When tax time comes, most of us have paid, or will pay, a substantial amount in tax and we do it with a feeling that it’s our obligation but always wonder if we’re paying too much. We hear about others who have substantially larger incomes than we do who are paying the same amount, or even less and wonder if we’re missing something. And usually the answer is “yes." Most of us are paying too much in tax.
Of all the areas of law, the Tax Code may be the most confusing. The “Code," as it’s often referred to, requires so many volumes of text that it would fill a good sized house. And unlike other areas of the law where most of the time you don’t need an expert, the Tax Code has thousands of provisions that may benefit you but they’ve not been reported in the news or show up in the tax preparation software so you’ll never know about them. And as a result, most Americans pay more than they need to in federal tax. And if you live in a state that also has a tax, it’s probably based on the federal tax so you’re paying too much, twice!
So how do you know if you’re paying too much? And more importantly, how can you find out how much less you could pay? Because the Code is so complicated and every situation is a little different, those aren’t easy answers. But there are some general guidelines that will help you get a sense for the answers.
First, start with your bank account. Is it larger in December than it was in January? If so, then you probably made money that wasn’t consumed by living and other expenses so your tax return will probably show that and you’ll owe some tax. But if that wasn’t the case but your return still says you owe a lot of tax, then something’s probably wrong. And don’t be fooled into thinking everything’s OK just because you don’t have to send in a payment when the tax return is submitted. If it was withheld from your income, you paid it. Look at the total amount withheld and paid on the return. That’s money you earned, and then had to pay in tax. If it’s sizeable (more than a few thousand dollars in most cases) and your own bank account didn’t grow during the year, then it’s probably too large.
Second, look at your expenses. Are most of them reflected on your return and do they count towards reducing your overall income? A few expenses will never be tax deductible. Things like basic groceries, basic utilities (electricity, water, sewer), and personal hygiene/underwear will almost never be tax deductible. But everything else might be. And that’s the important part. EVERYTHING else might be. So if your return doesn’t reflect the cost of just about everything else as a deduction on your return then you’re likely to pay too much in tax.
Third, ask a tax professional. Seems simple but far too many don’t. We often perceive that using a tax professional costs money and is more inconvenient than putting the figures into a software program. But far too often that’s flawed thinking. If you’re paying $4,000 to $5,000 in tax each year but using a tax professional could reduce this by 50% then spending even $1,000 on the tax professional’s fees makes economic sense. Spend a little time talking to a few tax pros to get a sense of the fees and compare that to what you’re paying in tax. If there’s room to pay the fees and still have a savings then try it.
You should also know that all tax professionals are not created equal. Preparing a tax return requires knowledge of the Code, an understanding of business and finance, and a grasp of the administrative requirements of submitting tax returns. It also helps to have a pretty good sense of what triggers a tax audit and what doesn’t. Most tax preparers may understand one or two of these areas. You’re looking for someone who understands ALL of them. No one wants to be a part of a tax audit but 95% of the returns are prepared so that they WILL result in an audit. That’s because the person preparing the tax return is a tax preparer, not a tax professional. There’s a difference so pay attention to who’s doing your taxes and make sure it’s someone that understands all the dimensions of tax.
Whatever you do, take a serious look at your last few returns. If you’re paying very much in tax, you may be paying too much. Review your savings and expenses. And don’t be afraid to ask a tax professional for help. Spending a little time evaluating may result in some very pleasant surprises you weren’t expecting