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Income Tax Guide for 2020
Tax time is drawing near once again and April 15 comes up, it’s important to take note of all of the changes — big and small — that will affect returns this year. As you prepare, this comprehensive income guide for 2020 can provides the basics you need to know from tax forms to credits to deductions for the 2019 tax year. Plus, dig deep into topics like what you can do if you can’t pay your taxes by the deadline and what happens if you don’t file on time. It can be hard to navigate through the many pages of the tax code or IRS website so here you have all you need to know in one convenient place.
The 3 Best Tax Software Services for 2021
The basics of income tax
Depending on your filing status and yearly income, you may not be required by law to file a return with the IRS. However, even if you don’t have to file, it may still be in your best interest to submit a tax return. You may not owe any income taxes but you might be eligible to receive a refundable credit.
If your income for the year is above a certain amount, you must file a federal income tax return. This amount for which you are liable is dependent on several factors, including your age and the type of income you received. For instance, for the 2019 tax year, a single, independent adult under the age of 65 must file a return if they earned $12,200 or more gross income during the year.
Improperly filing your taxes could end up costing you more than you owe. Worse yet, it could even trigger a dreaded IRS audit. Correctly filing your taxes on time can ensure you receive the amount owed to you by the IRS and avoid paying any penalties. And by utilizing the numerous credits, write-offs and other benefits available to certain taxpayers, you can maximize your refund or even reduce the amount you owe. These are the basic ideas to keep in mind to get started.
Calculate your gross income: If you’re going to do your taxes on your own, start by figuring out your gross income (GI). This is the total amount of money you’ve made in a year from all sources: wages, dividends, gifts, alimony, etc. If you’re going to let a professional handle your taxes, it’s still a good idea to know how much you’ve made, but your tax professional can help you through the process.
Calculate your adjusted gross income: After you’ve determined your gross income, determine your filing status and which tax forms you’ll use. Your filing status is based on family and marital status and will determine your standard deduction, which is a set amount you can deduct from your gross income. Subtracting the standard deduction from your gross income will provide you with your adjusted gross income (AGI).
Calculate your taxable income: Some individuals are eligible for exemptions that can bring their AGI even lower. Once you or a tax professional determine the tax credits and deductions you qualify for, you’ll be able to find your taxable income. In many cases, deductions and credits can take your taxable income to zero, resulting in refunds from the IRS.
There are some sources of income that are usually not taxable. Types of income that are exempt from tax include:
- Child support payments
- Welfare benefits
- Gifts, bequests, and inheritances
- Awards for damage from personal injury and illness
- Cash rebates from manufacturers
- Reimbursements for qualified adoption expenses
There are other forms of income that are usually not taxable except in specific instances:
- Life insurance payouts are typically not taxable. However, if you redeem the policy for cash, any amount that exceeds the cost of the policy is taxable. Early withdrawals are also taxable.
- Scholarship payments used for tuition and course textbooks are not taxable, but payments used for room and board are
Modified adjusted gross income: Your AGI is used to calculate your modified adjusted gross income (MAGI), which the IRS uses to determine eligibility for certain deductions and credits. This figure is equal to your AGI plus any nontaxable sources of income, such as tax-exempt forms of interest earned or income from foreign investments. For many individuals, their MAGI won’t differ much from their AGI. However, things such as student loan interest, tuition, rent losses, and retirement contributions can all have an impact.
How to file taxes
There are three main ways to file your income tax: through the mail, electronically via tax-preparation software like TurboTax or through a tax professional. The deadline for filing is April 15 unless you request and are approved for a six-month extension which pushes the date to Oct. 15. No matter the method you choose, you’ll need to fill out a Form 1040, 1040-EZ, or 1040-A with the necessary information.
Paper filing is the traditional way of preparing taxes, and many people are still more comfortable handling financial information with pen and paper. This method of filing takes longer for the IRS to process, so returns are slower to arrive. The completed 1040 must be mailed to one of several addresses, depending on your location and whether or not you have included a payment.
Tax preparation software is the preferred DIY way of handling taxes. Most software is designed to make taxes easier and will help the user identify available tax deductions and credits they might otherwise miss. Built-in databases are usually updated each year to help you remain on top of changes in tax law.
Tax professionals handle your tax returns for you. Hiring an accountant or going to a professional company takes the work out of your taxes and removes the burden from your shoulders. Of course, the tradeoff is you must pay for the service, as well as provide all of your personal financial information to a stranger.
Unless you use the paper filing method, your taxes will be submitted electronically. Electronic submissions are typically safer and see a much faster return than paper submissions.
What happens if you file late
If you missed the April 15 tax-filing deadline, and you owe taxes, there will usually be penalties to pay. If you are owed a refund, you won’t be penalized for filing late. However, you must file a return within three years, or the government will keep your refund.
For those who owe the government money, there are two types of penalties: the failure-to-file penalty and the failure-to-pay penalty.
The penalty for filing late is equal to 5% of the taxes you owe each month that you don’t file, up to 25%. After 60 days, the minimum penalty for returns to be filed in 2020 will be $435 or equal to 100% of the tax amount due (whichever amount is less).
The penalty for paying late is 0.5% of the amount of taxes due, up to 25%. You may still incur this penalty if you applied for an extension of time to file. If the tax remains unpaid for more than 10 days after receiving a notice on the IRS’s intent to levy, the penalty rate increases to 1% and if you get on an installment plan, it decreases to 0.25%.
Interest is also charged on any amount of taxes that haven’t been paid by April 15. The interest rate is the current Short-term Applicable Federal Rates (AFR) plus 3%. For example, the interest rate for the first quarter of 2020 is 5%.
How to file taxes if you can’t pay what you owe
Always file your taxes as soon as possible, even if you can’t pay what you owe. By simply filing your taxes, you avoid a bevy of fees and penalties that will be even harder to pay back.
However, if you can’t pay, you still have options.
“The IRS Official Policy is to collect all possible collectible taxes, interest, and penalties. However, IRS Tax Debt Forgiveness Programs are aimed at tax debt deemed uncollectible or on which collection is doubtful.,” explains enrolled agent Steven J. Weil, Ph.D. and president of RMS Accounting.
He adds, “These programs include extensions of time to pay, installment agreement, currently not collectible status and offers in compromise.” If you can’t pay immediately, one of these programs may be able to help you.
Apply for an extension of time to pay by submitting Form 1127 if you can demonstrate that paying the full amount of taxes you owe would cause “undue hardship.” According to the instructions on the form, undue hardship must be “more than an inconvenience,” and must result in a “substantial financial loss.” The example given is if the on-time payment forced you to sell a property at a “sacrifice price.” The maximum amount of time that is typically granted is six months. If your application is accepted, you won’t have to pay a penalty for late payment, but you will still be charged interest.
Set up an installment agreement if you don’t qualify for an extension to pay – this means that you agree to pay a certain amount every month until the tax amount that you owe is paid in full. You can choose from a short-term agreement (repay the debt in 120 days or less) or a long-term agreement (repaying the debt in more than 120 days). Keep in mind that there are fees associated with setting up some of the agreements and you will continue to be charged interest on the amount that you owe.
If you owe less than $50,000, you can file an installment agreement online. Short-term agreements have no set-up fees while long-term agreements cost $149 if you pay manually each month or $31 if you set up automatic withdrawals. The appropriate fee will be added to your tax bill if you select this option.
Currently not collectible status may be an option if you can prove to the IRS that you can’t pay anything. The IRS can place your account in a temporary “currently not collectible” status and collection attempts will pause.
Offer in Compromise: In rare situations, you may be able to settle your debt for less than the total amount that you owe to the IRS. If you can’t pay (based on income and allowable expenses) and there is little likelihood that you will be able to pay before the collection statute expires, or you are only able to pay a small amount that will never settle the balance owed, an ‘Offer in Compromise’ might be right for you. However, you can’t use this avenue while holding onto assets that have equity and could be liquidated to pay what you owe. Further, if you qualify, it also requires you to commit to paying all taxes when due for the next five years. Any breach in your agreement to file and pay on time can bring the debt right back at you.
Request an abatement or refund of interest charges or fees due to an error made by the IRS or another cause that is either “reasonable” or allowed under the law by filing Form 843. You must have a solid reason to use this form. A summary of the typical reasons for filing this form can be found in the instructions for Form 843.
Consider a low-interest loan if you can secure a lower interest rate than would be charged by the IRS. For instance, some credit cards come with a 0% introductory APR for a certain period of time. Be sure to check with the issuer to verify that the card can be used to make a tax payment, as not all credit card companies will allow that type of usage.
Note that all of these options are available directly to you. However, you may encounter tax relief firms that make you big promises to relieve you of your tax problems. Weil warns, “Don’t be fooled into thinking that a tax relief firm can just make your debt go away or settle for pennies on the dollar. This can only happen if you just don’t have the income, assets, and ability to borrow to make required payments.”
If you have further questions about what options may be available for you if you can’t afford to pay your taxes, you can visit IRS.gov or call 800-929-1040. If you cannot resolve your issues by speaking with an IRS representative, you can seek additional help from the Taxpayer Advocate Services.
How income tax is calculated
The United States has a progressive income tax scale. The more money you make, the more you’ll pay in taxes. However, earning a high wage doesn’t mean your entire income will be taxed at the same rate because the progressive income tax scale uses marginal tax rates to determine how your taxes are calculated.
To better understand how your income is taxed, imagine your taxable income is divided into sections. The first section is taxed at one rate, then the next section is taxed at a higher rate, and the section after that is taxed at an even higher rate, and so on. These different portions are called tax brackets. There are seven different tax brackets, and their rates differ based on your filing status (see below for tables of each filing status and their respective marginal tax rates).
Marginal tax rate is best defined as the amount of tax you pay on an additional dollar of income and the United States uses multiple increasing rates for specific ranges of income. For example, a single person will pay a marginal tax rate of 24% on $91,900 in 2020 for the 2019 tax year. However, that’s only on their last bit of income; it is broken down further. They pay 10% on the first $9,700 earned, $970 plus 12% on taxable income over $9,701 and up to $39,475, $4,543 plus 22% on amounts over $39,475 and up to $84,200 and $14,382.50 plus 24% on amounts over $84,201 and up to $160,725. So only $7,699 of the $91,900 is taxed at the 24% marginal tax rate.
Effective tax rate is the percentage of your taxable income that you pay in taxes. Take the above example; if that single person pays a total of $16,230.26 in taxes, divide that by $91,900 and you get 0.176, or a 17.6% effective tax rate.
State income tax
State income tax is required alongside federal income tax, but can often be deducted from federal taxes. State income tax varies widely among states.
There are seven states that don’t tax income: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. New Hampshire and Tennessee both don’t tax wages but do tax money made on investments and other forms of income.
The three states with the highest income tax rates in 2019 are California with 13.3%, Hawaii with 11%, and Oregon with 9.9%.
The three states with the lowest income tax rates in 2019 are Pennsylvania with 3.07%, North Dakota with 3.22% and Indiana with 3.40%.
The five filing statuses
There are five different marital statuses you can choose when filing: single, married filing joint, married filing separate, head of household and qualifying widow(er) with a child.
To file as single, a person must be unmarried, divorced, or legally separated on December 31 of the tax year with no qualifying dependents. The standard deduction for the 2019 tax year for a person filing is $12,200.
|Single Filer’s Income||Tax Due|
|$0 – $9,700||10%|
|$9,701 – $39,475||12%|
|$39,476 – $84,200||22%|
|$84,201 – $160,725||24%|
|$160,726 – $204,100||32%|
|$204,101 – $510,300||35%|
Married Filing Jointly
If you are married by December 31st of the tax year, you can file your taxes with your spouse. However, this is not required. Married couples can file separately from one another but it is often less beneficial than filing together. The standard deduction for the 2019 tax year for couples filing jointly is $24,400.
|Married Filing Jointly Income||Tax Due|
|$0 – $19,400||10%|
|$19,401 – $78,950||12%|
|$78,951 – $168,400||22%|
|$168,401 – $321,450||24%|
|$321,451 – $408,200||32%|
|$408,201 – $612,350||35%|
Married Filing Separate
Married filing jointly usually yields better returns, but not always. In instances where unique tax situations may result in more taxes owed, a couple might choose to file separately from one another. The standard deduction for someone filing separately from their spouse for the 2019 tax year is $12,200.
|Married Filing Separate Income||Tax Due|
|$0 – $9,700||10%|
|$9,701 – $39,475||12%|
|39,476 – $84,200||22%|
|$84,201 – $160,725||24%|
|$160,726 – $201,100||32%|
|$204,101 – $306,750||35%|
Head of Household
You may file as head of household if you are unmarried and have paid for more than half of the upkeep and maintenance of your home in the past year. You must also have one or more qualifying dependents. The standard deduction for filing head of household for the 2019 tax year is $18,350.
|Head of Household Income||Tax Due|
|$0 – $13,850||10%|
|$13,851 – $52,850||12%|
|$52,851 – $84,200||22%|
|$84,201 – $160,700||24%|
|$160,701 – $204,100||32%|
|$204,101 – $510,300||35%|
Qualifying Widow(er) With Child
You may file as a qualifying widow(er) with a child if your spouse has died in either of the previous two tax-filing years if you haven’t remarried and you have a child. The standard deduction for the 2019 tax year for a qualifying widow(er) with a child is $24,400.
|Widow With Child Income||Tax Due|
|$0 – $19,40||10%|
|$19,401 – $78,950||12%|
|$78,951 – $168,400||22%|
|$168,401 – $321,450||24%|
|$321,451 – $408,200||32%|
|$408,201 – $612,350||35%|
Common tax forms you need to know
Aside from the W2 and 1040, there are multiple other tax forms you are likely to encounter when filing your taxes. While you don’t need to know the specifics of each form, a surface-level familiarity with them will help you understand which form to use when.
|Tax Form||Details||Example Download Link|
|W2||The W2 is the primary employer-issued tax form. If an employer paid you wages of more than $600 from which income, social security, or Medicare was withheld, you will receive a W2.||W-2|
|W-2G||Form W-2G is the “Certain Gambling Winnings” form. It is used to report gambling winnings and any taxes withheld on those winnings. If you have won a significant sum from any gambling institution, you’ll receive a W-2G.||W-2G|
|1040||Form 1040 is the “U.S. Individual Income Tax Return.” It’s the primary form used by individuals to file their income tax returns with the IRS, although there are two variants: the 1040EZ and the 1040-A. The first page of the 1040 collects information on the taxpayer, any dependents, income, and adjustments to income. The second page shows deductions and credits and taxes due.||1040|
|1040EZ||The 1040EZ is a simplified version of the 1040 that consists of only six sections known as the “Income Tax Return for Single and Joint Filers With No Dependents.” Only taxpayers with taxable income below $100,000 who take their standard deduction can file with the 1040EZ.||1040EZ|
|1040A||The 1040A is a shortened version of the 1040, but is still more complex than the 1040EZ. Its nickname is “the short form.” The 1040A has the same usage requirements as the 1040EZ.||1040A|
|1099-MISC||The 1099-MISC is similar to a W2 in that it is provided by employers, but to independent contractors who have earned at least $600 over the course of the year in rent, services performed, prizes and awards, medical and health care payments, crop insurance proceeds, cash payments for fish or other aquatic life, payments to an attorney, and more. This form is also given to individuals who have earned at least $10 in royalties or broker payments.||1099-MISC|
|1099-DIV||Form 1099-DIV is used to report ordinary dividends, total capital gains, qualified dividends, non-taxable distributions, federal income tax withheld, foreign taxes paid, and foreign source income from investments held by fund companies.||1099-DIV|
|1099-INT||Form 1099-INT shows interest income from the previous tax year such as that paid from savings accounts, interest-bearing checking accounts, and US Savings bonds. The form is issued by banks, brokerage firms, and other financial institutions.||1099-INT|
|1099-G||1099-G is the “Certain Government Payments” form. It’s used to report unemployment compensation, state or local income tax refunds, credits, offsets, reemployment trade adjustment assistance (RTAA) payments, taxable grants, and/or agricultural payments.||1099-G|
|SSA-1099||The SSA-1099 reports any social security benefits earned, including retirement benefits, disability benefits, and survivor benefits. Depending on a variety of factors, social security benefits may or may not be taxable. There are two variants of the SSA-1099: the SSA-1099-R-OP1 and the SSA-1099-SM. These forms are handled exactly like an SSA-1099.||SSA-1099|
|1098-T||Form 1098-T is known as the “Tuition Statement.” It is used to determine potential education credits, tuition and fee deductions, and other benefits for qualified tuition expenses. This form enables credits like The Lifetime Learning Credit, the American Opportunity Credit, and others.||1098-T|
|1098-E||This form is known as the “Student Loan Interest Statement.” Like the name implies, this form displays the amount of interest paid on student loans during the previous tax year. These interest payments are often deductible from your federal tax return, which can lower the amount of taxable income you’re liable for.||1098-E|
|1095-A||Form 1095-A is the “Health Insurance Marketplace Statement.” If you purchased health insurance through one of the Health Care Exchanges, you will receive one of these forms showing the necessary information for you to obtain the Premium Tax Credit, a benefit introduced with the Affordable Care Act to offset the cost of healthcare.||1095-A|
Income tax calculator
To help you cut through all the tax talk and figure out what you owe, The Simple Dollar has built a simple income tax calculator to help you figure out your bottom line.
To use it, simply select your state of residence and tell us what your gross income is for the year. Next, select whether you’ll be choosing a standard deduction or itemizing. Finally, tell us whether you’re married, and if so, whether you’re filing separately or jointly. If you’re filing jointly, we’ll also need to know your spouse’s gross income.
Once you input that info, you’ll be able to see our estimates for what you’ll owe in federal income tax, state income tax (if applicable), and your expected take-home earnings.
Tax credits and how to save money on your return
The purpose of filing your taxes is to reduce the amount of taxable income you’re liable for. You can reduce your taxes by investing in retirement savings accounts, contributing to health savings accounts, using tax credits and itemizing.
Retirement savings accounts
A retirement savings account is similar to a traditional, Roth, or Simple IRA. Contributions to these plans are often tax-deductible, although the amount is based on your filing status and your MAGI.
Health Savings Accounts and Flexible Spending Accounts
Health savings accounts (HSAs) and flexible spending accounts (FSAs) are both set up via employers. Employees can contribute a portion of their income to these accounts before taxes are deducted (pre-tax) resulting in significant income tax savings. HSAs roll over into the next year if the contributions are not used, unlike FSAs.
If you have a particularly high number of expenses, you can often itemize deductions and receive more than if you had taken the standard deduction. This is useful for self-employed individuals who spend thousands each year on transportation, office expenses and more.
Tax deductions versus tax credits
There are a few basic differences between tax credits and tax deductions. Tax credits provide a dollar-for-dollar reduction of your income tax liability. This means that a $1,000 tax credit saves you $1,000 in taxes. On the other hand, tax deductions lower your taxable income and they’re equal to the percentage of your marginal tax bracket. Tax credits, as a rule, are nonrefundable; they reduce your overall liability. However, there are “refundable” tax credits that will get you a tax refund once your liability drops to zero. Tax deductions lower your taxable income as calculated by your marginal tax rate.
Here’s a look at some of the tax deductions for the 2019 tax year.
State and local taxes: You can take deductions for amounts you’ve paid to state and local income, sales and property taxes up to $10,000 ($5,000 if you are married filing separately).
Home mortgage interest: You can deduct up to $750,000 ($375,000 if married filing separately) of interest on acquisition indebtedness.
Charitable donations: You can deduct up to 60% of cash donations to public charities for the 2019 tax year.
Personal casualty losses: You can deduct losses attributable to a federal disaster.
Student loan interest deduction: Deduct up to $2,500 in student loan interest paid in 2019 if your MAGI was below $85,000 ($170,000 for joint returns). Note the phaseout starts for taxpayers with MAGI of $70,000 ($140,000 for joint returns).
Medical and dental expense deduction: Deduct medical and dental expenses that exceed 10% of your AGI.
Tax credits reduce the amount you owe. Like the deductions above, this is a list of the most common credits, but not an exhaustive list.
American Opportunity Credit
The American Opportunity Credit is an education credit available to a parent or spouse of a student. If no one claims the student as a dependent, then the student can claim the credit for themselves.
Who is eligible?
A student must be pursuing a degree, have no felony convictions, have been enrolled for at least one academic term and must not have previously claimed the AOTC credit for more than three years. To gain the full credit, the person claiming it must have an MAGI under $80,000 if filing single or $160,000 if married filing jointly. If your MAGI exceeds $90,000 ($180,000 for married filing jointly), you won’t qualify for any credit.
The AOTC is one of the more beneficial credits because it allows taxpayers to claim all of the first $2,000 in qualified education expenses per year, per student. It also allows taxpayers to claim 25% of the next $2,000 education expenses per year, per student. Further, the credit is 40% refundable– up to $1,000.
How to apply
To apply for the American Opportunity Credit, you will need to fill out Form 8863, titled “Education Credits.” You’ll need a copy of your Form 1098-T, as well as a list of all qualifying education expenses, to properly fill out Form 8863.
Lifetime Learning Credit
The Lifetime Learning Credit is an education credit available to a parent or spouse of a student. If no one claims the student as a dependent, then the student can claim the credit for themselves.
Who is eligible?
Anyone taking courses at an eligible institution to improve their job skills, obtain a degree, and is enrolled for at least a single academic period is eligible for the Lifetime Learning Credit. However, if you claim the Lifetime Learning Credit, then you cannot claim the American Opportunity Credit. For full credit, your MAGI must be below $58,000 if filing single or below $116,000 if married filing joint.
The Lifetime Learning Credit allows you to claim 20% of your first $10,000 in qualified education expenses. Unlike the American Opportunity Credit, it’s not refundable; once your tax liability reaches zero, the credit no longer has any benefit.
How to apply
To apply for the Lifetime Learning Credit, you will need to fill out Form 8863, titled “Education Credits.” You’ll need a copy of your Form 1098-T, as well as a list of all qualifying education expenses, to properly fill out Form 8863.
Earned Income Credit
Earned Income Credit, commonly abbreviated as the EIC, is a credit available to low to mid-income working individuals, especially those with children. Also, there are other stringent requirements to qualify for the EIC: you must not have any foreign investments, you must have earned at least $1 and your 2019 tax year investment income must be below $3,600.
|Filing Status||No Children||1 Child||2 Children||3+ Children|
|Single, Head of Household, or Widowed||$15,570||$41,094||$46,703||$50,162|
|Married Filing Jointly||$21,370||$46,884||$52,493||$55,952|
Child Tax Credit
The Child Tax Credit was designed to offset the cost of raising children. To qualify for this credit, you must have a dependent who is under the age of 17 on December 31 and is a United States citizen. The child must be related to you. Also, the dependent must have lived with you for half the year (183 nights) and not provided more than half of their support. The Child Tax Credit can be worth as much as $2,000 per child. Up to $1,400 of the credit can be refunded for each child. However, the credit begins to phase out once you reach a MAGI of $200,000 ($400,000 for married filing jointly).
Child and Dependent Care Credit
If you paid someone to take care of your child (under the age of 13) while you were at work or school, you might be eligible for the child and dependent care credit. This credit is available to all those who earned income (or are disabled and unable to work), have a qualifying dependent and paid someone to provide care for a qualifying person. The total expenses used to calculate the credit can’t exceed $3,000 for one qualifying person ($6,000 for two). Also, this credit is not refundable.
Saver’s Tax Credit
The Saver’s Tax Credit, otherwise known as the Retirement Savings Contributions Credit, is a special break created for low to mid-income individuals saving for retirement. If you qualify, you can claim 50%, 20%, or 10% of the first $2,000 you put into a qualifying retirement account ($4,000 if married filing jointly). The credit maxes out at $1,000 ($2,000 if you are married filing jointly). The amount you can claim depends on your income. Single filers with a MAGI over $32,000 won’t qualify (and a married couple filing jointly with a MAGI over $64,000).
Energy and Appliance Tax Credits
If you have made improvements that make your home more environmentally friendly and energy-efficient, then you may qualify for a tax credit on the cost of those upgrades. Homeowners can receive a credit equal to 30% of the cost of qualified energy-efficient improvements in 2019 such as solar electric systems and water heaters, wind energy equipment, and geothermal heat pumps. Those hoping to utilize these credits should get written certification from the manufacturer stating that their product qualifies for a tax credit. This information may be found on the company’s website or the product’s packaging and should be kept with your tax records. Also, note this credit is planned to phase out after 2019 and cease after 2021.
Tax-free tuition savings plans
Tax-free tuition plans are a way for people to save money for future education expenses. In most cases, distributions from these savings plans are tax-free. These earnings can also continue to grow without being taxed if used for qualified expenses.
Qualified Tuition Program
Qualified Tuition Programs (QTPs) are sometimes called Section 529 plans. These programs allow contributors to prepay education expenses, or to place money into an account that will be used to pay for education in the future. While there are no tax benefits for contributing, any money placed in the account will continue to grow tax-free. QTP earnings are not taxable unless the funds are used for non-qualified education expenses.
Coverdell Education Savings Account
The Coverdell Education Savings Account (ESA) is a trust fund. Each account is paid out to a beneficiary. In most cases, the beneficiary must be under 18; however, those with special needs may also qualify. Contributions to an ESA are not tax-deductible, and you cannot contribute more than $2,000 per year. Distributions are tax-free unless used for non-qualifying expenses.
Education exception to additional tax on early IRA distributions
In most cases, you can’t withdraw funds from an IRA before the maturation date without an additional 10% penalty. However, for certain qualified education expenses, this penalty may be waived—but all normal taxes for IRA withdrawals will still apply.
Education savings bond programs
You may be able to exclude the interest from Series EE and Series I bonds issued after 1989 if you use these for qualified education expenses. This benefit can only be claimed fully by taxpayers with an MAGI of less than $$81,100 if filing single, or $121,600 if married filing joint. To claim this, you would fill out IRS Form 8815: “Exclusion of Interest From Series EE and I U.S. Savings Bonds Issued After 1889.”
Scholarship funds used for qualified education expenses are usually considered tax-exempt, but only if they meet eligibility requirements. The amount received must be less than or equal to a student’s qualified education expenses, the scholarship must not be designated for non-qualified expenses like room and board, and it must not be repayment for services such as teaching.
Scholarships granted for research, travel, room, and board, clerical help or equipment are not tax-free.
Other potential tax breaks for students
If you’re a student, there are numerous potential tax breaks you may be eligible for. Remember that tax breaks are often like scholarships: many go unclaimed simply because people don’t know they exist.
Student loan cancellation
Student loan cancellation normally counts as income; however, if your loan contains a provisional clause that the debt will be canceled if you meet certain conditions, it may not be taxable. The loan must be a qualified loan from a qualified lender used to attend an eligible educational institution.
A refinanced loan may be a tax break if it is made from a qualified educational institution or tax-exempt organization to encourage students to work in a specific area. For a refinanced loan to qualify, the one receiving the loan must be provided services for a governmental unit or a tax-exempt 501(c)(3).
Student loan repayment assistance
According to the IRS, loan repayment assistance granted by the National Health Services Corps Loan Repayment Program is tax-free.
Potential military and veteran tax breaks
Tax law is heavily based on the state a person resides in. Because military personnel often live all over the country at different points in the year, their tax situations can be particularly tricky and complicated.
The ROTC program sometimes grants education and subsistence allowances for students enrolled in the program. These allowances are exclusions and are therefore not taxable on your income tax return.
VA Education Benefits
Veterans Affairs benefits provided for things such as subsistence, training, and education are tax-free. However, there may be limits to how far this benefit extends.
Service Academy Cadets
If a cadet or midshipman at a military service academy is paid, this is generally considered personal income and is therefore not tax-exempt. However, certain circumstances may make payment for services exempt.
Potential homeowner tax breaks
Home mortgage interest
If you took out a mortgage to finance your home, some of those associated monthly expenses can be deductible if you decide to itemize your deductions. Typically, any interest payments on a mortgage for a main or second home are deductible as long as the mortgage balance is below $750,000 (or $375,000 if married filing separately) and was strictly used to buy, build or make improvements.
Property tax deductions
Homeowners must often pay annual taxes to local and state governments on the value of their property. In 2019, you can deduct up to $10,000 ($5,000 if you are married filing separately) worth of property taxes, state and local income taxes and sales tax.
Mortgage insurance premiums
Mortgage insurance premiums paid or accrued on a mortgage issued after 2006 may qualify for inclusion as itemized deductions. Mortgage insurance premiums associated with funds provided through the Department of Veterans Affairs, the Federal Housing Administration, the Rural Housing Service or qualified private providers are all eligible for deduction. However, this deduction begins to phase out if your MAGI is over $100,000 and completely phases out above $109,000.
Advice on tax preparation
Filing your taxes doesn’t have to be a nightmare. Despite the forms, deadlines and endless numbers, tax preparation can be a rather simple process if you approach it the right way.
Guard against tax identity theft
Tax identity theft (often called tax fraud) has increased in recent years. Thieves will take your name, your social security number and your date of birth and use them to file a tax return in your name. When you file your return, the IRS will kick it back to you—and leave you with a long, lengthy process to correct the situation.
Criminals can get this information from wallets, internet phishing schemes, even misplaced hospital bills. You can take steps to lower your risk. Shred bills when you are finished with them, only browse trustworthy websites, and never enter your personal information online unless you are using a reputable site.
Choose a tax company with year-round access
Ask yourself: what would you do if audited? Many professional tax preparers offer assistance in handling the IRS in these situations. H&R Block, for example, sells additional “Peace of Mind” insurance which means all you have to do is turn over your audit letter to them and the company will handle it. Tax companies that close at the end of the tax season are unable to provide services like this, as audit letters often arrive in the weeks following the April 15 deadline.
What to do in case of an audit
The first thing to remember is that audits are not always a negative thing. You might be audited as the result of a random screening or because something on your return was filed the wrong way. Audits may be performed via mail or through an in-person interview; all contact information and related materials will be in the initial letter you receive.
There are a few steps to take:
- Determine why you are being audited: Did you make a mistake on your math? Did you claim too many donations? Did you forget to include a form? The audit letter will usually inform you of the reason you’re being audited. Once you determine the reason the IRS is investigating your return, you’ll be able to address the situation.
- Gather all relevant documents related to the audit in one place: Collect all of your tax forms together, including any W2s, 1099s or other forms you have received. It may also be a good idea to collect your previous years’ tax returns to prove consistency.
- Maintain courtesy and politeness in your responses: Treat an audit like a speeding ticket; if you are courteous and quick with your responses, the process will go much more smoothly.
DIY taxes vs. hiring a professional
Hiring a professional to do your taxes can be an expensive endeavor, so many people would prefer to handle it themselves. However, you should ask yourself a few things first. Are you comfortable with your tax situation? Do you understand the laws enough to apply them, and are you okay researching tax law if you find something you don’t understand?
If you aren’t comfortable researching tax law, the idea of working with numbers and calculations scare you, or the entire concept of deductions and credits seems like black magic, you might be better off hiring a professional. On the other hand, if you don’t mind numbers and tax law holds some interest for you, then do it yourself—but be sure to double and triple check your calculations before submitting.
Asking for an Extension
It’s possible to file your taxes after April 15. Filing Form 4868 will allow you to extend your filing deadline to Oct. 15. However, estimated tax payments are still due April 15. Even if you file later in the year, you must still include a payment with your estimated total taxes by April 15 to avoid late penalties from the IRS.
The most popular tax software
Filing taxes on your own doesn’t need to be a nightmare. There are plenty of free and paid tax software companies that created products to help Americans file their taxes.
However, make sure you’re not paying for tax software that you don’t need. If you don’t have complicated taxes — like real estate, investments or foreign income — free tax software can usually get the job done. Shop around for the software that gives you everything you need for free before committing to one company to file your taxes for you.
If you do have real estate, investments, foreign income or self-employment income then it could be helpful to pay for an upgraded version to ensure that your deductions, wages and credits are properly filed and accounted for. It would be a bigger pain down the road if filed incorrectly.