Tax Preparation Basics

A tax return must be filed by anyone whose income is above the level designated by the Internal Revenue Service (IRS), which is dependent upon one’s age, filing status, and income type. The taxes due are calculated based upon the provisions of the Internal Revenue Code and should be paid out of income received throughout the year. These provisions are set by Congress and enforced by the IRS. Even if a person is not required to file a return, it might be beneficial to file in order to receive a refund of any amounts that were withheld.

The annual preparation of a tax return calls for an understanding of the provisions of the tax codes as they apply to an individual’s specific situation. There are tax preparation manuals and websites devoted to providing this information in nontechnical language. There are also seminars, computer software, and tax professionals who can answer questions or prepare the return.

Background

The collection of taxes is an issue that has existed in some form since the earliest civilizations. In the colonial United States, protests such as the Boston Tea Party represented peoples’ consternation over high taxation imposed by the British government. However, as the country obtained independence and continued to develop, Congress began instituting new taxes to fund the government. The Revenue Act of 1861, which was later repealed, is typically cited as the first inclusion of the income tax and was implemented as a means to pay for the Civil War. The Sixteenth Amendment, ratified in 1913, officially allowed Congress to tax personal income. First codified in 1939 and since revised, the Internal Revenue Code is intended to maintain a progressive tax system in which those who earn more pay more in taxes. However, debates have continued to focus upon whether the system requires the wealthy to pay a high enough percentage of their income in taxes.

This debate springs from the tax bracket concept that has been instituted and altered at least since the ratification of the Sixteenth Amendment. A tax bracket designates a range of incomes that is taxed at the same specific rate. For example, the lowest rate might be 10 percent and that rate would be applied to the part of one’s income that is in that bracket. The next amount of money would be taxed at the rate set for the second bracket, and so on until all of the income is taxed.

By April 15 of each year, certain individuals must file a tax return to determine whether, according to the tax codes, they were charged too much, too little, or just the right amount in taxes. If it is determined that more taxes were due than had been withheld over the year, the individual must pay the additional tax. If more taxes had been withheld over the year than were due, the individual will be issued a refund. Penalties may be applied if the amount withheld was significantly less than what was due. Interest will be assessed on the amount due until it is paid in full.

Overview

As preparing to file a tax return can seem rather complicated, especially for those who choose to file themselves but also for those who use a professional, there are several steps recommended throughout the year to ensure that the process is conducted as smoothly and accurately as possible.

Individuals should keep accurate and meaningful records. The better the records, the less likely a problem will arise if the IRS decides to do an audit. In the digital age, many transactions, receipts, and other records are stored online or on computer hard drives. For cash transactions, however, one should be sure to get a physical receipt. One could keep an envelope and pencil in the glove compartment to hold the receipts and write an explanation of the expense, or keep a note in ones phone to track the payments or expenses. It will make it easier to categorize the expense when tax time rolls around.

Because mileage for business, charitable donations, and medical purposes is tax deductible, individuals should keep track of these trips. Some logs call for a beginning mileage and an ending mileage. Some allow for individual mileage amounts as long as the automobile mileage at the start and end of the year is recorded. There are also applications (apps) for phones that automatically track mileage and allow the taxpayer to categorize the trips at the end of the day. The ability to produce a log of trips to back up the amount taken for mileage is imperative in the case of an audit.

Take the time to categorize electronic payments and income by purpose. The program to do this can be one that is supplied by the bank. It can be one in which the taxpayer downloads transactions to an accounting package. It can be categorizing by hand on the statements each month. The method is up to the taxpayer. The better the records, the easier it will be to prepare the return and defend the return if necessary. If a tax professional is used, that professional may have forms or other methods of keeping track of expenses. Find out up front and work with the system that will result in the least work at tax time.

There are also many ways to reduce a tax bill. Some of the ways are in the form of deductions that can be taken by individuals making enough to qualify for such deductions. These deductions reduce the taxable income and result in lower taxes due. Another way to reduce tax liability is in the form of tax credits. These are designed to be deducted from the tax due by those whose earnings are beneath a certain income threshold. Married couples are typically encouraged to file a joint return because of the available tax breaks. However, some choose to file separately to maintain individual liability and control over any refund.

One sure way to take advantage of all available tax reduction strategies is to have a list of eligible expenses. By knowing up front which expenses are going to make a difference and tracking those expenses in an organized manner, it will be possible to determine if there is anything extra that can be done with those expenses to reduce total taxes due.

Some common deductions are those for medical expenses and charitable contributions. Charitable deductions can be made by cash, check, or credit card. They can also be made with stock or bonds that have gained in value. The individual can deduct the full value of the investment without selling the investment and paying taxes on the appreciation. An individual might also want to take advantage of tax-free rental income. An individual can rent a home for up to fourteen days without reporting that income to the IRS.

Other reductions can be taken for the cost of tax preparation by a tax preparer, for the software used to prepare taxes, any books related to the preparation of the tax return, certain expenses related to investments, and work-related expenses that are not covered by the employer. Some self-employed individuals can also delay income payments until after the first of the year. Because individuals record income when it is received rather than when it is earned, that income would then count toward the next tax year, which could be favorable for the individual.

Investing in a 401(k) or an individual retirement account (IRA) is another way to lower a tax bill. By putting the entire amount allowed into one of these accounts, the tax bill will be reduced and the income earned on the investments will be tax free—at least until the money is withdrawn in retirement in the case of a traditional 401(k) or IRA. Establishing a medical reimbursement account can also result in savings since medical expenses paid out of these funds are paid with pretax dollars. The same is true with a childcare reimbursement account.

Common ways to reduce the tax bill through the use of credits include child and dependent care, appliances or modifications to a home for the purpose of rendering the home more energy efficient, adoption, and some education expenses.

There is a lot of paper, time, and detail involved with the tax return process. There is also pressure to be sure all available deductions and credits are taken and that all amounts are input correctly in case of an audit. There are questions of strategy and what to do in situations where there is a choice in timing. Especially for a complicated situation or for someone with a large income who is new to tax preparation, there is a lot to know and a lot to learn. Turning the preparation of a tax return over to a tax professional who knows the ins and outs of the tax code is often well worth the added expense and effort. At the same time, individuals must devote time and research to find a qualified professional and plan far enough ahead to schedule the preparation of the return during the busy tax season.

Bibliography

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Gordon, John Steele. "A Short History of the Income Tax." Wall Street Journal, Dow Jones, 27 Sept. 2011, www.wsj.com/articles/SB10001424052970204422404576594471646927038. Accessed 6 Dec. 2024.

Held, Joey. “The Pros and Cons of Hiring a Tax Professional.” Bench, 12 Nov. 2024, www.bench.co/blog/tax-tips/hiring-tax-professional-pros-cons. Accessed 6 Dec. 2024.

Lee, Bonnie. "Getting Organized for Tax Preparation." Fox Business, Fox News Network, 22 Jan. 2015, www.foxbusiness.com/features/getting-organized-for-tax-preparation. Accessed 6 Dec. 2024.

Polk, Ryan. “New IRS Funding Boosted Tax Enforcement and Improved Taxpayer Services during the Biden Administration.” The Conversation, 3 Dec. 2024, theconversation.com/new-irs-funding-boosted-tax-enforcement-and-improved-taxpayer-services-during-the-biden-administration-243891. Accessed 6 Dec. 2024.

Pratt, Katherine, et al. Federal Income Tax. 7th ed., Wolters, 2014.

“Preparing Your Tax Document Checklist.” H&R Block, www.hrblock.com/tax-center/filing/preparing-your-tax-document-checklist/?srsltid=AfmBOorluvMRzjkTSLG7CtUV9jEF2-jocx9Ln-‗8qrCKn5M1cQLoKpdQ. Accessed 6 Dec. 2024.

"Itemized Deduction, Standard Deduction." Internal Revenue Service, 20 Aug. 2024, www.irs.gov/faqs/itemized-deductions-standard-deduction. Accessed 6 Dec. 2024.