It’s that time of year – tax season. You start hearing about people receiving refunds, owing money, and saying things like, “I should really start working on my tax return.”
Nobody likes filing taxes. In the US, we have a plethora of rules and records we need to track to properly file our taxes.
Our system is not like other countries, such as the United Kingdom or Japan, where some people do not need to file tax returns. There are about 36 countries that utilize a return-free tax filing system. According to the Tax Policy Center, about 90 percent of taxpayers eligible for final withholding in the United Kingdom did not have to file in 2014.
Sounds nice, right?
We don’t live in that world, but there are ways to make tax season easier for you. We’ll explore ideas and actions you can take throughout the year to make filing your tax return before April 15 easier.
Set Up an Organizational System
Many people cannot stand the thought of filing their taxes because it requires time to organize everything. They sit down on a Saturday and then start trying to remember everything from the year.
Instead, set up an organization system you use throughout the year. For example, I keep a tax folder on my computer for next year’s taxes. This way when something changes, I receive a tax document, or I need confirmation of an estimated tax payment, I can put it in the file and review it in February or March.
The biggest benefit of this system is for charitable receipts. If you do not itemize, there is no need to keep charitable receipts, but if you do, this method is very helpful. In order to itemize, you need to have itemized deductions in excess of $12,400 if filing single or $24,800 for married filing jointly in 2020.
Whenever I receive a charitable receipt throughout the year, I put it in the folder. For example, if I donate online and receive an email confirmation acknowledging the donation, I will print it as a PDF and put it in the folder. If I donate clothes to Goodwill, I will scan the receipt or take a photo of it with my phone and put it in the folder.
This is a much better system than making donations throughout the year and then trying to find a physical folder or search emails for charitable receipts.
Imagine sitting down at your kitchen table or desk in February and all your charitable receipts are organized already.
You can do the same for other expenses you need to track, such as tuition for education, medical expenses, child care expenses, and home and office expenses.
You should consider doing the same for estimated tax payments. Business owners or people with side income need to track their income and make estimated tax payments to avoid underpayment penalties. Depending on your income level, you need to pay 100% or 110% (for higher-income earners) of the prior year’s tax or 90% of the current year’s tax.
I recommend making a calendar reminder a week before each payment needs to be made or scheduling them in advance using the IRS system. If you schedule them in advance, you should also set up a corresponding automatic transfer into your checking account or the IRS may pull money that is not in your checking account.
After the payment is made, take a screenshot or print the page as a PDF and put the confirmation in your tax folder. Now, you do not need to remember if you made an estimated tax payment on time or the amount.
Below is a list of items you should consider keeping in your folder:
- Charitable receipts
- Tuition expenses
- Medical expenses
- Childcare expenses
- Self-employment expenses, such as utilities, marketing, insurance, travel, etc.
- Estimated tax payment confirmations
Other notes you can put in your folder include if you closed an account, opened a new account, or any other changes.
For example, people often forget if they close an account. Since it is not a current account they think about, they may not be on the lookout for a 1099-INT from a bank or 1099 from a brokerage company. Eventually, the IRS will catch up with unreported income and send you a notice showing a discrepancy between your tax return and what was reported to them, resulting in additional payments and penalties.
For people who prefer paper, you can adapt the system to be a physical folder instead of a digital folder on your computer. Don’t forget to back up to DropBox, Google Drive, or other cloud providers! You do not want your files destroyed for forever if something happens to your computer. For this same reason, I prefer not relying on a paper system. If something happens to my house, my files are gone for forever.
What I like about this organizational system is it is simple and easy to follow. You create one digital folder, and anything related to taxes can be put into it throughout the year. Once you get into the habit, it becomes second nature. Plus, you will appreciate those one or two-minute actions throughout the year and how much time it saves during tax season.
Think about it this way: 15 extra minutes throughout the year to organize tax documents could save you more than two hours of time.
As with anything in finances, you need to design and commit to a system that works best for you.
Opt for Electronic Statements
Another way to make filing taxes easier on yourself is to opt for electronic statements. I know plenty of people who receive electronic monthly statements and then select paper tax statements.
Electronic statements are much easier. If you move, you do not need to worry about whether it came to your new address. If something is incorrect on the tax form, you can see it sooner. You will also receive corrected tax forms more quickly.
Plus, if you are already using the digital folder system, it’s as simple as downloading and dropping it into the new folder. You do not need to scan the document to back it up.
One common complaint I hear about online systems is tracking passwords. If that is a problem, consider using a password manager, such as LastPass. Instead of tracking passwords to multiple websites, you only need to remember one main password, which will log you into the password manager vault and allow you to log in to previously saved websites.
Similar to the organizational system, I recommend keeping a list of all financial accounts because then you can cross-reference it to ensure you downloaded all the electronic statements. I would not rely on email notifications around tax season because they are easy to miss.
Schedule Time
During this time of year, I schedule time on my calendar to prepare the taxes. I always schedule time after March 15 because 1099s from brokerage companies are often corrected. I may prepare part of the tax return prior to March 15, but I never fill in the 1099 data until March because almost every year there are corrections. If you have a brokerage account, you may want to do the same.
By scheduling time, I am mentally preparing myself, and if there are any last-minute things I need to organize, I can start to prepare.
The mistake I see most people make is to put off thinking about their tax return until April and then something comes up that is more interesting, which means the tax return preparation is delayed.
Now, there is nothing wrong with filing an extension and filing later, but you still need to pay any taxes due before April 15 and the only reasonable way to do that is to have a rough estimate of your income and deductions. Essentially, you’ll need to do a draft tax return. If you prepare a draft, why not finish?
If you know you are due a refund, then this is less of a worry, but why wait for the refund if you have everything you need? It’s an interest-free loan to the government.
There are people who cannot file a tax return until closer to October 15. Often, people with K-1s will not receive their tax document until later in the year; however, I still encourage people to organize and finish everything else except the documents yet to be received.
Like any other responsibility, schedule time on your calendar. Treat it as a music lesson, sports game for your child, or a business meeting instead of wishfully making the time.
How Long to Keep Records
You filed your tax return – now what? How long do you keep the records?
You probably know that person who has decades of old tax information stuffed in a filing cabinet. You may be that person. Or, you may be that person who keeps nothing.
Like most things in life, there is a balance.
In most cases and if you do not want to remember the separate rules, you may be okay only keeping the last seven years of records.
You want to keep W2s, 1099s, receipts to support deductions, documents related to the sale of a home, and records to show how much you paid for a rental property, depreciation taken, and what you sold it for.
In general, the IRS has a three year statute of limitations, meaning in many situations, only keeping three years worth of records is okay. The IRS cannot look at returns more than three years old, except in a few circumstances.
Below are the rules from the IRS website:
Period of Limitations that apply to income tax returns
1. Keep records for 3 years if situations (4), (5), and (6) below do not apply to you.
2. Keep records for 3 years from the date you filed your original return or 2 years from the date you paid the tax, whichever is later, if you file a claim for credit or refund after you file your return.
3. Keep records for 7 years if you file a claim for a loss from worthless securities or bad debt deduction.
4. Keep records for 6 years if you do not report income that you should report, and it is more than 25% of the gross income shown on your return.
5. Keep records indefinitely if you do not file a return.
6. Keep records indefinitely if you file a fraudulent return.
7. Keep employment tax records for at least 4 years after the date that the tax becomes due or is paid, whichever is later.
Source: IRS
As you can see, three years covers most situations, seven years is on the safer end, but you may need to keep records indefinitely if you do not file a return or file a fraudulent return.
Another benefit of the electronic system discussed earlier is that you do not need to worry about how long to keep files. Most tax files are small and do not take up much space, which means even if you have 20 years’ worth of tax records, it probably is cheap to keep on your computer or backed up to the cloud, such as with DropBox.
If you still have old paper records, now may be a good time to consider making them into digital files or shredding the files you no longer need. It will feel nice purging old documents!
Summary – Final Thoughts
Until the US has a simpler tax code, filing taxes is going to be somewhat of a burden. There are simple steps you can take, such as setting up an organizational system that works for you throughout the year.
I personally use a digital folder for taxes, which makes organization throughout the year easy. When I need to file my taxes, everything I need is in the folder.
If you have not taken the plunge to electronic statements, consider making the switch. I know it’s tough to change habits, but this is one worth doing.
As we approach April 15, put a time on your calendar now. Block out a morning or afternoon to work on your tax return. Your future self will thank you.
Lastly, know how long you need to keep documents for your situation. It could be anywhere from three years, seven years, or indefinitely if you are not following the law. If you are still keeping paper records, consider a digital copy with a backup to simplify your records retention.
If you have tips for tax season, please write them in the comments below. Good luck with tax season!