax time. Remember to collect the required documentation at tax time so that you get the full deduction for money contributed to these accounts.
3) Adjust Withholding as Needed
My wife and I have had a fairly large tax bill the past couple years. Prior to that we were used to getting a refund from the government. Having to write a large check to the government two straight years definitely motivates you to plan better for taxes.
Here are two scenarios where you likely aren’t having enough taxes withheld:
- Part-time jobs – If you have a couple of part-time jobs or your spouse is working a part-time job or two, you likely are not having enough taxes taken out of your paychecks. The reason is that the businesses where you receive part-time income assume that the money they are paying you is your only income. So if you make $25,000 at one employer and $25,000 at another employer, they won’t take out enough to compensate for the fact that your income is $50,000 instead of $25,000. Either set aside money for taxes throughout the year or have an additional specified amount withheld each paycheck.
- Small Business and Self-Employment Income – If you have a small business or are self-employed, you need to start planning early for tax time. You also need to start paying quarterly estimated taxes if you haven’t already. We have a thorough post on the topic including calculators to estimate your tax liability, and in turn calculate how much you should pay each quarter. The tax rate on this income is a lot higher than you might think.
Even if your only income is full-time income, you still can have additional money withheld from each paycheck. If you take this approach you will almost certainly get a refund, which most people prefer.
4) Learn about potential credits, write-offs, and deductions
Learning about the tax code might not be very high on your priority list, but if you commit some time to learning some of the basics of the tax code you may save yourself some headaches next year.
For example let’s say you have a home business. If you have a good understanding of what expenses you can and can’t write off, and what sort of exceptions come into play, it’ll be easier to keep track of your expenses throughout the year. This will also help you plan for taxes better, as you will have a better understanding of your tax liability throughout the year versus calculating it all at year-end.
For example, let’s say you bought a brand-new laptop and tablet this year and plan on writing it off as an expense. It’s important to understand the rules surrounding whether you can write-off this expense. If you only use your laptop 25% of the time for your small business and 75% of the time for your own personal use, there’s a good chance it won’t pass as a business expense. If you recognize this from the get-go you won’t be surprised at year-end when you consult the tax code and realize you had $1,500 less of small business expense than you originally thought.
Disclaimer: This article is for informational purposes only. Always consult a tax professional for tax-related questions, issues, and preparation.
Was your refund or amount owed this year surprising to you? What do you do throughout the year to prepare for taxes?
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Good tips, DC.
I have definitely learned to set aside a portion of money for any “side income” over the course of the year, since most of that money comes in without any tax withheld.
Great tips DC! We have monthly meetings to go over all our expenses, write offs, etc. so we’re not surprised at the end of the year. I was fearing that we were going to be absolutely slammed this year, but ended up owing about $250 when you net out the State & the Feds. I was fairly happy with that.
We got a big refund for 2013, so I’m paying less in this year. I don’t necessarily want to owe but I don’t want a huge refund. I’m trying to get as close to zero as possible.
#1 and #4 are a high priority for us. We’ve gotten fairly good at organization, but are working hard to improve this year on write-offs. So far, it’s going well! Great article, DC. :-)
seedebtrun Definitely a good idea, and while I did set aside a large chunk of money, I was still in ‘sticker shock’ mode when the tax bill came. I plan on reviewing our income and tax withholdings in June and September to make sure I’m on the right path.
One area I need to be better in is organizing all year like you do. The year just seems to fly by and the next thing I know it’s Feb again and I’m in tax hell! :) This year I’m paying a lot more in quarterly estimated taxes. One lesson I learned is that if your income fluctuates a lot, talk to your accountant to adjust your estimated taxes. Oh, and having and by contributing to a regular IRA versus a Roth (I had it transferred) can really save your butt if you owe a lot.
Oh man, the last thing I want to think about is next year’s taxes! This is a great idea though and it’s best to get off on the right foot. I think I can do a better job of keeping records and I want to learn about more possible deductions that can help us out next year.
DC, can’t you make us an awesome spreadsheet to track it all? I have about 5 that I use and they are all pretty basic. I tried Quickbooks but it was a little much. There has to be a happy medium somewhere!
I’ll definitely be taking advice on #3 for next year. I came pretty close to being penalized for last year and not having paid in enough ( .. too much blog income? …)
We had a nice refund for 2013. We were used to paying in the past but now we have deductions from our home mortgage interest and property taxes. I’m wondering if we need to adjust our withholding.
Everyday my wife comes home with examples of business owners who are doing horribly with keeping good records. What they don’t realize is that, not only are they unorganized, but they are costing themselves money, in that it takes the accountant longer to piece together their tax situation. Accountants typically bill on the per/hr. basis so the longer they work, the more it costs you.
Great tips, DC. I don’t think you can stress #1 enough if you own a business or earn income outside a traditional job. Records make it easier for you (or your accountant) to do taxes and if you do get audited – make it a lot less painless when you can document all your deductions, etc. Even though we go through this exercise every year, we tend to forget about it and I think we could all benefit from some regular reminders.
FrugalRules Yeah I’d be happy with that as well! Monthly meetings seem like a really good idea considering all your income is coming from small business/self-employment.
Holly at ClubThrifty That makes sense and I definitely can agree that hitting as close to zero as possible would be ideal. I don’t want a huge refund, but this year the primary goal is to not pay, so getting a big refund is definitely a possibility.
Laurie TheFrugalFarmer It’s pretty amazing how you really can never be too organized when it comes to taxes. I am always looking to improve how organized I am tax-wise and I hope reconciling my finances each month help.
Beachbudget To be honest I didn’t do a great job of organizing throughout the year, but this year I am making it a higher priority. I would just much rather spend a few hours a month doing it versus a whole weekend in February or March…and that’s just for the side hustle stuff!
Green Money Stream Haha that’s exactly how I feel, but I’m afraid if you don’t think about next year’s taxes now then you (or I) will end up in the same spot next year wondering what went wrong (at least things went wrong for me this year haha).
Eyesonthedollar Oh if only a simple spreadsheet would do the trick. If I had the time and willpower I think I could make a complicated spreadsheet that would do the trick, but I’m afraid I just don’t have the time right now. I started to create monthly files that reconcile my income and expenses. I plan on reconciling it all together in January and having everything ready to go for the side hustle taxes so I don’t have to worry about it in March when I’m trying to gather all the other forms and documentation for other income.
MyMoneyDesign You can’t complain when the blog income is going well, but it can make for a tough tax season. I’m definitely having a LOT more money withheld this year. The goal is to not pay in next year and I’m definitely dedicated to making that happen.
Raquel@Practical Cents I also have some deductions from home mortgage interest, property tax, and student loan interest. It was nice to itemize for the first time this year.
Brian @ Luke1428 I hear you, Brian, and definitely something people with small business income or self-employed income need to keep in mind. I would hate to hand a mess of files to an accountant and have to pay them hundreds (or thousands) of dollars to reconcile everything. As someone who works in corporate finance/accounting I know how time consuming some of the most menial tasks can be.
ShannonRyan I think reviewing things quarterly is the best way to go. I found out the hard way this year just how difficult it can be to reconcile things from 6+ months ago that I can hardly even remember.
I think it is really important like you mentioned in #4 to push yourself to “learn”. The tax code isn’t exactly easy to understand and changes every year. Even if you have an accountant prep your taxes, you should still try to make yourself aware of the changes/opportunities. Accountants are people too – they can make mistakes and miss potential money savers.
You tax posts are so helpful! Thank you for sharing them!
I keep a record of every expense and every dime I make from freelancing. It’s been helpful!
I know next year my taxes will be a pain to complete. I need to learn more about deductions and write offs.
We had an AWFUL tax year last year, and I vowed like you to not make the same mistakes again, so we actually did much better this year, but it was thanks to starting my new company and having two LLCs now on our returns. But I absolutely agree that keeping great records is mission critical. It takes time while you are doing it, but saves money down the line.
I always log all my receipts in Quicken. I then have a folder for every month for the receipts. A P&L can easily be generated with Quicken all throughout the year,
taxes are never fun, but if you can do your own, you save a lot of money. Why pay an accountant $100 per hour to go thorough your receipts?
fitisthenewpoor Thanks for the kind words! Good record-keeping goes so far when it comes to taxes.
BudgetforMore It’s amazing how complex the tax code is. I know it’s easy for newer self-employed/freelancers/small business owners to not even be aware of quarterly taxes.
blonde_finance It definitely helps to keep good records throughout the year and to spend a little time reconciling your finances.
Jason @ The Butler Journal Same here. The tax code is so complicated there will always be more to learn.
No Nonsense Landlord Exactly. I think tax preparers are going to be in a tough spot a few years down the road. With Turbotax and other tax prep software evolving it seems to become easier and easier to do it all yourself with minimal knowledge of the tax code.
I wouldn’t say surprising as much as I was in denial. It’s well into the 4 digits which I expected. I started saving up last year, but fell behind and then had to use some money on months when I wasn’t getting much work. Now I owe a lot and the vicious cycle begins because I won’t have the money to save up this year for next year because I’ll be paying last years taxes. Kicking myself in the butt right now, that’s for sure!
Miss Entrepreneurette The same thing happened to me and I wrote out some sizable checks to the government for last year’s taxes. I’m definitely planning on turning things around and ‘getting ahead’ so that I don’t get hit as bad this year. My goal is to get a refund!
The biggest thing we need to do is to change our tax withholdings to ensure we pay enough in taxes to not owe at the end of the year. We got hammered on our return this year due to my blogging income. Since my income is very consistent (I write the same # of blogs at the same price each month), I think it would just be easier to have more taxes taken out of my primary career’s paycheck than to do quarterly tax payments.
DebtChronicles You’re right, it would be easy to just adjust your work withholding, unless you plan on taking on additional work/hustling more this year.