The Basics: What You Should Know as You Prepare to File Your Taxes

Hey People!

Becky the Bookkeeper here to drop some tax knowledge as you prepare to file your taxes for the 2020 tax year.

As I’m sure you've heard, the federal government has extended the federal income tax filing deadline to May 17, 2021 (from April 15th), so if you haven’t completed your federal tax return yet and need help understanding the basics, you’ve showed up to the right place.

In the U.S., we have what is called a progressive tax system. Basically, the more you make, the more they take. But if you do your homework, you will see there are a few ways to chop at the amount you owe (as you’ll see below).

While there’s a good chance you’ll also need to pay state income taxes (unless you live in a tax-free state) and local income taxes, the focus here will be on making sure Uncle Sam gets his cut.

For those of you looking to file your taxes without giving up an arm and a leg, FreeTaxUSA offers free filing for your federal tax return.

Filing Status

Your filing status is an important factor in determining what you owe. There are 5 different filing statuses you may qualify for:

• Single

• Married Filing Jointly

• Married Filing Separately

• Head of Household

• Qualifying Widower

Take a look at the 2020 federal tax brackets (the tax rates you are charged for a certain range of income) for each filing status and what is needed to qualify for each.

Your filing status at December 31st will determine your filing status for the whole year.

Income

If there’s one thing you should know, it’s that the IRS is the biggest pocket-watcher out there. In general, any time you earn a dollar, you should expect the government is going to try to get their hands on a piece of it. For this reason, it’s important you have all the paperwork handy in identifying your sources of income.

If you were employed during the previous year, you should have received a W-2 by now. If you were a contractor working for yourself, you may have received a 1099 from the company (or companies) you provided services to.

If you’re playing the game right, you should have also made some extra cash from sources outside of your day job, like interest or gains from stocks you sold during the year. Yup, you guessed it; the IRS will be coming to collect on that, too. These types of income will be reported on a 1099-INT and 1099-B, respectively.

FYI - all that money you made on Dogecoin (or other cryptocurrencies for that matter) doesn’t get to skip out on all the fun either. If you sold your cryptocurrency (or exchanged it for another type of cryptocurrency), that is considered a taxable transaction and should be reported.

Unfortunately some platforms used to purchase cryptocurrency do not keep track of your gains and losses for the year. That means you’ll need to do some number crunching on your own.

I recommend keeping a running spreadsheet of all the cryptocurrency transactions you make (if the platform doesn’t already do that for you) to help you understand what your gain or loss will be.

I understand this may be a bit confusing, so please reach out if you

would like to chat more on taxes for cryptocurrencies.

Tax Deductions (Everybody’s Favorite)

And now the moment you’ve all been waiting for…tax deductions.

Tax deductions are used to decrease your taxable income (and in turn, the amount you owe). There are 3 kinds of deductions we will focus on: above-the-line deductions, the standard deduction and itemized deductions.

Above-the-line Deductions

Above-the-line deductions are considered before all other deductions when you file your taxes, and reduce your adjusted gross income, or AGI (we will save AGI for another discussion, but just know, the lower it is the better).

Here are some common above-the-line deductions you may be familiar with:

• IRA Contribution

• Student Loan Interest

• Educator Expenses

• Self-employment

• Payment of Alimony

• Moving Expenses

• Health Savings Account Contribution

You may take above-the-line deductions regardless of whether you take the standard deduction or itemize your deductions.

Standard Deduction vs. Itemized Deductions

When it comes to the standard deduction and itemized deductions, you may choose one, but not both. Of course, the option you should go with will be the one most advantageous to your wallet.

The standard deduction is a fixed amount of money that you can deduct from your taxable income no matter what you make. Below are the standard deductions for each filing status mentioned above:

Itemized deductions, taken on Schedule A of form 1040, would have to be greater than the standard deduction in order for it to make sense. The most common itemized deductions are:

• Medical and Dental Expenses

• State, local, real estate and property taxes

• Mortgage Interest

• Gifts to Charity

• Casualty and Theft Losses

If you own a home, there’s a good chance you will choose to itemize your deductions due to the mortgage interest and property taxes you pay.

Take me for example. In 2020, I paid about $25k in mortgage interest and $5k in property taxes for the house I own. That’s about $30k of expenses that I can itemize. Compare that to the standard deduction of $12,400 (I’m a single filer) and you can see that I would be better off itemizing for 2020.

Side Hustles (Schedule C)

If you don’t have one, you should.

You can take advantage of so many more tax benefits than if you were just an employee (W2 only). Expenses such as meals, travel, office supplies and equipment, technology and rent are items you pay for that are not usually deductible when you file your taxes. With a side hustle (your own business), you can use these expenses to reduce your tax bill.

Bringing it All Together as You Prepare to File Your Taxes:

1. Understand what your filing status is. This will have implications on the amount you owe.
   

2. Make sure you have all your documents available to enter each source of income.
   

3. Check out the links above to see if you can use some of the deductions available. I know you want to keep the most money you can and knowing what you can deduct is one of the best ways to do that.