Tax season is upon us with tax forms arriving in inboxes and mailboxes. Tackling your 2016 tax return may be a dreaded chore (because of complexity or the prospect of owing additional tax) or a welcome event (because you are due a refund). Either way, getting started early may help make your tax-filing season less stressful and potentially save you some money.
Beginning your tax preparation now may help you avoid surprises, give you more time to gather your documents, reduce your taxable income, and even protect you from identity theft.
Here are seven reasons to get a start on your 2016 tax return now.
|1.||Protect yourself from identity theft.|
Filing your tax return as soon as possible is one of the best ways to guard against becoming a victim of tax-related identity theft. For the scheme to be successful, a criminal files a fraudulent return and collects a refund in your name before you do. If you file your legitimate return before a crook tried to file one for you, the fraudulent return is rejected.
That doesn’t mean you should submit an incomplete return, cautions Gil Charney, director at The Tax Institute at H&R Block. “Your goal should be to file as early as possible without compromising the completeness or integrity of your tax return, which could cause other problems,” he notes.
If you haven’t received the necessary tax documents from an employer, financial institution, charity, or some other source, be proactive and ask for them. On the other hand, if you owe a payment with your return and you need time to raise the money, Charney points out that you can file your return early and instruct the Internal Revenue Service to deduct the amount from your bank account or debit card, or charge your credit card, at any time right up until the filing deadline. (The deadline is April 18, 2017, for your 2016 taxes because of a District of Columbia holiday.)
|2.||Lower your taxable income.|
You have several options for potentially reducing your taxable income with a contribution to a tax-advantaged account up until the tax deadline. The sooner you make a contribution, however, the sooner you’ll be able to invest your contribution and give that money the chance to grow tax free.
One opportunity available to many taxpayers is a contribution to a traditional IRA. A traditional IRA contribution can reduce taxable income and, in turn, 2016 taxes for those eligible for the tax deduction.1 The tax-deductible contribution limit for the 2016 tax year is $5,500. For those who are age 50 and over, the limit is $6,500.
It isn’t necessary to have a job to have a traditional IRA. A nonworking spouse, as long as his or her spouse has taxable income up to the contribution limit, can contribute to a Roth or traditional IRA. Alimony is also considered income, so a nonworking person receiving alimony may also be able to contribute to a traditional IRA.
Self-employed individuals and freelancers can open a Simplified Employee Pension plan—more commonly known as a SEP IRA—even if they 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 your 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 2016, the contribution limit is 25% of pre-tax income (20% for the self-employed) or $53,000, whichever is lower. The deadline for 2016 contributions is the tax deadline—April 18, 2017.
|3.||Review your 2015 tax return.|
Looking back at your 2015 tax return can give you a great head start on what you’ll need in order to prepare your return for 2016. You can see which financial institutions should be sending you tax documents, which charities you might have contributed to, and which deductions you might again be eligible to claim.
Here’s another benefit to taking time to review your 2015 return: If you spot an error, you can file an amended return and possibly get back some money you thought was long gone.
|4.||Take into account significant life events.|
Got married? Had a child? Divorced? Retired? Bought a new home? All of these and many others can have a significant impact on your tax return. Be prepared for the effects they might have on your tax liability and how you file your return. Newly married couples, for example, are typically better off filing a joint tax return, but there are circumstances, such as one spouse owing back taxes or having large medical bills, when filing separately may make sense.
|5.||Make a checklist.|
After reviewing last year’s return and any significant life events from 2016, make a checklist of items you need to prepare before filing your return. By starting early, you’ll give yourself time to compile all the information you need and to explore potential tax-saving deductions and strategies. H&R Block offers a checklist as well as an option to create a customized list.
|6.||Avoid "sticker shock."|
The last thing you want is to get to the bottom line and see an unexpected large balance owed to the IRS. If you wait until the last minute to prepare your taxes, you may not have time to raise the cash for the payment. Filing for an extension won’t help. You still have to pay what you owe by the filing deadline or face a penalty and interest.
H&R Block’s Charney notes that last-minute surprises may become more common as larger numbers of Americans earn self-employment income from things such as driving for a ride-sharing service, renting out a room in their home, or performing consulting services. People engaged in these types of income-producing activities are required to pay estimated taxes throughout the year. If you’re new to self-employment and failed to make quarterly payments, you’ll probably need time to plan for any additional taxes due.
|7.||Catch errors in tax documents.|
Tax preparation software is great at filling out forms and calculating your tax liability, but it doesn’t always spot reporting errors in tax documents sent to you. Unless you catch them yourself, they could significantly impact your tax bill.
For example, suppose you received money from a lawsuit settlement or a sweepstakes prize in 2016 and it was reported on a Form 1099-MISC. The amount should appear in Box 3, “Other income,” but if the issuer mistakenly placed it in Box 7, “Nonemployee compensation,” it would be considered self-employment income and subject to an additional 15.3% self-employment tax. Another example is Box 7 on Form 1099-R, which may contain a letter or number code as well as a check box for IRA, SEP, or SIMPLE distributions. The entries can make a difference in how you report the distribution and whether it’s taxed.
If you can’t determine on your own what the proper entries should be on the forms you receive, you should consult a tax professional.
Start as soon as you can.
By starting your tax return now and giving yourself time to resolve questions and issues that might arise, you may find the process less anxiety producing and may discover some opportunities to lower your tax bill.
Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.
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