How to File Your Taxes Confidently

Welcome to the beginning of tax season. Paying your taxes can sometimes feel like a black box. You pay taxes all year, and then you either get a refund or owe more. Time to shed more light on this.

What Does “Filing Your Taxes” Mean?

At its core, filing your taxes is reporting your financial picture from the previous year.

You start with how much income you make, determine what deductions and credits apply, and the result is the amount of taxes you owe.

What determines if you owe additional money or get a refund is the amount you’ve withheld or paid throughout the year.

Our tax code is a “pay as you go” system, which explains why you get your income withheld on your paychecks, or pay quarterly tax payments for the self-employed.

Note:

You can control how much of a refund or additional taxes you owe. You do this by updating your form W-4, and submitting it to your employer.

Aim to get as close to $0 as possible. You don’t want to be giving the government interest free loans…

How You’re Taxed

Most people don’t realize that not all income is taxed the same.

This works on two fronts.

The U.S. tax system is progressive. You can think of the tax system like filling up buckets that are taxed at increasingly higher rates.

Each bucket is filled with your ordinary income (wages, bonuses) from your W-2 or 1099. As you fill one bucket and move on to the next, the tax rates get higher until it caps out.

They start at 10%, 12%, 22%, 24%, up to 37%.

Once you fill up the 10% bucket, any additional income you make is taxed at the next bucket’s higher rate. So no, you don’t “lose money” by making more of it, but it is taxed at a higher rate. Pay close attention to if your “tax bucket” is close to being full.

On the second front, taxes on your investments are different than taxes on your ordinary income.

Investment income is taxed two different ways:

Long-term capital gains rates, or investments held longer than one year are taxed at: 0%, 15%, or 20%, depending on your ordinary income level.

Short-term capital gains rates, or investments held shorter than one year, are taxed at your marginal rate, or the highest tax bucket you’re at with your ordinary income.

Note:

High Yield Savings Accounts interest is taxed at your marginal rate. Be mindful and set aside tax dollars to pay for this. I see a lot of people be caught off guard.

Interestingly, dividend paying stocks are taxed at long-term rates, if the appropriate conditions are met.

What Documents You’ll Need

To make filing your taxes easier, it is best to gather all the necessary documents ahead of time.

Have the following documents on hand while filing:

Income

• W-2s from employers

• 1099s for interest, dividends, or side income

• Brokerage statements for investment activity

• Retirement distributions, if applicable

Deductions & Credits

• Mortgage interest and property taxes

• Student loan interest

• Retirement contributions (401(k), IRA, HSA)

• Charitable donations

• Childcare or education expenses

Life Events

• Marriage or divorce

• Children or dependents

• Buying or selling a home

• Equity compensation

Options for Filing Your Taxes

There’s no single “best” option, only what fits your situation.

DIY Software (TurboTax, H&R Block, FreeTaxUSA)

Best for:

• Straightforward W-2 income

• Few investments

• No major life changes

Tradeoff: low cost, limited insight.

CPA or Enrolled Agent

Best for:

• Higher income

• Equity compensation

• Business/side income

• More complex financial lives

• People who value delegating their taxes and ensuring accuracy

Tradeoff: higher cost for more guidance and (hopefully) better outcomes.

How to reduce your taxes

While there are only a limited amount of things you can do to reduce your total taxes paid while filing, the rest of the year offers more opportunities.

This is the difference between tax filing, and tax planning.

Filing your taxes is a once a year event, while tax planning happens the entire year.

Tax planning serves to not only decrease next year’s taxes, but potentially many years into the future.

We’ll talk about that more next time.