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Tax Extensions Are Not Payment Extensions

During the last week of tax season, my office received many calls from clients wondering why they were making tax payments with their tax extensions. Many were under the misconception that a tax extension was a way to postpone any tax payments. That is not completely true.

Being that the U.S. government is funded by taxing their citizens, it will do everything in its power to get as much money as possible. So, if you owe tax, the IRS will charge you penalties and interest on any monies owed and not paid. So if you didn’t pay enough in taxes throughout the year and owe money in April, you can be charged penalties and interest on the money that you owe on April 15. If you file an extension, and thus postpone the due date to October 15, you may owe additional penalties and interest on any monies owed for the time between April, the regular tax due date, and October, the extended due date.

Related PostUnderstanding The 1040 Individual Tax Return

Related Post4 Ways I Increased My Tax Refund

So while you can technically postpone your tax payments until October, you may owe even more than you would have if you had just paid them on time. Paying an estimate in April of what you think you may owe will save you on penalties and interest. The instructions for the 1040 even say you may owe a penalty if the amount owed is more than $1,000 and that it is more than 10% of the tax shown on your return. It also says you will be charged interest on the tax not paid by April 15. Do you really want to give the IRS more than you have to? I know I tend to get mad at myself for having to pay more because I was too lazy to take care of it earlier.

 

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4 Ways I Increased My Tax Refund

Last year, for the first time in my working life, I had to pay taxes in April when I filed my tax return. It was largely attributed to the fact that both my hubby and I did not carry health insurance for ourselves, thus resulting in a health care tax. To prevent a repeat of that scenario this year, I employed four strategies that increased my tax refund.

As a way to decrease our taxes owed last year, my hubby and I made $4,500.00 in IRA contributions right before April 15. Even though we made the contributions in 2016, it counted towards our 2015 taxes, thanks to the IRS’ attempt to foster retirement savings. You’re allowed to deduct your IRA contributions, among other deductions, from your income, in calculating your AGI and taxable income, thus lowering your taxes.

Related post: Understanding The 1040 Individual Tax Return

Related post: It’s Never Too Late To Save For Retirement

We’ve done this twice now, for our 2014 and 2015 taxes, both right when we filed our taxes. Rather than waiting until the last moment like I do, you can make small regular contributions throughout the year to ease the cash flow burden it creates in April. Just keep in mind there are IRA contribution limits every year.

The limit for 2016 is $5,500.00 for those under 50, and $6,500.00 for those 50 and over.

When I changed my employer in February 2016, I made a mental note to set up a 401(K) contribution as soon as I became eligible in six months. In the second week of August, I had HR set up my retirement account, and have even increased my contribute rate since then. My hubby also contributes to his 401(K), although at a much lower rate than I do.

401(K) contributions basically lower your taxable wages by deferring a portion of your income to your retirement account. So if your salary is $50,000 a year, and you contribute 10% to your 401(K), which is currently my contribution rate, the wages you put on your tax return is actually $5,000.00 less (10% X $50,000.00) at $45,000 a year, with the $5,000.00 deferred to a future year, when you withdraw the money from your 401(K). As a word of caution, withdrawing from your retirement account, whether an IRA or 401(K), could result in huge tax penalties, so do your research first.

When I started my new job last year, I filled out the W4 in a way that allows the most taxes to be withheld from my paycheck. A W4 is the IRS form that tells my employer how much taxes to withhold from my paycheck. Thus, if I claim on my W4 that I am single with no children, my employer will withhold more taxes than if I claim that I am married with a child.

This ensures that I pay enough taxes throughout the year and don’t owe more when I file my tax return in April.

And finally, when I started my new job, I also picked up health insurance for my hubby and myself, starting in March 2016. We were no longer subjected to the health care tax fine for going without any health insurance that directly added to our taxes in 2015. And while my employer pays for my health insurance premium, we pay out of pocket for my hubby’s portion of the premium, which can be declared as an itemized deduction.

Related post: Renewing My Health Insurance

Related post: I Was Pregnant Without Insurance

It’s important to remember that these strategies are not quick fixes. The earlier these strategies are implemented, the better tax position you will be in. While contributing to your IRA can be decided after the end of the year, the other three strategies, contributing to your 401(K), picking single on your W4, and carrying health insurance, have a greater affect when done earlier than later. You also can’t pick up health insurance whenever you want, but you can change your W4 selections and contribute to a retirement account, whenever you want.

 

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Understanding The 1040 Individual Tax Return

Tax season is upon us once again. While most people are afraid of taxes, I see it as a challenge to overcome. Successful millionaires learn to work with taxes, and incorporate them into their financial plans. To overcome that fear of taxes, I’m going to explain what a 1040 is and how to read one.

A 1040 is the individual income tax form that you file every April 15 with the IRS. You report your income and certain expenses on it, and it calculates how much taxes you either owe or will get back. The top part is your personal and contact information, like your name, address, and social security number.

The next part is your Filing status. You’re either single, married filing jointly, married filing separately, head of household, or qualifying widow with dependent child. If you’re single or engaged by December 31 of the year, you file single. If your married filing jointly (MFJ), the IRS treats you and your spouse as a single entity. Most married couples file MFJ. Married filing separately (MFS) is just as it sounds. You’re married, but your each filing separate returns as if you’re single. There are pros and cons to filing MFS. Head of Household (HH) is designed for those who are not married, but are substantially supporting someone (there is a specific definition for support). Lastly, qualifying widow with dependent child allows widows or widowers with children to retain the benefits of MFJ for two years.

The next section is the Exemptions. An exemption is a yearly amount that is deducted from your taxable income to reduce your tax liability. The 2016 personal exemption is $4,050.00, and increases every year. Generally speaking, there is an exemption for every person that the tax return covers. For example, if you’re single, you only get one exemption. If you’re married with two kids, and filing MFJ, you get four exemptions, one exemption for each person.

Now we come to the main parts of the 1040. The Income section is where you report all the income you received for the year. Basically, everything is taxable unless it is explicitly stated in the IRS code that it is tax exempt. Taxable income includes your wages, interest and dividends, selling stock, certain retirement distributions, and personal business and farming. It also includes alimony received, unemployment compensation, lottery winnings, social security, and many other less common items, such as forgiveness of debt.

Nest is the Adjusted Gross Income section, commonly referred to as your AGI. It’s a widely used figure calculated by subtracting specific deductions from total income. Common deductions may include educator expenses, health savings account (HSA) contributions, moving expenses, IRA contributions, student loan interest expenses, and tuition expenses.

Related PostIt’s Never Too Late To Save For Retirement

Related Post: I Contribute To My IRA Once A Year

There are additional deductions, but they are less common. All of these deductions are referred to as above the line deductions, because the IRS allows you to deduct them to calculate your AGI “line”.

On the second page of the 1040, is the Tax and Credits section. This section calculates your taxable income by deducting the exemptions previously discussed and either the standard deduction or your itemized deductions from your AGI. The standard deduction is a flat amount that you are allowed to deduct from your AGI to lower your taxable income. Or you could itemize your deductions and keep track of receipts and records for certain expenses. There are lot of rules to itemizing your deductions, which is why you only itemize if it’s higher than your standard deduction.

Once you’ve calculated your taxable income, the next two lines are the taxes and alternative minimum taxes calculated based on your taxable income. The alternative minimum tax (AMT) is a supplemental income tax on those who are in the position to use tax loopholes to avoid paying taxes, i.e. wealthy tax payers. Most taxpayers do not have to deal with AMT tax.

Once you have calculated your taxes, you now calculate how much in tax credits you get to offset your taxes. Tax credits reduce your taxes dollar for dollar, whereas deductions reduce your taxable income, from which taxes are calculated from. Most people are familiar with child and dependent care credits, education credits, retirement savings contributions credits, child tax credits, and residential energy credits. There are also credits for getting health insurance through the health insurance market place (while it’s well known, it’s relatively new), and many more credits that affect only a few taxpayers.

Once you’ve calculated your tax credits, you calculate even more taxes in the next section, called Other Taxes. Fortunately, these taxes are not common, and affect only a small group of taxpayers.

You’ve now calculated the taxes on all your activity for the year, and reduced it by all the tax credits you’ve also earned for the year. It’s time to figure out how much of those taxes you’ve already paid, which you do in the Payments section. That’s why you have to file a tax return every April, to reconcile the taxes you’ve already paid with the taxes you should have paid. Most people pay the most taxes from their paychecks, which comes from the W2s, or less commonly, 1099s. Some people are unfortunate enough to have to prepay taxes for the next year by making estimated tax payments. Others forgo their tax refund and apply it to their upcoming taxes the next year.

There are also some additional less common tax credits that get applied here that increase your tax payments. You add all those up, and get your total tax payments that you have made during the year.

We are now at the last main part of the 1040, the Refund and Amount You Owe. If you’re total payments is more than your total tax, than you overpaid your taxes. This overpayment can be refunded back to you or applied to your taxes next year. If you underpaid, then you owe taxes (and penalties) in April.

That brings us to the bottom of the 1040, where you, and your tax preparer, sign and date the tax return. And there you have it. A 1040 basically totals up all your income, deducts certain above the line expenses to calculate your adjusted gross income (AGI), deducts additional below the line expenses to calculate your taxable income, and then deducts tax credits (and adds less common taxes) to calculate your total taxes. Lastly, it calculates your total payments and tax credits to determine whether you overpaid or underpaid.

 

 

 

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I Contribute To My IRA Once A Year

I am proud to say that I have had an IRA since my mid twenties. And of course, it laid dormant for several years until my early thirties. Every now and then, I rolled over an old 401k from a former employer into it, a few hundred here, a thousand there. Then, in 2015, I exercised my American right to file taxes (sense the sarcasm there?), and discovered that my hubby and I owed $350 for 2014.

Up until that point, I never owed any taxes, and always got a refund. Using my knowledge about taxes, I decided that I wasn’t going to kiss away $350 to the IRS, and that the hubby and I would make our first real contribution to our IRAs to eliminate the taxes owed. We contributed $2,200 ($1,100 each) to my IRA, bringing the balance to $4,558.54.

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That not only eliminated the $350 to the IRS, but also got us a $349 refund, $3 from the IRS and $346 from NY.

HandRBlocktaxesA year later, I got an early start to our taxes in February 2016. But as soon as I saw that we owed $1191 to the IRS, I cursed the Affordable Care Act, put our taxes down, and ignored them until April.

The week before they were due, I realized I was about to become the accountant that needed to get an extension on her own taxes, so I picked them back up and finished them.

To reduce the taxes owed from $1191 to $426, my hubby and I had to contribute $2,250 each to our IRAs. We also got $622 back from the state.

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I basically contribute to my IRA once a year, as a way to not pay additional taxes. At the moment, my savings account is at an all time low of $2,100, thanks to some irregular medical expenses, and the $2,250 contribution to my IRA. But when I logged into my IRA account this month, it felt great to see a $6,332.72 balance. And then I was over the moon when I saw my hubby’s IRA balance has an additional $6,008.11.

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I may even attempt to meet the IRA contribution limit of $5,500 this year. Maybe $2,000 this year, and the remaining $3,500 by April 15 next year.

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