Spring Cleaning: Which Financial Documents to Keep/Shred

The folks at the Internal Revenue Service have an uncanny sense of timing. Most of us prepare our individual tax returns just as the clocks spring ahead and the calendar says that the Vernal Equinox will bring longer and warmer days.

The folks at the Internal Revenue Service have an uncanny sense of timing. Most of us prepare our individual tax returns just as the clocks spring ahead and the calendar says that the Vernal Equinox will bring longer and warmer days. To celebrate, clean out the cobwebs, fire up the shredder, prepare to hit the delete button and get ready to clean up your financial life!

Here's a list that I have provided in the past of what you need to keep and for how long you need to keep it. If you have any question about whether or not to hang on to something, err on the side of being a hoarder. That said, in the digital age, you may find that you don’t have to cope with bulging files any more. In fact, maybe 2018 will be the year that you go paperless…once and for all!

Tax Prep 2016

Tax prep season is in full swing and the good news is that due to a local Washington DC holiday, the tax -filing deadline is April 18^th, rather than the traditional April 15th, so you will have an extra three days. That doesn’t mean that you should dawdle. In fact, there may be a good incentive to get your act together earlier this tax season: fraud prevention. Last year the IRS acknowledged that criminals had accessed IRS.gov to steal information on nearly 400,000 taxpayers and states are also on high alert, after the filing of fraudulent returns, which prompted TurboTax to halt e-filings. While the IRS announced several measures the agency says will prevent tax fraud, filing early may be your best bet to prevent others from trying to file a return in your name. Another anti-fraud tip to remember: the IRS never initiates contact with taxpayers about their accounts through e-mail, text messages or other social media. If you get an unsolicited e-mail claiming to come from the IRS, do not open attachments or click on any links and forward it to the IRS.

Whether you prepare your own returns or engage a professional, create a file called “2015 Taxes”. In it, put last year’s return, which will be your guide to what’s missing. Be on the lookout for tax documents that are rolling in, including 1099’s and W-2s and information from bank, investment/mutual fund companies and lenders should have all sent tax documents by mid-February. If you didn't receive them, they may be  available online. Gather your credit card summaries and review checking accounts for deductions, like charitable donations and job search costs.

This is the second tax season where you will need to tell the government whether or not you have health insurance. Taxpayers are not required to send the IRS information forms or other proof of health care coverage when filing their tax return. However, if you have coverage through the Marketplace and qualify for a premium tax credit, you must file a tax return with Form 1095-A to claim the credit and to reconcile any advance payments made on their behalf in 2015. A reminder, the penalty for not having health insurance has increased: it is the greater of $325 per adult or 2 percent of your taxable income. There are a number of exemptions - go to HealthCare.gov to see if you qualify.

Many of you have asked me whether or not you need to hire CPA. If you have a complicated financial life, you may want to pay up for a professional. For example, those who are self-employed may want someone who is familiar with Schedule C; who can advise on the best type of retirement plan to use; and who will let you know if you should file a Form 1099 to report any payments you made to others. Or if you had a lot of investment activity, sold property, have to file an estate tax return for someone else, or if you are one of the over 5 million taxpayers who are subject to Alternative Minimum Tax, you may want to guidance to help minimize the tax consequences. If this is the first year that you are hiring a tax preparer, make sure that he or she is legitimate -- use the IRS database to check on credentials.

Low-and moderate-income taxpayers should use the Volunteer Income Tax Assistance or and Tax Counseling for the Elderly, which is operated by the AARP Foundation’s Tax Aide Program. If eligible, you can get FREE help by visiting one of the more than 12,000 community-based tax help sites staffed by volunteers. To find the nearest site, use the IRS' VITA/TCE Site Locator.

If you are going it alone and your income is $62,000 or less, the IRS provides free tax prep software called “Free File”. If you don’t qualify, you are left with three main choices: Turbo Tax, H&R Block and Tax Act. Most tax preparers that I spoke to say that Turbo Tax may be the best bet, even though it costs more than its competitors. They cite Turbo Tax’s easier to use platform and the interface’s ability to save time and reduce errors.

Whether you prepare your own returns or hire a pro, be sure to e-file, because the IRS says that the the error rate for a paper return is about 20 percent, compared with an e-file return error rate of about one percent. And if you are due a refund, it will come faster if you e-file.

If you are worried about an audit, take heart in the fact that due to IRS budget cuts, audits of individual taxpayers fell to the lowest rate in 11 years. Less than one percent (0.84%) of individual taxpayers – just over 1.2 million individuals -- were audited in the 2015 fiscal year, the lowest level since 2004. That doesn't mean that you should go cray. The top audit red flags include: Not reporting income, a large change in income, being self-employed and taking higher-than-average deductions. And the highest earners, especially those with incomes of more than $1 million, are much more likely to be audited than everyone else. Just have plenty of back up records and documentation if you fall into one of these categories.

Attack Your Taxes: Deductions, Credits, IRAs

In a separate post, I outlined "What’s New for 2014 Tax Filing Season". Today, we return to tax basics, starting with tax credits, which provide a dollar-for dollar reduction of your income tax liability. Here are some of the most popular and widely available credits:

• The Child Tax Credit: Up to $1,000 for each qualifying child who was under the age of 17 at the end of 2014. This credit can be claimed in addition to the credit for child and dependent care expenses, but phases out for married couples earning over $110,000 ($75,000 for singles). (IRS Publication 972.)
• The Child and Dependent Care Credit: Available if you pay someone to care for your dependent that is under age 13, so that you can work or look for a job. The credit is 20 to 35 percent of your child-care expenses up to $6,000 -- the size of your credit depends on your income. (IRS Publication 503.)
• The Earned Income Tax Credit: A refundable credit for married couples with 2014 earned income under $52,427 and singles who made less than $46,997. The more children you have, the more money you receive. Your income and family size determine the amount of the credit, but the maximum credit is $6,143 this year. (IRS Publication 596.)
• The American Opportunity Tax Credit: A refundable tax credit for undergraduate college education expenses that was extended through December 2017. The credit modifies the Hope Credit for higher education expenses, making it available to a broader range of taxpayers, including many with higher incomes and those who owe no tax. The full maximum annual credit of $2,500 per student is available to individuals, whose modified adjusted gross income (MAGI) is $80,000 or less, or $160,000 or less for married couples filing a joint return.
• Lifetime learning credit income limits: In order to claim a lifetime learning credit, your MAGI must be less than $63,000 ($127,000 MFJ).

Deductions: Nearly two out of three taxpayers take the standard deduction rather than itemizing deductions. If your deductible expenses exceed the 2014 standard deduction limits of $6,200 for single and $12,400 MFJ, you should itemize and grab these write-offs:

• Miscellaneous deductions: Tax-preparation fees, job-hunting expenses, business car expenses, and professional dues are deductible if they total more than two percent of your adjusted gross income (AGI).
• Medical and dental expenses: You can deduct only the part of your medical and dental expenses that exceed 10 percent of your AGI or 7.5 percent if either you or your spouse is age 65 or older.
• Standard mileage rates: The rate for business use of your vehicle is 56 cents per mile. The rate for use of your vehicle to get medical care or move is increased to 23.5 cents per mile. The rate of 14 cents per mile for charitable use is unchanged.

Tax time also means scrambling to make contributions to Individual Retirement Accounts (IRAs). As a reminder, when you contribute to a traditional IRA, you will snag a tax deduction right now, but will pay tax on the money when you withdraw it during retirement. With a Roth, you are not entitled to a tax deduction today, but when you withdraw the money later, there is NO tax due.

For tax year 2014, your total contributions to all of your traditional and Roth IRAs cannot be more than: $5,500 ($6,500 if you’re age 50 or older), or your taxable compensation for the year, if your compensation was less than this dollar limit. One last note: If you're covered by a retirement plan at work, you may also be able to deduct contributions to an IRA, subject to income limits (single: $60,000-$70,000, MFJ $96,000-$116,000).

Tools/Info: The IRS provides free tax prep software (“Free File”) to taxpayers whose incomes are $60,000 or less; electronic e-filing is available to all taxpayers, regardless of income; and the IRS2Go mobile app or the Where’s My Refund? tools allow you to track refunds within 24 hours after the IRS has received an e-filed return or within four weeks after you have mailed a paper return.

Volunteer Income Tax Assistance and Tax Counseling for the Elderly (VITA/TCE): Low-and moderate-income taxpayers can get help for free by visiting one of the more than 12,000 community-based tax help sites staffed by more than 90,000 volunteers. To find the nearest site, use the VITA/TCE Site Locator.