Don’t Dread the IRS: Four-Part Guide to Tackle Your Taxes
by Maia Monell | Updated February 25th 2021
As tax season begins, no reason filing your taxes after a year of COVID has to be another source of financial stress. In fact, our three-part guide is still as relevant as it always has been, with an updated Part 4 for COVID.
To begin: Why the f*&k are we (always) so afraid of tax season?
Because, my fellow Navigators, what you don’t know, you won’t ask, and what you won’t ask, you won’t ever find interest in. I hope this 3 Part Guide to Tax Filing will bring some relief in knowing that you’ve done it right. That you got this.
Let’s get started.
Part 1: Who the Hell are You?
So, before we get into the world of deductions, credits, and those frustrating acronyms, let’s first consider Rule #1, know who you are.
The IRS cares less about your hopes, dreams, commitment to financial fitness, or even your goals – they prioritize your bottom line. So, when filing, first consider your gross annual income as this will dictate how much you owe.
There are seven federal tax brackets, each assigned a different rate, ranging from 10% – 37%, with ranges in each varying based on your status…
Your filing status determines how much your income is taxed.
There are 5 filing statuses to become familiar with:
Single: For you single-tons out there, this one’s for you. If by December 31st you’re single (or legally separated) you’ll likely file under Single.
Married Filing Jointly: For those of you married and choosing to file a joint tax return (where you report your combined income and deductions).
Married Filing Separately: If you’re married, this one might benefit you if you want to be responsible only for your return. This can be helpful if you pay less tax filing separately than if you would together.
Head of Household: This one’s for you if you meet the following criteria:
You’re unmarried on the last day of the year,
You paid more than half the cost of home expenses for the year,
A dependent lived with you in your home for more than half the year (school absences are allowed). That said, if you care for a parent, that parent doesn’t have to live with you.
Qualifying Widow(er) with Dependent Child: This one allows you to file under this status in the first two years after your spouse has passed. You’ll be entitled to a joint return tax rate and the highest standard deduction.
The government makes most of its revenue for budgets on income taxes, or money they take out of each paycheck earned. So why do we need to file taxes each year? Well, it’s actually to determine whether the government collected enough taxes through withholding a portion of your income or if they owe you money (hint: refund) for paying too much tax.
So then, what is considered taxable income? It’s not just from your bi-monthly or monthly paycheck.
And, honey, that’s not all. Taxable unearned income includes:
Interest, dividends, profit from the sale of assets, business and farm income, rents, royalties, gambling winnings, alimony
What about deductions and retirement contributions? I’m glad you asked.
Tax-deductions are typically expenses that you incur during the year that can be applied against (or subtracted from) your total income to figure out how much tax you owe. Here’s a list of general deductions:
Capital loss on a stock
Healthcare costs like medical bills and prescription drugs
Home office and other job-related expenses
One additional deduction term to be familiar with is a tax loss carryforward. This is a deduction for a capital loss that was carried forward from the previous year.
Now, let’s cover contributions to your retirement accounts (like a 401(k) or IRA) first. When you allocate a portion of your income into a retirement account, you should decide if you want a tax-deferred or a tax-exempt account. Here’s the breakdown:
Tax-deferred: Think traditional IRAs or 401(k)s. These accounts allow you to contribute a portion of your pre-retirement income each year. That income isn’t taxed; instead, it’s deferred until you reach retirement age. In 2020, individuals can contribute up to $19,500.00 / year to a 401(k) and up to $6,000 to a traditional IRA.
Tax-exempt: Think Roth 401(k)s and IRAs. These accounts provide future tax benefits as the income generated from these accounts is not taxed upon withdrawal. Meaning, your investment returns grow tax-free.
This brings me to capital gains tax. If you proceed with a retirement account that’s tax-exempt, you’ll earn every penny of interest earned on that account. However, suppose you contribute consistently to a standard taxable portfolio. In that case, your earnings will be vulnerable to capital gains tax or a tax on your capital gains (earnings from a capital asset) when you decide to sell those investments. Losses on personal capital (like your home or car) are not tax-deductible.
Capital assets include things like stocks, bonds, precious metals, jewelry, and real estate. The tax you pay on the gain depends on how long you’ve held onto the asset before selling it. In terms of taxes, these gains are considered to be either short-term or long-term. Any gain is deemed to be short-term if it’s been owned for one year or less. These short-term gains don’t benefit from any special rate.
However, taxes on those long-term gains are generally lower than if the gain was realized in a year or less, making it more favorable to you to hold onto the asset for over a year. Fun fact: the Tax Cuts and Jobs Act (TCJA) in 2018 created tax brackets for long-term capital gains tax.
Unlike deductions that reduce your taxable income, tax credits subtract from income from what you owe to the IRS. The Internal Revenue Code allows for various credits based on things like the number of dependents you care for or your or your earned income (for low-income earners). You’ll be responsible for applying for these credits on your tax return form.
And that gets me to arguably the most confusing part of the tax process, the Forms. Here’s a helpful list of forms, what they mean, and if you need to consider them when filing your tax return.
Part 3: Grab a Pencil
Forms, Forms and More Forms.
I think the worst part of taxes is the acronym-ridden forms. So, I thought I’d break down the most used tax return documents here for the benefit of all of us.
Income and the 10’s:
1040: This is your starting point. All US residents must file a Form 1040. It’s the form where you identify your filing status and where you report income, calculate deductions and credits, considers tax due, and applies money already withheld from wages or estimated payments towards tax liability.
1099: This one’s what the IRS considers “information returns.” There are 1099s used to report various types of income you may receive throughout the year, other than your full-time salary. Pay attention to this for your side hustle, crowd-funding investment platform, etc.
Look out for a 1099-MISC from any business that pays you at least $600 during the tax year.
Look out for a 1099-DIV report if you own a portfolio of stock investments or mutual funds. This report will convey the dividends and other distributions you receive throughout the year.
Have an interest-bearing account (like a high yield savings?), be sure to get the 1099-INT form from your bank as this form reports these interest payments.
Retired? You’ll need a 1099-R form to report total withdrawals from your traditional IRA, pension plan, annuities and profit-sharing plans.
Have a debt cancellation? Be sure to get a 1099-C form from your creditor (like your credit card company) as the cancellation translates to ‘income’ which may be taxable.
W-2: Otherwise known as the Wage and Tax Statement is what you probably have been sent by an employer at the end of the year if you’re a full-time employee. This one reports your annual wages and the amount of taxes withheld from your paycheck. You should get this before Jan 31st to allow for enough time to file!
W-4: This is the form that you fill out for your employer which indicates your current tax situation (see filing status info above). It will tell your employer how much tax to withhold from your paycheck.
Schedule 3 on your 1040: This new section is where you can claim (as of 2019) both refundable and non-refundable tax credits. Unfortunately, you can’t just claim a credit on your 1040, to do so, you’ll need to fill out this Schedule 3.
Part 1: Non-refundable Credits: these will lower your tax bill but you won’t get any refund. Things that count towards a nonrefundable include:
Foreign tax credits
Credits for child / dependent care
Retirement savings contributions
Residential energy (have you upgraded to solar? This one’s for you!)
+ a few others. More info here.
Part 2: Other payments and refundable credits: These are those credits that you’ll receive a refund for, even if they reduce the amount you owe to $0. Including some standard situations like:
Estimated tax payments and amount applied from previous return
These are needed if you’re self-employed, have income from interest on dividends or expect to owe more than $1,000 in taxes.
Net premium tax: for those of you who purchase healthcare coverage through the insurance marketplace, you could get a credit towards ‘advance payments.”
COVID broke several institutions across multiple industries, but not the tax system. There were also several updates based on acts that former President Trump and Congress enacted.
Stimulus Checks: One of the number one most searched questions as tax season gets started is “do I owe taxes on my stimulus checks?” No, 99.9% of people owe absolutely no money on either one of their stimulus checks, even if you have dependents. Known as a “recovery rebate credit,” your stimulus checks will equal the rebate, zeroing out that amount. The only way this wouldn’t happen is if your stimulus checks were less than the amount specified by the rebate credit. This is the perfect time to speak to an accountant if you think this might have happened to you!
Standard Deductions: These amounts were raised in 2020! Married couples saw a $400 increase, and singles saw a modest $200 gain.
Charitable Gifts: This one is a little confusing – if you itemize your charitable deductions, the 60% of AGI limit on cash donations doesn’t apply. If you don’t itemize, you can deduct $300 worth of cash donations.
There were a lot of changes to our taxes in 2020 – 27 total, in fact. While I covered the majors one, check out this handy guide from Kiplinger that outlines, in detail, the various changes.
Woah, you made it here. Are you ok? Are you as angry with me as my editor was for a total and complete lack of brevity?
I get it, taxes suck. Paying the government your hard-earned money, frankly, sucks. But at the end of the day, we can’t all be living off the land and grid in sheer peace. Because, honey, how boring would that be? Thus, we have to pay for the lives we want to lead. But that doesn’t mean we can’t optimize our “take-home” potential.
Remember, the more we know, the more we SAVE and the more we save, the more we earn, grow, and thrive. While taxes might stay the same, the way you feel about them sure might change.
We’re changing the narrative around money but change can’t happen with a one-sided conversation. That’s why we’re excited to bring different voices and experts to share their wisdom. Send us an email and let us know what you think. And remember the nav.it money app offers you free tools for managing your money moves like automated savings and budget tracker.