How to Do Taxes on Your Own was written by Riley Adams and originally appeared on Your Money Geek. It has been republished with permission.
If you earn a steady income or even an inconsistent one, you're likely paying taxes or on the hook for them. Employers withhold taxes each pay period from their employees' paychecks, sending them to the IRS and your relevant state and local governments.
But that's only the first step in the process of handling your taxes. You’ll need to consider tax deductions and credits as well when looking to lower your taxable income. The last thing you want to do is wait until tax season rolls around and then find yourself scrambling to figure out how to do your taxes on your own.
That's why we created this step-by-step guide for the typical person who wants to learn how to prepare their taxes at home without all of the stress that comes with doing it themselves.
Why Do I Have to File a Return?
You have to file a tax return because you're probably a taxpayer. The IRS considers taxable income as all income from whatever source derived, including gains realized, unless otherwise excluded.
If you have enough income, the IRS looks to tax in one year to exceed the standard deduction for your filing status. Then it's time for you to do your taxes on your own and file that return with the appropriate government agency. If not, you might still consider filing a tax return.
One of the significant learnings from 2020 and 2021 has been the value of filing your tax return regardless of need. Filing a return allowed millions of people to receive each of the three rounds of stimulus checks that came out due to the pandemic.
Therefore, you'll want to save the correct paperwork to prepare your taxes, even if you don't exceed the standard deduction and don't technically need to file.
If you exceed the standard deduction, filing your return gives you the chance to reconcile your tax bill with the IRS. You might have overpaid through paycheck withholdings, entitling you to a tax refund you can spend how you please.
Likewise, you might have underpaid and need to cut Uncle Sam a check. Not the best scenario, but better than having the full brunt of the federal government come after you for the money you owe.
To fight against this happening again in the future, be sure to file an Amended Form W-4 with your employer asking to withhold more in taxes for the current tax year. That will avoid the nasty surprise that shows at the bottom of your tax return.
How to File a Tax Return on Your Own
To prepare your taxes on your own, you'll need to assemble the correct paperwork. That includes all of those forms that have been coming in from various sources:
- Form W-2: Wage and Tax Statement
- Form 1099-NEC: Nonemployee Compensation
- Form 1099-MISC: Miscellaneous Income
- Form 8949: Sales and Other Disposition Assets
- Form 1120: U.S. Corporate Income Tax Return
Not to mention the paperwork related to your situation or small business. Things like:
- payment invoices
- receipts for deductible expenses
- detailed expenses related to your trade or business
- contributions to non-profit organizations or charitable donations
The list goes on and on. If you plan to take a specific deduction that requires documentation, make sure to hold onto anything and everything if the IRS looks for supporting paperwork.
Once you have this information squared away, it's time to prepare your taxes using Form 1040, Individual Income Tax Return. You can file 1040 manually by filling out and mailing the form to the IRS.
Filling it out by hand can be time-consuming, but you'll have complete control over how you prepare your taxes. However, math errors can result and are likely best avoided.
Instead, you might consider using tax software through a service like TurboTax. It will walk you through each section of your 1040, asking you questions about your income, deductions, credits, and filing it for you electronically.
Well worth the cost in many cases, especially if it avoids computational errors on a mailed-in paper form and the IRS comes calling. You can also receive help by contacting a tax professional directly to solicit their services.
How Income Tax Brackets Work
When you begin tallying your income earned for the year, you will eventually end up with your “gross” income from all sources. This includes your wages, tips, self-employment income, investment income, real estate income, and more.
It also includes income from signing up to a company that offers incentives to open an account. If you learned how to get free stocks from apps like Robinhood or even sign up bonuses from SurveyJunkie or other apps, that money technically counts as taxable income. You'll need to report this on your tax return.
When you've calculated your total gross income, you can then subtract the relevant tax deductions and credits to your situation to reduce your gross income to your adjusted gross income and, finally, taxable income. From here, you then figure out how much taxes you owe based on the progressive set of seven income tax brackets used by the IRS.
This progressive system means for higher levels of taxable income, you pay a commensurately higher effective tax rate. For example, if you earned $100,000 of taxable income as a single taxpayer, you'd fall into the 24% tax bracket.
- Your income between $0 and $9,950 gets taxed at 10%
- Your income between $9,951 and $40,525 gets taxed at 12%
- Your income between $40,526 and $86,375 gets taxed at 22%
- Your income between $86,376 and $100,000 gets taxed at 24%
Each year, the IRS adjusts these brackets to account for inflation.
How to Calculate Your Taxes
If you work as an employee, your employer will send you a Form W-2 in the mail and possibly electronically. This documents all the details related to your pay, deductions, and other elections made during the tax year.
It includes your gross pay, pay withheld and remitted to the IRS, as well as other money used to pay for various deductions like your 401(k), health savings account (HSA), life insurance, and more.
If you're self-employed, you should expect to receive 1099-NECs from any company that paid you $600 or more during the tax year. Once you gather all of this information, you'll also need to track all of your receipts and other documents substantiating your costs of doing business.
One way to avoid paying income taxes is through investing in assets that pay qualified passive income. These are some of the best assets to invest in because you can receive income but not pay taxes on it.
Such examples include qualified dividend income, municipal bond income, or long-term capital gains on the sale of certain assets. For these to be tax-free, you'll need to have income below certain levels, however.
How to Reduce Your Taxable Income
Now that you know a bit about the income side of the ledger, you might want to learn a bit more about how you can lower this income in the eyes of the IRS.
Aside from having certain types of income, the IRS awards better taxation preferences. You have two levers to lower your taxable income: tax deductions and tax credits.
Tax deductions work by reducing your taxable income on a dollar-for-dollar basis.
For example, if you earned $100,000 of gross income and claimed the standard deduction as a single taxpayer in 2021, you'd have a reduced taxable income of $87,450 ($12,550 standard deduction in 2021).
There are many different ways to do this: some items will give you a deduction no matter how much money you make. Others only work if you have low taxable income.
Here’s an overview of the most common deductions:
- Standard deduction
- Student loan interest deduction
- Charitable donations deduction
- Medical expenses deduction
- State and local taxes (SALT) deduction
- Gambling loss deduction
- Employer-sponsored plan and IRA contributions deduction
- Health savings account contribution deduction
- Self-employment expenses deduction
- Educator expenses deduction
- Mortgage interest deduction
- Depreciation expense deduction
- Health insurance premiums deduction for freelancers
There are many, many examples of tax deductions to consider when looking to lower your taxable income. Deductions reduce your taxable income, thereby lowering the taxes you pay indirectly and less effectively than tax credits.
If you are self-employed or own a small business, you’ve got a bevy of tax deductions you can use to lower your taxable income considerably.
My wife, who works as a dermatologist in Pleasanton, knows she needs to keep track of her expenses because her employer runs his practice network of clinics as a small business owner. He minimizes his business income taxes by capturing eligible expenses to reduce the taxable income of his business.
He also keeps track of anything which might qualify him for business tax credits as well.
Whether a business or individual taxpayer, all things equal, a tax credit carries more use than a tax deduction.
Tax credits work by reducing the amount of tax you owe on a dollar-for-dollar basis. This is different from a tax deduction which reduces the taxable income on your W-2, 1099s, or other types of income that get taxed. Tax credits look at your total tax liability after calculating what you owe and reduce it on a dollar-for-dollar basis.
Tax credits come in two flavors: refundable and non-refundable.
Refundable tax credits allow you to lower your tax liability dollar-for-dollar and pay you any excess credit value if your tax liability turns negative. For example, if you owe $1,500 in taxes but you can claim a $2,000 refundable tax credit, not only will your tax bill go to $0, it'll trigger a $500 tax refund to you.
Such examples of refundable tax credits include:
- Earned Income Tax Credit
- American Opportunity Tax Credit
- Child Tax Credit (partially)
- Premium Tax Credit (partially)
Conversely, non-refundable tax credits also work to lower your tax liability on a dollar-for-dollar basis but differ from how the unused portion gets treated. If you qualify for a non-refundable tax credit that pushes your tax liability to $0, the unused balance does not come to you as a tax refund.
Instead, you might have this balance roll forward to future years as a future income tax offset, or you might forfeit the unused balance altogether.
Some examples of non-refundable tax credits include:
- Child and Dependent Care Credit
- Adoption Expense Credit
- Foreign Tax Credit
- Lifetime Learning Tax Credit
- Retirement Savings Contribution Credit
- Renewable Energy Investment Tax Credit
Getting Your Tax Refund (or Paying Your Bill)
After you've gone through all of your tax forms, gathered and tallied your eligible deductions, it's time to put pen to paper (so to speak) and put everything in the right place.
Using tax software can make this a breeze, though if you've got a very simplified tax picture, you can choose to do it by hand. It's your personal preference and will depend on how you value spending your time. You can also participate in the IRS Free File program to receive the tax software for free if you earn below a certain income level.
You should determine your tax balance owed for the year and compare this to the amount you've already paid through paycheck withholding or estimated quarterly tax payments made throughout the year.
If you've overpaid, you're due a refund. If you've come up short, you'll have to cut Uncle Sam a check. You can provide your bank account information for a direct deposit or opt for a paper check to be mailed to the address listed on your return.
Likewise, if you need to send in payment, you can use the IRS Direct Pay system to send your payment from a bank account or debit card directly to the IRS.
If you find you need more time to do your taxes independently, you can file an extension. You'll still need to pay the taxes you think you may owe by the filing deadline, even if you haven't completed your tax return.
Running afoul of this rule will land you in hot water with the IRS as they're likely to come knocking (figuratively) with a bill. Not a pleasant experience by any means.
If you need assistance filing your taxes, make sure to look into tax preparation services that are available through many professional organizations, university programs, or a Volunteer Income Tax Assistance (VITA) program.
Even if you have no income or don't earn enough to exceed the standard deduction, it may still make sense to take the time necessary to file a tax return. Those who filed found it far easier to receive their stimulus checks in 2020 and 2021. It also gives you good practice for future years when you may have enough income to file your return to reconcile your tax bill with the IRS.