Filing taxes can be an overwhelming and confusing process: how do you know what deductions and credits are available to you? Should you file on your own or work with an accountant? And how does working remotely and investing in cryptocurrency impact tax returns?
With Tax Day approaching on April 18, Stephen Schiestel, Frederick S. Addy Professor of Practice in finance in the MSU Broad College of Business, explains the basics of tax filing and offers some tips to help you get the most out of your tax return.
What is a tax return?
A tax return is a series of forms that report income and expenses. They are filed with a tax authority: the Internal Revenue Service, or IRS, for the federal government. There are also state taxes and, in many cases, local taxes.
Taxes are an important source of revenue for governments. At the federal level, over 50% of revenue is collected from individual tax returns. That’s probably why taxes are talked about every single year by politicians both sides of the aisle.
What are some common mistakes people make when filing their taxes?
Tax codes are complicated. If you don’t know what the rules are or are unaware of opportunities that are in the tax code that may benefit you – either through credits or deductions – you could be paying more in taxes than you need to.
Filing at the last minute is also a common mistake. Being rushed can raise the probability of missing out on opportunities that benefit you. If you end up filing after the deadline, you’ll need to pay a penalty.
Filing too early can result in issues as well. If you’re really on top of things and just want to get your taxes out of the way, that’s great; however, you need to make sure you have received all the required documentation, such as W2s and 1099s. Proceeding without accurate documentation will result in an incorrect tax return and cause you more harm than good.
What is the difference between a tax deduction and a tax credit?
A tax credit is a dollar-for-dollar reduction in the amount of tax that you owe. A deduction reduces your taxable income and, therefore, lowers your tax bill. For example, say I’m in a 25% tax bracket. A $100 tax credit will give me $100 back while a $100 deduction is going to reduce my taxes by $25.
Deductions are useful, but credits are more powerful.
What are some common tax credits?
- Child tax credit, which is available to parents who list their child(ren) as dependents, meaning the children rely on the parents to support them monetarily. These child(ren) must live with their parents at least half of the time and be under 19 years of age (if not a full-time student), be under 24 years old if they are a full-time student or have a permanent disability that requires them to be under their parents’ care.
- American opportunity tax credit, which provides a $2,500 credit for qualified tuition expenses, school fees and course materials for taxpaying students or parents who claim their child(ren) attending school as dependents.
- Lifelong learning credit, which provides up to $2,000 for qualified tuition and related expenses paid for eligible students enrolled in an eligible educational institution. There is no age limit on claiming this credit.
- Environmental tax credits, which are incentives offered for installing solar panels, buying an electric vehicle or other efforts that reduce CO2 emissions or help create clean power.
What are some common tax deductions?
- Individual Retirement Account, or IRA, contributions can reduce your taxable income by up to $6,000.
- Health Savings Account, or HSA, contributions that you, or someone other than your employer, make to your health savings account can qualify you for tax deductions.
- Charitable cash contributions made to qualifying organizations (limited to a percentage of your adjusted gross income) may qualify for an itemized deduction.
- Home office expenses may qualify for an itemized deduction for individuals who use their home as their primary place of work.
What is the difference between an itemized deduction and a standard deduction?
For most people, the standard deduction works best. It’s about $13,000 for a single filer and almost $26,000 for a married couple filing jointly.
To itemize deductions, which can include things like charitable donations, home office supplies, mortgage payments, interest expenses, property taxes and medical expenses, you have to fill out a Schedule A form. Itemizing your deductions makes sense if you think your deductions would add up to more than $13,000 for a single filer or $26,000 for a married couple filing jointly. But in most cases, the standard deduction is the way to go because the limits are so high.
What are some responsible ways to use your tax refund?
It’s tempting to use your tax refund for something fun, such as booking a vacation. But my recommendation is to put it toward your retirement fund, pay down debt or save for the future.
a person or family consistently receives large returns, it might make sense to reevaluate the amount of money you’re withholding. It might be best for you to adjust withholdings and keep more income on a paycheck-by-paycheck basis. Some people love getting large returns, but it’s also like you are giving an interest-free loan to the government throughout the year.
What are the pros and cons of doing taxes on your own versus working with an accountant?
Doing your own taxes is fairly inexpensive: you can file them online for free or pay for a service. You also have control over the filing process – you can complete them whenever you want prior to the filing deadline without the hassle of getting on an accountant’s calendar.
However, if you file taxes on your own, you risk making a filing mistake or missing out on some credits and deductions. Tax accountants are experts in tax code and can help you take advantage of these opportunities, as well as help you avoid other mistakes. It’s also best to work with an accountant if you own your own business, do gig work or have a complex financial situation that requires professional expertise.
How does working remotely affect how you file taxes?
Working remotely can benefit the employee from a tax perspective, especially if you live in an area without a city tax. For example, say you work at Michigan State University, and you split your time between an on-campus office and working from home. You are only required to report the taxable income associated with the percentage of time you’re physically working in East Lansing. So you would divide your income based on the percentage of time worked in East Lansing and report that amount to the city.
If you invested in cryptocurrency, how do you report it on your tax return?
Cryptocurrencies are considered a security, just like a stock or a bond. As a result, if the value increases over the purchase price, the gain is taxed at the more favorable capital gains rates when it is sold.
If you bought crypto last year and it lost money, you can offset up to $3,000 of your ordinary income with this loss. If you lost $50,000 on crypto, you can only claim up $3,000 of it, and then you defer the balance of $47,000 to subsequent years. It could take a while to claim the full loss unless you have other gains that can offset it.
What are capital gains and capital losses?
An example of a capital gain is if I paid $100 for a stock and sold it at $200, the gain on that investment is $100. If I bought a stock for $100, and sell it at $50, the capital loss is $50.
There are short-term gains and losses and long-term gains and losses. A gain becomes long-term if the asset is held for at least one year. If you need to take gains, the tax code has preferential tax rates for long-term capital gains. So, if I buy a stock, hold it for a year or more, then sell, I get much lower tax rates on that gain. If the investment is not held for a year, then it’s considered short-term and it’s taxed at ordinary tax rates.
What should people pay attention to as they start to think about next year’s taxes?
Getting organized is always key. Keep track of your expenses. Whether you’re doing your own taxes or enlisting the help of an accountant, it helps to have a list of charitable contributions, medical expenses and other deductions readily available, especially if you think they will exceed the standard deduction.