Advertising
Advertising

Taxes: 10 Terms You Should Know If You Want to File By Yourself This Year

Taxes: 10 Terms You Should Know If You Want to File By Yourself This Year

If you want to prepare and file your own tax return, you’re not alone. More than 27 million people did their own taxes[1] in 2014, a nearly 6 percent increase from the year before.

However, joining the 27 million-person-strong tax preparers and filers around the United States doesn’t mean that understanding your taxes is easy. Taxes can be daunting, especially if you don’t know the terms.

To help, here’s a list of 10 tax terms that you need to know if you’re doing your taxes yourself this year.

Adjusted Gross Income

Your adjusted gross income (AGI),[2] sometimes referred to as gross income, refers to all the income you’ve received in the year. This includes income you’ve earned, such as wages and income you may have received because of owning stocks, bonds or money market accounts. Interest, dividends and capital gains all fall into this category.

Advertising

The “adjusted” part of AGI comes in because you can subtract certain items from the income you’ve received. Contributions to an IRA, for example, might be subtracted, along with alimony costs. Be sure to read the fine print for what you can subtract. AGI is an important step in determining how much you owe.

Tax Deductions

Deductions are amounts of money that you can subtract from your AGI. They come in two forms: standard and itemized. The key to deductions is that they lower your AGI so that you do not have to pay as much tax. In general, the lower your income, the less tax you have to pay. So if, for example, you’ve earned $40,000 in a year and have a $9,000 tax deduction, you’ll only pay tax on $31,000, not the entire $40,000.

The Internal Revenue Service (IRS) lists a certain number of deductions right on the Form 1040A or longer and more detailed Form 1040. These include student loan interest, deductible individual retirement accounts contributions, alimony payments and moving expenses.

Standard Deductions

The IRS is the agency that determines tax code. Every year, all tax filers get a standard deduction. The standard deduction is an amount that you can deduct from your AGI to lower your taxes. The amount of standard deduction for the year will be given in the IRS instructions for 1040 and 1040A. The standard deduction depends on your income and is usually given in a table. The IRS adjusts this figure every year for inflation.

Advertising

Itemized Deductions

You can deduct items such as mortgage interest, state, local and property taxes, medical expenses, travel expenses if for work or medical needs, charitable contributions, casualty and theft losses and more from your AGI as well.

Note that in some states, medical expenses must exceed a certain percentage of your AGI. It’s a good idea to keep track of your expenses[3] so you know what your medical expenses, including health insurance deductibles, totaled for the year. These are called “itemized deductions” because they need to be itemized, on Schedule A of Form 1040.

If your itemized deductions equal more than the IRS’s standard deduction in a given year, it’s good tax news for you, as you’ll have to pay tax on less of your AGI. You can take itemized deductions or the standard deduction in a given year, not both. Be sure to read the fine print about what’s allowed as an itemized deduction and how much.

Exemption

An exemption is an amount the IRS allows you to subtract from income to reflect people who share your household and may depend on you for income. You can take exemptions, for example, for yourself, any dependents and your spouse. A fixed amount of money is provided for every exemption. You’ll subtract the amount of all exemptions, including for yourself, from your AGI to arrive at your taxable earnings.

Advertising

Withholding

Withholding refers to the amount of money taken out of your wages or other income as you earn it, but before you get your paycheck. Paycheck stubs will list the amount of withheld money and what it’s for. Employers withhold taxes for Federal, state and local tax, as well as Social Security.[4] The withholdings go  to your tax accounts. For example, your Federal taxes go into an IRS account.

When you calculate your taxes, you’ll arrive at the taxes you owe for the year. The final step is to subtract any taxes that have already been withheld. These are given on your W-2 and other income forms. If you owe $10,000 in Federal tax, for example, and have had $9,800 in Federal tax withheld from your paycheck, you’ll owe just $200 when you file. If you owe $10,000 in Federal tax and you have $10,100 withheld, you’ll receive a Federal tax refund of $100.

Tax Credits

You can compare tax credits to credits from a store. After you calculate your tax bill, you can use tax credits to reduce the amount you owe.[5] They’re more valuable to the individual taxpayer than deductions because they reduce the amount of tax itself, rather than just the amount of taxed income.

If you have a $1000 tax credit and owe $10,000 in taxes, you’ll end up owing $9,000 instead. You may receive tax credits for some educational programs and home solar power installation, for example. These are revised every year, so be sure to read the IRS’s information about available tax credits carefully.

Advertising

Taxable Income

Taxable income refers to your total before tax — or gross — income with every allowable deduction, exemption and adjustment subtracted. Taxable income is the final step in determining how much you owe in taxes.

Basis

If you have stocks, you’ll need to know its basis. Any asset’s basis is the value original paid for it. If you’ve sold stocks this year, you’ll need to know what you paid originally, in order to calculate the gain or loss upon sale. You’ll then use those gains or losses to calculate your tax.

Capital Gains

Capital gains refer to any profit you made from selling a capital asset. Real estate, stocks and bonds are all examples of capital gains. You’ll have to pay capital gains tax on the profit from sale. If you sold at a loss, the loss can generally be deducted.

Doing your taxes yourself may seem like a daunting task, but understanding the language is half the battle. Now you’re ready to get a head start on tax season!

Reference

More by this author

Anum Yoon

Writer & Journalist

Taxes: 10 Terms You Should Know If You Want to File By Yourself This Year Weird Laws Around the World That You’ve Never Heard Of Six Unconventional Ways to Become a Homeowner 10 Underrated Netflix Movies And Shows To Binge Watch During The Cold Weather Can Self-Driving Cars Be Ethical?

Trending in Money

1 How to Set Financial Goals and Actually Meet Them 2 25 Killer Sites For Free Online Education 3 10 Recession-Proof Debt Consolidation Tips 4 The Definitive Guide to Get out of Debt Fast (and Forever) 5 25 Easy Tips on How to Save Money Fast

Read Next

Advertising
Advertising
Advertising

Last Updated on September 2, 2020

How to Set Financial Goals and Actually Meet Them

How to Set Financial Goals and Actually Meet Them

Personal finances can push anyone to the point of extreme anxiety and worry. Easier said than done, planning finances is not an egg meant for everyone’s basket. That’s why most of us are often living pay check to pay check. But did anyone tell you that it is actually not a tough task to meet your financial goals?

In this article, we will explore ways to set financial goals and actually meet them with ease.

4 Steps to Setting Financial Goals

Though setting financial goals might seem to be a daunting task, if one has the will and clarity of thought, it is rather easy. Try using these steps to get you started.

1. Be Clear About the Objectives

Any goal without a clear objective is nothing more than a pipe dream, and this couldn’t be more true for financial matters.

It is often said that savings is nothing but deferred consumption. Therefore, if you are saving today, then you should be crystal clear about what it’s for. It could be anything, including your child’s education, retirement, marriage, that dream vacation, fancy car, etc.

Once the objective is clear, put a monetary value to that objective and the time frame. The important point at this step of goal setting is to list all the objectives that you foresee in the future and put a value to each.

2. Keep Goals Realistic

It’s good to be an optimistic person but being a Pollyanna is not desirable. Similarly, while it might be a good thing to keep your financial goals a bit aggressive, going beyond what you can realistically achieve will definitely hurt your chances of making meaningful progress.

It’s important that you keep your goals realistic, as it will help you stay the course and keep you motivated throughout the journey.

3. Account for Inflation

Ronald Reagan once said: “Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hitman.” This quote sums up what inflation could do your financial goals.

Therefore, account for inflation[1] whenever you are putting a monetary value to a financial objective that is far into the future.

For example, if one of your financial goal is your son’s college education, which is 15 years from now, then inflation would increase the monetary burden by more than 50% if inflation is a mere 3%. Always account for this to avoid falling short of your goals.

Advertising

4. Short Term Vs Long Term

Just like every calorie is not the same, the approach to achieving every financial goal will not be the same. It’s important to bifurcate goals into short-term and long-term.

As a rule of thumb, any financial goal that is due in next 3 years should be termed as a short-term goal. Any longer duration goals are to be classified as long-term goals. This bifurcation of goals into short-term vs long-term will help in choosing the right investment instrument to achieve them.

By now, you should be ready with your list of financial goals. Now, it’s time to go all out and achieve them.

How to Achieve Your Financial Goals

Whenever we talk about chasing any financial goal, it is usually a two-step process:

  • Ensuring healthy savings
  • Making smart investments

You will need to save enough and invest those savings wisely so that they grow over a period of time to help you achieve goals.

Ensuring Healthy Savings

Self-realization is the best form of realization, and unless you decide what your current financial position is, you aren’t heading anywhere.

This is the focal point from where you start your journey of achieving financial goals.

1. Track Expenses

The first and the foremost thing to be done is to track your spending. Use any of the expense tracking mobile apps to record your expenses. Once you start doing it diligently, you will be surprised by how small expenses add up to a sizable amount.

Also categorize those expenses into different buckets so that you know which bucket is eating most of your pay check. This record keeping will pave the way for cutting down on un-wanted expenses and pumping up your savings rate.

If you’re not sure where to start when tracking expenses, this article may be able to help.

2. Pay Yourself First

Generally, savings come after all the expenses have been taken care of. This is a classic mistake when setting financial goals. We pay ourselves last!

Advertising

Ideally, this should be planned upside down. We should be paying ourselves first and then to the world, i.e. we should be taking out the planned saving amount first and manage all the expenses from the rest.

The best way to actually implement this is to put the savings on automatic mode, i.e. money flowing automatically into different financial instruments (mutual funds, retirement accounts, etc) every month.

Taking the automatic route will help release some control and compel us to manage what’s left, increasing the savings rate.

3. Make a Plan and Vow to Stick With It

Learning to create a budget is the best way to get around the uncertainty that financial plans always pose. Decide in advance how spending has to be organized

Nowadays, several money management apps can help you do this automatically.

At first, you may not be able to stick to your plans completely, but don’t let that become a reason why you stop budgeting entirely.

Make use of technology solutions you like. Explore options and alternatives that let you make use of the available wallet options, and choose the one that suits you the most. In time, you will get accustomed to making use of these solutions.

You will find that they make it simpler for you to follow your plan, which would have been difficult otherwise.

4. Make Savings a Habit and Not a Goal

In the book Nudge, authors Richard Thaler and Cass Sunstein advocate that, in order to achieve any goal, it should be broken down into habits since habits are more intuitive for people to adapt to.

Make savings a habit rather than a goal. While it might seem to be counterintuitive to many, there are some deft ways of doing it. For example:

  • Always eat out (if at all) during weekdays rather than weekends. Weekends are more expensive.
  • If you are a travel buff, try to travel during off-season. You’ll spend significantly less.
  • If you go shopping, always look out for coupons and see where can you get the best deal.

The key point is to imbibe the action that results in savings rather than on the savings itself, which is the outcome. Focusing on the outcome will bring out the feeling of sacrifice, which will be harder to sustain over a period of time.

Advertising

5. Talk About It

Sticking to the saving schedule (to achieve financial goals) is not an easy journey. There will be many distractions from those who are not aligned with your mission.

Therefore, in order to stay the course, surround yourself with people who are also on the same bandwagon. Daily discussions with them will keep you motivated to move forward.

6. Maintain a Journal

For some people, writing helps a great deal in making sure that they achieve what they plan.

If you are one of them, maintain a proper journal, where you write down your goals and also jot down the extent to which you managed to meet them. This will help you in reviewing how far you have come and which goals you have met.

When you have a written commitment on paper, you are going to feel more energized to follow the plan and stick to it. Moreover, it is going to be a lot easier for you to track your progress.

Making Smart Investments

Savings by themselves don’t take anyone too far. However, savings, when invested wisely, can do wonders.

1. Consult a Financial Advisor

Investment doesn’t come naturally to most of us, so it’s wise to consult a financial advisor.

Talk to him/her about your financial goals and savings, and then seek advice for the best investment instruments to achieve your goals.

2. Choose Your Investment Instrument Wisely

Though your financial advisor will suggest the best investment instruments, it doesn’t hurt to know a bit about the common ones, like a savings account, Roth IRA, and others.

Just like “no one is born a criminal,” no investment instrument is bad or good. It is the application of that instrument that makes all the difference[2].

As a general rule, for all your short-term financial goals, choose an investment instrument that has debt nature, for example fixed deposits, debt mutual funds, etc. The reason for going for debt instruments is that chances of capital loss is less compared to equity instruments.

Advertising

3. Compounding Is the Eighth Wonder

Einstein once remarked about compounding:

“Compound interest is the eighth wonder of the world. He who understands it, earns it… He who doesn’t… Pays it.”

Use compound interest when setting financial goals

    Make friends with this wonder kid. The sooner you become friends with it, the quicker you will reach closer to your financial goals.

    Start saving early so that time is on your side to help you bear the fruits of compounding.

    4. Measure, Measure, Measure

    All of us do good when it comes to earning more per month but fail miserably when it comes to measuring the investments and taking stock of how our investments are doing.

    If we don’t measure progress at the right times, we are shooting in the dark. We won’t know if our saving rate is appropriate or not, whether the financial advisor is doing a decent job, or whether we are moving closer to our target.

    Measure everything. If you can’t measure it all yourself, ask your financial advisor to do it for you. But do it!

    The Bottom Line

    Managing your extra money to achieve your short and long-term financial goals

    and live a debt-free life is doable for anyone who is willing to put in the time and effort. Use the tips above to get you started on your path to setting financial goals.

    More Tips on Financial Goals

    Featured photo credit: Micheile Henderson via unsplash.com

    Reference

    Read Next