Getting Organized for Tax Season

Lima, Peru, 2011

The deadline to file for individual income tax returns is less than one month away. The annual tax filing season is exciting for those who are expecting a big refund check and dreadful for those who are sending a sizable check to Uncle Sam. For everyone, filing the annual tax return is a time-consuming process. According to the IRS, the average American spends 13 hours on filing taxes; those who are filing the full 1040 form spend 16 hours on average.

Not only is tax filing time-consuming, income tax is also the single highest annual expense for most of us. To illustrate, based on our 2015 family tax return as a married couple, we paid 26.5% of our income in federal taxes, 2.0% in Medicare taxes, 2.3% in Social Security taxes, and 5.0% in state taxes (two states combined), for a hefty 35.8% in total taxes. For 2016, we paid 24.7% of our income in federal taxes, 2.0% in Medicare taxes, and 2.5% in Social Security taxes, and 4.8% in state taxes (one state), for a total of 34.0%. Optimally filing your return can have a meaningful impact on your tax refund and personal financial position. In order to maximize your wealth, it is crucial to minimize your taxes through all legal means.

In this post, I will help you organize your tax documents. Even if you are using a professional tax preparer, it is important to understand the tax return components. Don’t expect tax preparer to cover all the basis. They ask you the typical questions but don’t know all the details of your life. You should be the one that covers everything and pass on all relevant information to your tax preparer. A tax preparation software such as TurboTax typically walks you through the steps, but I always use my own Excel spreadsheet as a check and guide.

Form 1040

There are different versions of form 1040, the IRS form used to file individual taxes. Form 1040 is the most comprehensive form, whereas forms1040EZ, 1040A, and other variations are shorter forms that can save you some time but you will likely miss some meaningful deductions. I recommend using the full 1040 form to make sure all components are captured to minimize your taxes due and maximize your refund.

Machu Picchu, Peru, 2011

Tax Return Components

When I think of my tax return, I put all my documents and calculations into the following categories.

1. Employment & Unemployment Income – My Excel file outlines both my spouse’s and my income & tax components:

  • Gross income
  • Federal tax
  • State tax
  • Medicare and social security tax

Employment income

If you are a salaried employee, your W-2 will show your total and taxable income. Note that your income contributed to your employer-sponsored pre-tax 401k retirement plan is not taxable in the tax year (but taxable upon withdrawal). If financially possible, I recommend maxing out your contribution at the $18,000 per year limit.

Unemployment income 

If you are unemployed any part of the year and received income from the state (via unemployment insurance), you will receive a 1099-G, showing the amount of unemployment income received as well as the amount of federal and state taxes paid.

Self-employment (e.g. commission income) as independent contractors

Even though this is an income component, I typically address this separately due to the need to aggregate both income and expenses. I have a separate tab in my Excel tax file to organize business expenses. I will do another post just on self-employment tax deductions.

2. Other Income

  • Interest (e.g. interest earned from savings & checking accounts, checking account opening bonuses, etc.) – Most banks will mail out 1099-INT forms. Income from this category can be meaningful. Last year, we have received approximately $2,600 from bank interests and checking account opening bonuses.
  • Stock dividends and bond interests – brokerage firms typically provide 1099-DIV or 1099-Composite forms.
  • Stock and bonds gain or loss on sale (short term vs long term)

3. Income (or gain) from sale from real estate (e.g. sale of your primary residence) – I recommend keeping good documentation from your HUD closing statement during your initial purchase. In addition, I would recommend keeping track of all home improvements and respectively costs. If the gain on the sale of your primary residence is below $500,000 (per couple) and certain conditions are satisfied, the gain is tax free. If you have sold your investments properties, with the exception of 1031 exchanges, your gains are typically taxable in the tax year the transaction took place.

4. Deductions

Tax payers can choose from two types of deductions: standard deduction ($6,300 for single filer and $12,600 for married couple filer in 2016) and itemized deductions. If you own your own home (paying real estate tax and mortgage interest) and have other meaningful deductions (e.g. donation to charity), you will be better off with itemized deductions as the itemized deduction amount will meaningfully exceed the standard deduction amount. Common itemized deduction items include:

  • Mortgage interest – Interest is capped at interest on $1,000,000 loan. Any interest above loan amount of $1,000,000 is not tax deductible. If you bought your home during the year, your lender’s form 1098 may or may not include the interest you paid during closing.
  • Property taxes – If you have an escrow account with your lender, your lender may provide a form 1098. If you don’t have an escrow account, your town typically provides a bill you can keep as a record. Similar to mortgage interest, you may have paid additional property taxes during closing and may need to do additional calculation on your own to figure out the correct number. If you closed an escrow account during the year, remember to combine the 1098 from your lender and your tax bill from the town.
  • Traditional IRA contributions – you can contribute up to $5,500 per person or $6,500 if you are above age 50. One benefit of Traditional IRA is tax-deferred growth. In addition, for those with adjusted gross income below a certain threshold ($61,000 for single filers or $98,000 for married couple filers), the Traditional IRA contribution is fully tax-deductible.
  • Some states offer tax deduction on 529 plans – these are tax-advantaged savings plans sponsored by states to encourage the pursuit of higher education. Many states offer tax deductions for contribution to 529 plans of those particular states; Massachusetts will start offering tax deductions (of up to $1,000) in 2017.

5. Business income and expenses

The Schedule C is used to aggregate all your small business related income and expenses. The income components should be straight forward. Common expense components include:

  • Auto (choose from either mileage or actual expense incurred) including vehicle registration cost
  • Advertising
  • Supplies
  • Communication
  • Utilities
  • Food and entertainment
  • Insurances
  • Licenses
  • Home office expense – depreciation (building only; not land), mortgage interest, real estate tax, utilities, and other expenses for your home prorated based on the room you are using exclusively as office.

6. Rental income and expenses

The Schedule E is used to capture income and expenses from rental properties and several other sources. In addition to reporting the rental income received, it is important to report any and all expenses that could offset the rental income. Expenses may include:

  • Advertising
  • Maintenance and repairs
  • Insurance
  • Management fees
  • Mortgage and other interest
  • Supplies
  • Taxes
  • Utilities
  • Depreciation

Once the above key components are inputted into your tax software, the system will generate the total refund or tax due amounts. Easy enough?

Machu Picchu, Peru, 2011

Tax Preparation Software

Do not attempt to do the tax return without tax software as the amount of calculations and work is a lot vs the cost (discussed at the end of this post). For several of these items, I plan to do separate posts.

My favorite tax software is TurboTax. I found it generally easy to use. If you plan to file on your own online, expect to spend $90 for an online file. Alternatively, you can purchase a TurboTax CD. The CD will allow you to file up to five federal and state returns. To minimize your tax prep fee, consider sharing a CD with family or friends. The cost if you share a CD with others is a nominal $13 per year. Filing the federal return online is included and state return is included if you file by mail. Therefore, you can get a net saving of $77 per year. If you prefer to file the state tax return electronically, the cost is an additional $20.

Machu Picchu, Peru, 2011
Machu Picchu, Peru, 2011

Importing Prior Year’s Tax Returns

If you file online with TurboTax, your prior year’s return will be automatically loaded into the current year’s return. If you file using a CD, you can import your prior year’s return if you have a pdf copy (easily done as well).

I hope the above gives you a general structure for filing your taxes. I hope to have more blog topics on tax filing strategies.

Dear readers, how do you get organized for tax season? How many hours do you spend on filing for taxes? Do you have the system in place to maximize your tax refund?

1 thought on “Getting Organized for Tax Season”

  1. This is a great article, thanks Weina. You are right, there is so much to put together. I use a spreadsheet with all of the income and expenses so that I don’t forget anything when I’m gathering tax documents.


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