- The sooner you get started, the sooner you will get money back if you are owed any.
- Filing your taxes early could reduce your exposure to identity theft.
- Getting started ahead of time gives you plenty of time to look for opportunities to reduce your taxable income.
- If you end up owing money, starting early can mitigate some of the sticker shock since you’ll have time to plan how to make the payment.
Got 3 hours to spare? That's the amount of time that the IRS estimates it takes the average individual to fill in the blanks on their annual tax return forms.1 Of course, there's more to tax prep than just signing your name. One way to get through the process is to focus on the potential payoff—say, several thousand dollars in a refund, for one.
"People focus on the negative. They don't like locating all the files, math is scary, and there's this need to be very precise," says Andy Reed, PhD, Fidelity's vice president for behavioral economics.
The 2020 filing season officially opens on February 12, 2021, and the final federal deadline is now May 17, for most returns. So those are your general parameters on timing. Beside the possibility of getting a refund, these are other reasons to fast track your tax process, particularly for your 2020 return.
Here’s why you should get moving:
1. Get your stimulus
The biggest reason to file early is to get whatever is due back to you faster. This year, that not only includes refunds, but also any money that you didn’t already get from the 2 pandemic relief laws set up in 2020, first up to $1,200 per individual in the CARES Act last March and then $600 more in late December. While most of the payments got to people correctly, some people's circumstances changed or they didn't get the whole amount for which they qualified.
One of the top questions tax software provider TurboTax® is getting so far this tax season is if these relief payments are taxable, according to Lisa Greene-Lewis, a certified public accountant and tax expert for TurboTax.
The payments are actually advance tax credits for 2020, and there will be an area on the 2020 tax forms to reconcile your income for the year with the requirements of the program. This will finalize what you were due, because the initial payments were estimates based on your 2018 or 2019 tax returns. A lot can change in a year, particularly such a dramatic one.
"People who received a partial stimulus payment, or had a baby in 2020, or didn’t receive a stimulus payment for their dependent child under 17, can claim their stimulus in the form of a recovery rebate credit when they file. The recovery rebate credit can increase your tax refund or lower what you owe," says Greene-Lewis.
Note: The IRS says if your income went up in 2020 and you no longer qualify, you will not be asked to return any payments you might have received up to that point.
2. Beat the scammers
Filing your tax return as soon as possible is one of the best ways to guard against tax-related identity theft. In these scenarios, a criminal files a fraudulent return and collects a refund in your name before you file your return. If you file your legitimate return before a crook tries to file one for you, the fraudulent return is rejected.
If you are worried your account has been compromised, still continue to file your legitimate tax return and to pay your tax bill if you owe money, although you may have to submit a paper return rather than an electronic one. Attach Form 14039, Identity Theft Affidavit, when filing your return.
To protect yourself, remember that the IRS will not call you or contact you via email, and you should not give your personal identification to anyone over the phone. Visit Identity Theft Central for information about tax-related identity theft and data security protection from the IRS.
3. Fix mistakes and make adjustments
If you are delaying filing because you haven't received the necessary tax documents from an employer, financial institution, charity, or some other source, be proactive and ask for them. The earlier you get these, the more time you have to sort out any mistakes and make adjustments that could help lower your taxable income before the final tax deadline of the year.
During 2020, for instance, many people may have received unemployment payments without knowing that they are taxable and they need to make arrangements to pay what’s due. Also, because of lower income, some people may qualify for tax credits that they did not know about previously.
"While unemployment income is taxable, they may be eligible for income-based tax credits that they weren't eligible for before due to their income, like the Savers Credit worth up to $1,000 for single taxpayers and $2,000 for married couples filing jointly, or more of the Child and Dependent Care Credit, which increases with lower income," says Greene-Lewis.
4. Take stock for 2021 and beyond
"The beginning of the year is a good trigger for taking stock of your financial situation, which is good to do once a year," says Reed.
Knowing where you stand well before the tax filing deadline also gives you time to adjust your current tax withholding and also figure out what you can contribute to accounts like traditional IRAs, Roth IRAs, and health savings accounts, based on your modified adjusted income and your overall financial picture.
A contribution to a traditional IRA may reduce taxable income and, in turn, lower 2020 taxes for those eligible for the tax deduction.2 The tax-deductible contribution limit for the 2020 and 2021 tax years is $6,000. For those who are age 50 and over, the limit is $7,000.
Note: It isn't necessary to have a job to have a traditional IRA. A nonworking spouse, as long as their spouse has earned income, can contribute to a Roth or traditional IRA. The amount of a married couple's combined contributions can't be more than the earned compensation reported on their joint return.
Self-employed individuals and freelancers can open a Simplified Employee Pension plan—more commonly known as a SEP IRA—even if they also have a full-time job as an employee. Those who earn money freelancing or running a small business on the side could take advantage of the potential tax benefits from their side gig. With a SEP IRA, contributions may be tax-deductible, just like with a traditional IRA, but the SEP IRA has a much higher contribution limit. The contribution amount varies based on income. For 2020, the contribution limit is 25% of eligible compensation (or 20% of eligible compensation for the self-employed3) or $57,000, whichever is lower. For 2021, the ceiling rises to $58,000.
Consider speaking with a tax advisor to determine the impact of SEP IRA contributions on the tax deductibility of contributions to a traditional IRA in the context of your personal situation.
5. Get it done
People usually consider doing taxes one of the most onerous financial tasks of the year, and getting it done will make all of the other items on your financial to-do list seem easier.
The ironic thing about taxes is that people see it as a purely negative experience, but TurboTax's Greene-Lewis says 75% of her company’s users get a refund at the end of the process, at close to $3,000 per return.
"We associate taxes with losses, but if you've done it right, you've paid exactly enough or too much," adds Fidelity’s Reed. "If you can flip the frame, the reality is that if you do this paperwork for a couple of hours, you might get money back."
One of the keys to beating tax procrastination is to try to be realistic about how long it will take. Is it really going to be just a couple of hours? Perhaps you could time yourself.
If it's taking longer than you want, you can look for ways to make the paperwork easier for yourself throughout the year so you don't waste time looking for lost documents. Some people take photos of important receipts and store them in a folder on a phone, some set aside a folder for tax documents, some use the old-fashioned shoe box.
Human beings are also bad at guessing how they will feel in the future, says Reed. You might avoid discomfort in the present without thinking about how much worse it will feel down the line when you are pressed for time and find out something annoying, like you need to do a system upgrade before your tax prep software will work, or your accountant has no more appointments left.
To keep yourself on track, Reed says, "Focus on the benefit, not the cost. The cost is just a couple hours, the benefit could be money."