Prepping now for your taxes will help you avoid a stressful time next spring and can give you a chance to earn some money to make sure your tax bill can be paid in full.
While next April is six months away, if you think you will owe Uncle Sam a substantial amount, now is the time to figure it out so you can mitigate the complications of a large bill or penalties. Don't overlook deductions which could apply to you.
While you are unemployed and strapped for cash, it is tempting to not have tax withheld from each check in order to have more income. Be aware that you may have set yourself up to owe the government thousands of dollars.
Unemployment is taxable also as ordinary income, so be sure to check the box to withhold federal taxes on it, said Vickie Adams, a certified financial planner in San Pedro, California, whose wealth management firm specializes in tax.
The only time you should skip having tax withheld on unemployment compensation is if you are certain you will be receiving a refund and the tax liability created will be offset by taxes already paid during the year, she said.
If you are like many Gen X-ers and Gen Y-ers, then you are probably shelling out thousands of dollars in student loan payments. The good news is that you may be able to deduct the lesser of $2,500 or the amount of interest you actually paid for loans for yourself, spouse or dependent, Adams said.
People working on another degree can take advantage of the American Opportunity Credit, which has been extended through 2017 and allows an annual credit of up to $2,500 to be claimed for four post-secondary education years.
"It's one of the few refundable credits, meaning it is not just a dollar for dollar tax offset," she said. "You can get up to 40 percent of the credit back or $1,000 even if you have no tax liability, if you meet the criteria."
If you are just taking one or two graduate courses, the Lifetime Learning Credit can pay for undergraduate, graduate and professional degree courses, which also includes courses to improve job skills -- regardless of the number of years in the program, Adams said.
"Eligible taxpayers may qualify for a credit of 20 percent of tuition expenses up to a $2,000 credit," she said. "A credit offsets taxes actually owed."
Employees who tapped into their retirement funds during times of economic hardship are frequently surprised that they owe both federal and state taxes. If you must take money out of your 401(k) or an IRA to pay bills or for other necessities, make sure you set enough aside to pay for the huge penalties incurred when you withdraw and are under the retirement age of 59.5 years old.
Taking a loan against your 401(k) may seem like a good idea to pay for a costly home or car repair, but most experts advise consumers to avoid this unless you have exhausted all other options and have no other alternative.
"It's a bad idea on many levels because most people don't have enough saved for retirement," Adams said. "You are already short of cash, and that's why you've taken the loan. Payments are usually taken directly out of your paycheck which will also add to your monthly expenses."
The biggest problem arises if you are laid off or fired from your job which now classifies the money you received as an early distribution. Now you owe income tax on the amount you have not repaid, but you also pay a 10 percent penalty.
"It's the worst case scenario," Adams said. "People have a huge tax hit, no employment and no money working for them for their retirement."
Selling your unused items on eBay or other online marketplaces is a good idea to net extra income for things you no longer use, but the IRS has strict guidelines. Make sure you fill out form 1099-K to be compliant.
Any extra money you earned from a side job or part-time gig is also taxable, even if you just repaired someone's laptop, updated a company's website or babysat your neighbor's children. The official IRS stance is that all income is reportable, and there is no minimum amount that you aren't required to report.
"Independent contractors must report all income as taxable, even if it is less than $600," states the IRS.
Companies who give you the option to have your work-related expenses reimbursed are doing you a favor, said Mike Campbell, a tax partner at BDO USA, a Chicago-based tax and financial advisory firm.
"It is always a better result than deducting them on your own return," he said. "If the expenses are reimbursable by the employer, they shouldn't be included on your return and instead should be submitted for payment to you by your employer."
The law basically states that all "income" is taxable unless exempt by statute, so even if the income is not reported to you, it is still taxable, said Michael Damon, a CPA with Damon & Associates in Pembroke, Massachusetts. There are a variety of sources of income that taxpayers forget when filing their returns, include what you win from gambling in Vegas or at the racetrack.
"Gambling winnings are taxable in full unless you are a professional gambler," he said. "For non-professionals, gambling losses are reported as an itemized deduction."
Any money you spend looking for a job, preparing your taxes and obtaining investment advice are all good miscellaneous itemized deductions that taxpayers should not forget so they can get the most money from their refund.
Some deductions have a very high threshold before you can start receiving a tax benefit such as medical expenses or theft losses, said Paul Jacobs, a certified financial planner with Palisades Hudson Financial Group in Atlanta. Both of these items can only be deducted to the extent they exceed 10 percent of your adjusted gross income. If your income was $100,000 and you had medical expenses or a theft loss of $11,000, your deduction would be only $1,000.
"You can track these items as the year progresses, but you may not qualify for a benefit unless the amounts involved are substantial," he said. "Since the threshold for these items is so high, these are deductions that you typically should hope you'll never be able to claim."
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