Do the words "tax return" send shivers down your spine because you always end up with a gigantic headache and little or no tax refund at the end? Maybe the problem is in preparation and planning – or lack of it. Tax law is complicated, and it takes a coordinated, sustained effort to optimize your refund. Let these nine tips help you acquire the best refund possible.
1. Don't Delay – The IRS doesn't start processing forms for the 2020 tax year until February 12, 2021, but that doesn't mean you have to wait until right before this year's deadline of May 15. If you need motivation, think of what you can do with a tax refund windfall. The sooner you file, the sooner you can put your refund to use. Two other reasons to avoid procrastination: the earlier you begin, the more time you'll have to locate any missing documents and data; and the sooner you file, the harder it is for a tax identity thief to target you.
2. Contribute to Retirement Plans – Retirement plans allow you to build a tax-deferred nest egg while lowering your taxable income for the year. Max out your 401(k) and traditional IRA contributions if you can. The limits for a 401(k) are $19,500 for tax year 2020 and 2021, plus an extra $6,500 catch-up contribution if you are over 50. IRA limits for both 2020 and 2021 are $6,000 with a $1,000 catch-up contribution.
3. Review Possible Deductions – The Tax Cuts and Jobs Act (TCJA) raised the standard deduction in 2018 and placed new limits on some deductions, making it less likely that itemizing makes sense. Review the remaining itemized deductions in the Schedule A instructions and look for the "above the line" deductions on Form 1040 – these deductions subtract from your adjusted gross income and you don't have to itemize to take them.
4. Check Qualification for Tax Credits – Pay special attention to any tax credits for which you qualify. Tax credits are even more valuable than tax deductions because they subtract directly from your tax bill, while tax deductions only reduce your tax bill in proportion to your tax rate.
Refundable tax credits are the most valuable of all, as they can provide a refund in excess of the tax that you owe. Most credits, like the Earned Income Tax Credit, are targeted at helping low-income taxpayers who need the most help.
5. Get Organized – Do you have all of your tax documents in order? Start with the forms necessary for this year's filing – W-2 forms from employers, all varieties of 1099 forms that show income and assets, your 1095 form for proof of health insurance, and last year's tax form. If you plan to itemize deductions for things like charitable contributions, make sure you have the necessary receipts and paperwork to back up the deductions.
6. Use Helpful Software – If you plan to do your own taxes, there are many fine software packages to choose from that can guide you through the filing process. Check into your options, look for online reviews to see how previous customers have fared and select the software option that best fits your needs and cost limitations. If you can't afford any software, the IRS Free File system may be able to help.
7. Review Changes – Take the time to review the summary of the changes made by the TCJA in the "What's New" section of the Instructions for Form 1040 and see how they will affect your 2020 filing.
8. Adjust your Withholding – Review your withholding rate to make sure you are paying the right amount of taxes throughout the year. That's especially important given the new tax brackets that took effect in 2018. If you miscalculated your new tax bracket last year, change your withholding rate now to correct it for tax year 2020.
While a refund is nice, don't go overboard in your withholding. A refund is essentially the government returning your overpayment in taxes throughout the year. You could be putting that money to work yourself instead of letting the government hang on to it tax-free.
9. Seek Help If Necessary – Tax laws can be confusing. If your tax situation is complex and you don't have the time, patience, or ability to maximize your tax return, seek the advice of a competent tax professional – but do your research first and be skeptical of broad claims. Anybody who can guarantee you the highest refund without reviewing your individual situation is probably stretching the truth.
Armed with these tips, you can prevent those tax-time headaches with the best cure possible – a nice fat tax refund. It's more effective than aspirin.
Failing to pay your taxes or a penalty you owe could negatively impact your credit score. You can check your credit score and read your credit report for free within minutes by joining MoneyTips.