A Beginner's Guide To Filing Taxes In 2016

FROM FORBES.COM

Tax season has arrived—again. That means once you have the appropriate paperwork you can e-file your tax return for 2015 income. You have until Apr. 18 to file and pay. (That is not a typo. As you probably learned in school, Apr. 15 is generally Tax Day, but the deadline was pushed back this year in recognition ofEmancipation Day, a holiday observed in Washington D.C. to commemorate the signing of the Compensated Emancipation Act. Who knew?)

If this is your first time filing, welcome to adulthood. You’ll do this many times in your life, so take it slow and don’t panic. That said, if you’re an employee who has taxes withheld from your paycheck–as many first time filers are—you’re likely to be getting a refund anyway. So, really, there’s no reason not to tackle your 1040 ASAP. Paying taxes is not fun, but filing can be pretty painless.

Software

Theoretically many first-timers should be able to file free of charge with the help of software. In 2003, eager to head off free tax preparation by the Internal Revenue Service, a group of for-profit tax software companies, operating as the Free File Alliance, agreed to provide free filing for low- and moderate-income taxpayers. Each of the 13 alliance companies sets its own eligibility criteria, but anyone with 2015 adjusted gross income of $62,000 or less qualifies. (The group says about 100 million Americans meet the income criteria.)

The IRS vets the software for security and privacy standards and offers a handy Help Me Find Free File Software tool, which uses your age, estimated adjusted gross income and home state to recommend the best software for you. There are also questions about your earned income tax credit eligibility (if you’re single and childless, you can claim this credit only if you were older than 25 at the end of 2015 and had an adjusted gross income of less than than $14,820) and whether you or your spouse received military pay last year.

When determining what software is right for you, keep in mind that some participating companies will prepare state returns for free as well, while others will hit you up with a charge for state filing that can run more than $35. Also note that many “free” offerings are filled with gotchas that will force you to use pricier software. Maybe you have a health savings account or live in one state but work in another. These traps are hard to avoid, so before making plans for your expected tax refund, budget roughly $100 of it for preparation expenses.

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The tax software market is dominated by Intuit’s TurboTax program, with H&R Block a distant second. Both companies offer easy to use programs with a fair amount of explanation and produced identical results when I tested them in 2014 (which, of course, they should). The sites can even import W-2 information for you, although it is worth entering the information manually at least once so you understand what is on there. It is eye opening to see just how much is withheld from your paycheck over the course of a year.

(A W-2 reports your annual wages and the amount your employer already withheld to pay federal and state income, Social Security and Medicare taxes. Your employer sends you a copy and the IRS a copy. An IRS computer matches the information on it against your tax return—form 1040—so if the numbers on your W-2 are wrong, immediately ask for a corrected form. Ditto for any 1099s you’ve gotten reporting interest or miscellaneous income. You should receive most formsby early February.)

If you’re self-employed or do a little freelancing and have to file Schedule C, you’ll likely have to shell out for a paid version of the software. Shop around. At the start of this tax filing season, TurboTax was offering Home & Business (its most advanced personal filing option), which it claims lists for $104.99, for just $79.99, with a note that prices were expected to  increase on Mar. 18. That online price includes only preparation and e-filing of your federal return; preparing and filing your state return will cost you an extra $36.99. (Prices will vary. TurboTax seems to offer lower prices on computers that have recently spent time on its site.) On the other hand, Amazon was selling downloads of TurboTax Home & Business for $64.85, and that includes access to software for one state. (You’ll still have to pay extra to e-file your state return, but to save $36.99, you can print it out and mail it in.) If you have investments, including a 401(k) from work, find out if your broker or mutual fund company offers discounted access to TurboTax or others, and if so, which versions.

A cheaper option is the third-largest player in the market, TaxAct, which offers free federal filing no matter what forms you must fill out. It charges just $19.99 for a “premium” version, with state filing costing $14.99. H&R Block charges $49.99 for its “premium” online version and $36.99 per state return filed.

As your return gets more complicated—say you’re self-employed and pay other independent contractors, make extra cash via Airbnb or Grandma left you some shares in partnerships that generate indecipherable Schedule Ks—you may want to consider upgrading to human advice. “I would caution people,” says Clarence Kehoe, head of the tax department at accounting firm Anchin Block & Anchin. “Under the old garbage in, garbage out scenario–the information you get out of that computer is going to be as good as the information you put in. You have to be careful.”

Hiring a pro can run into hundreds of dollars. “Most people who are starting out really can’t justify going to a tax preparer,” argues Margaret Starner, a financial advisor with Raymond James. But for people who feel they need guidance beyond what software (or their parents) can provide, she recommends going to a preparer one year, and then, after seeing how a pro does it, using that example to do it yourself in the future. “You should understand every line on your return,’’ Starner says. (Or at least have a good enough idea that if you enter something wrong in TurboTax, you’ll be able to notice when it spits errors.)

Be careful whom you hire—here are 11 questions to ask when hiring a tax preparer. Ultimately your tax return is your legal responsibility and neither “my tax pro was a dishonest idiot” nor “the software didn’t ask me” is a valid excuse for excluding income or grabbing deductions and credits you’re not entitled to. (You really don’t want to mess with the IRS; you could waste the best years of your life on hold waiting to plead your case with a human being and if you let problems fester you could be hit with tax liens that sink your credit score for years.) On the flip side, if you don’t know what you’re doing or skip sections in the software you could miss out on a bigger refund. The IRS won’t mind, but your wallet will.

For more read Kelly Phillips Erbs’, “A Beginner’s Guide To Taxes: Do I Need To Hire A Tax Preparer Or Can I Do My Return Myself?”

Deductions and Credits

Deductions lower the amount of money you are required to pay tax on, and may even help you move into a lowertax bracket. Credits, on the other hand, cut your tax bill dollar for dollar. They are more valuable, but also rarer.

Exclusions and above the line deductions: On the W-2 you get from an employer, your gross pay will likely be higher than the W-2 wages that you’ll have to report to the IRS. That’s because certain amounts–such as what you contributed to a 401 (k) before tax, or paid for your health insurance, or contributed to a health savings account–aren’t subject to income tax right now, if ever. In addition you may be able to claim other “above the line” adjustments to income and deductions–they’re called that because they reduce your income before you get to adjusted gross income on line 37 at the bottom of the first page of a 1040.

(For more on why gross pay differs from what you take home read, “The Most Important Financial Document You Are Probably Ignoring“)

For example, if you don’t have a 401(k) at work, you may be able to deduct up to $5,500 above the line for a contribution to a pre-tax IRA. If you are self employed, you have a choice of retirement savings plan options that can reduce your gross income above the line.

Up to $2,500 in student loan interest payments can also be subtracted from your gross income. You can claim the deduction as long as the loan is in your name regardless of who paid the interest but the student loan deductions begin to phase out if your AGI (before the student loan deduction) is more than $65,000 for a single filer (or $130,000 for a couple). If you’re planning to get married watch out for what we are calling, “the Millennial marriage tax penalty”—you can only claim one $2,500 deduction, even if and your spouse both have big student loans.

Itemized/standard deductions: After determining your AGI, there are two options for further reducing your taxable income by at least $6,300 (assuming you’re no longer on your parents return, which recent grads may be). That magic number is the 2015 standard deduction for a single filer, which the government gives to people who don’t itemize or to people whose itemized deduction adds up to less than $6,300. Itemized deductions can include state and local non-business income taxes, property taxes, charitable donations, mortgage interest expenses and medical expenses (but only to the extent that they exceed 10% of your AGI).

Homeowners can easily cross the itemization line with mortgage interest deductions, but according to the Census Bureau’s most recent American Housing Survey the home ownership rate among households headed by people between 25 and 29 was 34% as of the 2013 and only 15% for the under 25 set, meaning most first time filers are unlikely to be itemizing deductions. Charitable giving is another popular deduction, but Millennials give away $481 a year on average according to a 2013 report from non-profit service provider Blackbaud, which doesn’t put them anywhere near the itemization threshold.

“Unless you are in Silicon Valley making $300,000, you are not going to have a lot of opportunities for tax breaks at this young age,” says Starner. “If you are making $30,000 or $40,000, that is not insignificant money, but there is not as much as you can do because you haven’t yet developed the expenses of itemized deductions – like a home.”

Software tools will walk you through an interview to roughly determine if you will hit the mark. If you have held onto papers throughout the year this process will be much easier; even if you know you won’t hit the number, going through this deduction exercise can help inform your tax planning going forward.

Credits: If you receive a $1,000 tax credit, $1,000 will be removed from your tax bill. They’re pretty sweet deals – but 20-somethings won’t qualify for most credits. The big exceptions are two types of education credits; students in their first four years of higher education may be able to claim an American Opportunity Credit which is worth up to $2,500. To claim the full credit you need to have paid your qualified education expenses, be attending school at least half time, be working on your first bachelor’s degree and have earned less than $80,000 as a single.

Students, who have already completed four years of college or people enrolled in too few eligible courses, may be able to claim a Lifetime Learning Credit worth up to $2,000. To claim the full credit you must make less than $52,000 as a single. Note that this is only a 20% credit; to save $2,000 you would have to pay $10,000 on qualified expenses.

Additionally, individuals making less than $30,500 and saving for retirement may be able to claim a savers credit of up to $2,000 depending on how much they put into qualified retirement savings funds. (For more on saving for retirement in your 20s read, “Start Now: A Step By Step, Tough Love Guide To Saving For Retirement In Your 20s.”)

Health Insurance

A major head scratcher for tax payers and pros for the last few years has been the implementation of the Affordable Care Act (a.k.a. Obamacare), with different tax requirements rolling out each year.

If you had employer provided health insurance throughout 2015 all you’ll do is check a box. On a standard 1040 this box is at line 61. Whatever form you are using look for “Health care: individual responsibility … Full-year coverage.” Same goes if you bought your own insurance on the Health Insurance Marketplace and paid full price or if you bought insurance privately. This is also true if you are still on a parent’s insurance plan as a non-dependent, which is allowed until age 26. (If you are claimed as a dependent – under 19 or a full time student under age 24 – do not check the box.)

Employees will receive a form 1095 – B or C depending on employer size – but you just need to file that away. The IRS recommends keeping tax records for three years from the date you filed your original return. Your employer is not required to get this form to you until the end of March so employees don’t need to wait to file unless you have had gaps in your coverage (and don’t panic if you get this form after filing).

If you bought insurance on a Health Insurance Marketplace do not file your taxes until you have received your Form 1095-A from your insurance company. You need this form to determine if you are entitled to more or less credit than you received. If you file without this form you may need to file an amended paper return. Refunds on paper returns can take six or more weeks compared to as little as seven days if you file online and use direct deposit.

If you do not have coverage or did not for a portion of 2015 you will need to fill out a form 8965. You will use this to determine if you are eligible for an exemption from the coverage requirement or to figure out the penalty you owe. This is where things get complicated. For more details read, “What To Do With New ObamaCare Forms 1095-B, 1095-C For 2016 Tax Filing Season”

State and Local Taxes

Unless you live in one of the seven states with no state income tax – this is the real reason your grandparents moved to Florida – you’ll need to file a state return by Apr. 18 in addition to your federal return. A few states have slightly later deadlines but it is easiest to knock out both your returns at once.

At the same time don’t assume that the rules governing your state return are the same as the rules you followed while completing your federal return. For example, health savings account contributions are an above the line deduction for federal taxes but are not deductible in Alabama, California or New Jersey. Presumably, if you’re using software, it should alert you to that fact.

If you moved to a new state in 2015 you’ll need to file part-year state returns for each state. If you moved from one job to another this is simply a matter of inputting the income listed on your W-2 for job A on the tax return for state A, and the income for job B on state return B. You can also take above the line deductions for certain moving expenses if you relocate for a job 50 miles farther from your old home than your previous job.

If you moved states but work for the same company find the pay stub from right before you moved and input your year-to-date income on the return for state A. Input the remainder for state B. If you finished college in 2015, moved to a new state and did not earn any income while you were still a student you likely do not need to file a return for the state where you attended college.

Remember to inform your employer if you’ve moved — especially between states — so they can withhold the proper amount for state taxes if needed. This can get tricky if you live in a different state than your workplace is located in. How tricky will depend on your employer’s tax situation and on if the two states have reciprocity agreements. Also inform your employer if you have moved within state, this will ensure not only that you receive your tax forms (though some employers now make these available online) but also that you are withholding the right local tax. If, for example, you move from a suburb of New York City to Manhattan you might pay a higher local tax post move.

A Note to Procrastinators

It may be tempting to wait to pay your taxes. Many people who will owe the IRS money do this to hold onto the dollars for longer. (Ask your parents to tell you about the long lines at the US Postal Service before the advent of online filing.) But the IRS takes deadlines very seriously–or at least those it imposes on taxpayers, if not itself. If it is Apr. 17 and you still haven’t gotten your tax act together you can get an automatic six month extension by filing form 4868. But you’ll still have to fill out that form and pay all you estimate you owe by Tax Day.