Lessons Learned from Filing My 2013 Tax Return

The following post was drafted back in October but never published because it needed editing, which I didn’t get to till now…

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I filed my 2013 tax return today.

The 24 hours leading up to me going to the post office was very dramatic and overwhelming.  I’ll spare you the details and just get to the lessons I learned:

1.  Your Tax Return is YOUR Responsibility

Ever since I started working and paying taxes, I relied on my mom to do my taxes for me.  She would get together with our CPA for a day or two and all I had to do was sign the bottom of my 1040 once it was complete.  This year was different.  In April, when tax returns were due, my mom was busy preparing for an out-of-country trip and didn’t have time to get it done so we filed for an extension.  Long story short, my tax return wasn’t ready until this morning, the LAST day of the extension.  I’m not a last minute person so I was in a panicked mess these last 2 days.  I wanted to blame my CPA for all the mistakes that were made/overlooked.  I wanted to blame my mom for not getting together with him sooner.  But at the end of the day, my tax return is ultimately my responsibility and I could’ve been more proactive and taken the time to get all the documents together myself.

2.  Save Your Tax Documents As You Go

When my coworker pointed out all the deductions that were missed, I scrambled to find all the necessary paper work to fill in those gaps: receipts, bank statements, etc.  If I had saved those documents as they were accrued, it would have saved me so much time and hassle.

3.  IRA & 401k Contribution Deadlines

Sadly, I realized on April 16th that you have to make your IRA contributions by April 15th to count for the previous tax year.  So in order for my IRA contribution to count towards my 2013 tax return, I had to have made the contribution by April 15th of 2014.  Just because you can file for an extension to complete your tax return, it does NOT mean you can get an extension on your contribution deadline.  I missed out on a key opportunity to lower my taxes.

4.  Make Sure You Are Withholding Enough

I wasn’t withholding enough of my paycheck and was slapped with a bunch of penalties, fees and interest.  You can estimate if you’re withholding enough using this calculator.

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I started working on my 2014 tax return a few weeks ago and feel much more prepared this time around!

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IRA Phase Outs (aka when you make too much money for IRAs)

A lot of us millennials are familiar with putting money into a Traditional or Roth IRA for retirement savings.  When we first started working, contributing the max amount ($5,500 for 2014) into an IRA was nearly impossible for us and our entry-level salaries.  But as we work our way up the corporate ladder, we will start to experience “rich people problems” such as making too much money for IRAs.  Let me explain…

First, you have your Traditional IRAs.  For someone who is single (for tax purposes), the phase-out for 2014 begins at $60,000 and ends at $70,000.  What this means is that if your Adjusted Gross Income in 2014 is $60,000 or less, you can deduct the full amount you put into your Traditional IRA (on line 32).  If your AGI is $70,000 or more, you can’t deduct anything that you put into your Traditional IRA.  And if your AGI is somewhere between $60k-$70k, you can deduct part of the amount you put into your Traditional IRA.  Fidelity has a simple calculator that you can use to see how much of a deduction you can take.  Click “yes” under the Employer-Sponsored Plan section if you have a 401k with your employer.

Next, you have your Roth IRAs.  For a single person in 2014, the phase-out begins at $114,000 and ends at $129,000.  The reason why the phase-out limit is so much higher for Roth IRAs than Traditional IRAs is because with Roth IRAs, you do not get an immediate tax deduction regardless.  That’s just not how Roth IRAs work.  So the phase-out is for whether or not you can even contribute to the account and if so, how much.  If your AGI is $114k or less, you can contribute up to the max ($5,500 for 2014).  If it’s $129,000 or more, you can’t contribute anything.  If you fall within the phase-out range, you can contribute up to a specific amount.  You can use the calculator provided above to see what that amount is.

And lastly, you have your Non-Deductible IRAs.  There is no phase-out for Non-Deductible IRAs because it works like a Traditional IRA without the immediate tax benefits.  This IRA is appropriate for people who have an AGI over the phase-out limits for both Traditional and Roth IRAs but still want to take advantage of the tax-free growth.  So even though you don’t get to deduct your contribution on your tax return, you still don’t have to pay taxes on your account’s earnings each year.

Calculate Your Estimated Tax for 2014

Most of you should have received your last pay-stub for the year by now.  My coworker sent me this link from the IRS website that you can use to estimate the amount of taxes you overpaid/underpaid in 2014.  A lot of the information you need for the calculator is on your last pay-stub so have it handy!

The goal is to get as close to zero as possible (no taxes owed or due).  A lot of people get excited when they get a large tax refund.  But that excitement is actually misplaced because when you overpay in taxes, you’ve given the government an interest free loan.  In other words, the government got to borrow your money for free.  If you had put that extra money in a CD at your local bank, the bank would have at least paid you interest when they gave you your money back, even if it is only 1%.  And if you had put that extra money in an IRA or 401k, you could have taken advantage of compounding interest and probably would have gotten an even higher return, much much higher (the S&P is up 8.5% YTD as of 12-17-14).

Of course, you also don’t want to withhold too little and end up owing a lot in taxes come April.  At best, it’ll take a chunk out of your savings account.  At worse, you won’t have the money set aside to pay for it.  Then you’re really in trouble.

Breaking perfectly even in the amount taxes owed/due is nearly impossible, so just try to keep the difference less than a few hundred dollars.  Using the calculator linked above helps a lot.  Of course you could also talk to a CPA to get even more accurate estimates.  If you see that the amount owed/due is over a couple hundred dollars, talk to your HR department about adjusting your withholding accordingly.

Using Money in Your Traditional IRA

Most people know that IRAs are used for retirement.  But what is considered “retirement” and what happens if you use the money before then?  The rules are a little different for Traditional IRAs and Roth IRAs so today I will only cover Traditional IRAs for the sake of brevity.

“Retirement” for IRA purposes is age 59.5.  Once you reach age 59.5, you can start taking money out of your IRA without penalty.  But don’t forget, you’ll still have to pay taxes on whatever amount you take out because Traditional IRAs are typically funded with pre-tax money (income you have not paid taxes on yet).  If you take money out of your IRA before age 59.5, you will have to pay a 10% penalty on the amount you take out (in addition to paying taxes).

Luckily, there are a few exceptions to this rule.  If you are not age 59.5 but use your Traditional IRA for things like:

  • unreimbursed medical expenses that are more than 10% of your adjusted gross income,
  • medical insurance when you’re unemployed,
  • when you are totally and permanently disabled,
  • qualified higher education expenses (i.e. grad school),
  • to buy, build, or rebuild a first home,

you will not have to pay the 10% penalty.  This is great news for those of us who are worried about not being able to use our IRAs anytime before we retire, which if you’re a millennial, probably won’t be for a long time.

Alternative Minimum Tax

The Alternative Minimum Tax was created by Congress to prevent people from using loopholes to avoid paying taxes.  The way your AMT is calculated is similar to the way your regular tax is calculated except a lot of the deductions that you were able to take for regular tax are no longer allowed.  If your AMT turns out to be higher than your regular tax, you will have to include the difference on Line 45 of your 1040.

Most of us millennials will not have to worry about paying AMT unless we’ve reduced our taxes by taking a lot of itemized deductions (mainly in real estate or property taxes).  But the only way to know whether you have to pay AMT or not for sure is to fill out Form 6251.

Taxable Income & Tax Rate Schedule

After you figure out what’s included in your Gross Income (Line 22 of your 1040),

and then subtract certain expenses to get your Adjusted Gross Income (Line 37),

and then subtract your Standard or Itemized Deductions from your AGI (Line 41),

you subtract from Line 41 your exemptions (Line 42) to get to your Taxable Income (Line 43).  Your Taxable Income is used with the Tax Rate Schedule to figure out how much Tax you need to pay that year (Line 44).  See below for a calculation example.

Here is the 2013 Tax Rate Schedule for someone filing Single on their tax return:

If taxable income is over—
but not over—
the tax is:
$0
$8,925
10% of the amount over $0
$8,926
$36,250
$892.50 plus 15% of the amount over $8,925
$36,251
$87,850
$4,991.25 plus 25% of the amount over $36,250
$87,851
$183,250
$17,891.25 plus 28% of the amount over $87,850
$183,251
$398,350
$44,603.25 plus 33% of the amount over $183,250
$398,351
$400,000
$115,586.25 plus 35% of the amount over $398,350
$400,001
no limit
$116,163.75 plus 39.6% of the amount over $400,000

Pretend your Taxable Income (Line 43 of your 1040) is $50,000.  Your marginal tax rate is 25% because your Taxable Income is between $36,251 $87,850.

To calculate how much Tax you need to pay, take $4,991.25 + [25% x ($50,000 $36,250)] = $8,428.75 (this amount will be reported on Line 44).

I suggest testing this calculation out yourself using your 2012 Tax Return.  See if you can get to the same number that was reported on Line 44 of your 2012 1040.  Just don’t forget to use the 2012 Tax Rate Schedule and not the 2013 one.