Now that April 15 is safely behind us, it’s time to start thinking about how to make tax time easier next year. I know you’d rather not think about taxes again for another 10 months, but taking a few small steps throughout the year will alleviate much of the pain.
The key to simplifying tax time is to keep track of your tax-related income and expenses throughout the year. Throwing everything into a shoe box and then trying to make sense of it later can be very difficult.
First, familiarize yourself with the categories of expenses that are deductible on a personal tax return. The IRS has a list here. As you bring home receipts, put aside those that fall into those categories, but first be sure to write on them what they were for. As I explained in Receipts, Receipts, Receipts:
“Write at the top of each tax-deductible receipt what the expenditure was for . . . This will make your life so much easier at tax time. You don’t want to wait until the end of the year and then go through a big pile of bunched-up receipts and try to remember what they were for and if it is deductible.”
Do the same thing with your monthly credit card statements, and with your canceled checks. Document this information while it is still fresh in your mind.
Now that I’ve gotten you into the habit of identifying tax deductions throughout the year, let’s take it to the next level. If you total up the amounts throughout the year, then tax reporting is simple.
One way to do this is with an Excel spreadsheet. I do this for my charitable donations. Each year, I start with a list of last year’s contributions. I insert two columns — one for this year’s donation amounts and one for the donation dates. Before I make any donations, I consult this spreadsheet to see if I’ve already given to that charity, and how much I gave last year. At the end of the year, I’ve got my charitable contributions totaled up.
Another way to keep track of the amounts throughout the year is to use a financial management program. I use Quicken for my personal finances, and QuickBooks for my business finances. Every time I bring home a receipt — tax-deductible or not — I enter into the program. It sounds like a lot of work, but it only takes a few minutes a day. For most of my accounts, I can connect over the internet and download expenses from my banks and credit card companies. Downloaded amounts will match up with receipts I’ve already entered.
What’s great about this method is that every expense has a category attached to it. The tax-related categories are already flagged. When tax time comes around each year, you can simply run a report which summarizes your expenses in each category. No pain!
What should you do with your tax-deductible receipts once you’ve captured the data in Excel or Quicken or a similar program? You’ll still need to save them in case you get audited. Created a file in your file cabinet called “Receipts” and drop them in there. Unfold them so that they are as flat as possible.
I’ve talked a lot about deductions, but what about income? In most cases, you don’t need to do much to keep track of income. In January and February of each year, most of the companies who have paid you income will mail you a form — possibly a W-2 form (wages) or a 1099 form (investment income). These amounts are also reported to the IRS. Collect these in a folder as they come at the beginning of each year, and hand them off to your accountant. It’s not necessary to hand off any monthly, quarterly, or annual statements.
If you receive any income throughout the year that does not typically result in one of those forms (for example, if you are a free-lance worker), then keep track of those the same way that you keep track of your expenses – via a spreadsheet or a financial management program like Quicken.
So take a few deep breaths to clear your head from tax time, and get started on documenting this year’s information so that you can have an easier time next year.