Most people that prepare their own returns need someone to review it for errors or omissions. Here is a step-by-step technique you could follow.
Tax Comparison Schedule
- When your tax return is completed, you should review the tax comparison schedule your software provides for differences. Look at every line and compare this year’s amounts with last year’s. Make sure you understand the reasons for any differences between the two years. If your salary increased, then the difference should be easily understood. However, if you had three W-2s last year and this year you only reported two, then perhaps you did not receive the third W-2, or you quit that job during the prior year. Do the same with every line item.
- If there is no tax comparison worksheet or if you prepared your return by hand, then prepare your own schedule. You can do this on a spreadsheet or write it out on a pad. Make sure to account for every line item.
- If you have a complicated tax return and the tax comparison schedule is inadequate, then you should prepare your own schedule, and I suggest using spreadsheet software. I consider a return complicated if you have more than one self-employment business or rental real estate property, receive even one Schedule K-1, have foreign income, extensive capital gain transactions or tax credits. When you prepare this schedule, I suggest having columns for the last three years and the past year and comparing the four years’ amounts. You could possibly add a column for a projection for the current year. You can enter in the projection column amounts you expect that will be different from last year. You can also use that to calculate estimated tax payments.
- When you get to the bottom-line tax amount, the difference in tax should be roughly similar to the top tax bracket you are in multiplied by the change in taxable income from last year. If you have dividend income or long-term capital gains, this would be harder. If you have self-employment income, then you also have to check for the Qualified Business Income deduction and self-employment tax.
- Once the tax amount is verified as being accurate, then look at the balance due or refund and see how that compares to last year. The differences should primarily be a function of your withholding and estimated tax payments. Look to understand why there are significant differences from last year.
- This process should also include state and local income taxes.
- Part of this review should include separate schedules of gross capital gain sales and withholding estimated tax payments to compare to the amounts reported on the tax return. These schedules should be prepared from the original data and not from what you entered on your tax return.
- This process seems like a lot of effort, and it is if you have a complicated tax return. However, it is a method to make sure you prepared your return properly and did not make any errors. It is also a fine mechanism to help you better understand your income, deductions and tax situation. No matter what your status, your income tax is a substantial amount of your overall income. Why not understand it better?
Tax Instruction Booklets
- You should read the IRS and State instructions for any line entry you do not understand. The instruction books usually have line-by-line info and are excellent.
- Even if you have no reason to check the instruction book, I suggest skimming through it to see if anything catches your eye that might apply to you.
Tax Planning
- When this process is completed, take another look at the tax comparison summary and ask yourself if anything could be done to save taxes on what you reported. An example is: if you have self-employment income, did you take advantage of retirement account deductions, and did you deduct any health insurance premiums that self-employed people can? If you are employed, did you max out on your employer’s matching amount of your 401k deductions or your employer’s medical plan salary reduction?
- There are some excellent books that you can buy with great explanations as well as searching specific topics on the Internet.
- Of course, if you have a complicated situation, should use a professional tax preparer.
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