The easiest way to start personal tax planning

an excerpt from Yes, But… Tax Planning for Solopreneurs by Debbie Evans, Enrolled Agent

Good Recordkeeping is Vital

If you want to minimize the amount of money you owe to the IRS each year, you will want to minimize any penalties and interest that could be added to your tax. To do this, you must keep good records of your financial transactions and follow the required recordkeeping rules.

Without good records, you could miss out on deductions simply because you don’t remember them the following tax season. Or, you could be unable to claim them because you don’t have the appropriate back up to prove the deduction.

Your odds of being audited are in your favor, but you should still file your return as if you will have to defend it in front of an auditor. You are legally responsible for the claims you make on your return for income and for deductions/credits. You must have proper backup as required by law for every deduction you take. You don’t need to submit most backup to the IRS with your return, but you are attesting that you have it.

I will be blunt. If you are unwilling to take the minimal effort required to be able to take these deductions and do effective tax planning, then you should probably not continue with this program.

In this book, I will teach you a wide variety of tax strategies and how to claim them. These strategies have been proven in court cases over the years. If a strategy is risky, I will tell you. Risky does not mean it’s illegal or unethical. It means that you might have a higher chance of having to prove it to the IRS.

I often have clients come to me and tell me that they’ve heard about an amazing deduction that will save them a lot of money. Usually, this advice comes from a friend who has no idea what they’re talking about, or, worse, from a TikTok video. I like to use the “Giggle Test” test.

Could you sit in front of an IRS auditor and tell them that you believe this is a legitimate deduction while keeping a straight face?

Honestly, when you get past the excitement of potential savings and think about it, many of these strategies just don’t sound right. The Tax Code is generous, but it’s not ridiculous. One I heard recently: if you put an advertising wrap on your personal car, you can fully deduct your car. Nope. You can deduct the cost of the wrap as an advertising expense. And you can deduct the business use of your car as if there wasn’t a wrap on it.

Just because someone who knows someone who got away with an illegitimate tax deduction does not mean that you will. If you come across something that sounds amazing but out there, just ask me. I’ll tell you the truth.

Most Common Penalties and Interest That You Can Avoid

Even a relatively small balance owed can balloon quickly. Say you owe the IRS another $1,000, but don’t file your return or pay the money for six months past the original due date. Your bill could grow to at least $1,615.

 The IRS assessed $37.3 billion in civil penalties in FY 2021. Of this, $17.1 billion was assessed in civil penalties on individual and estate and trust income tax returns

Failure to Pay Penalty

Tax payments are due by April 15, even if you get an extension to file until October 15. If you’ve had appropriate withholding or estimated tax payments throughout the year, you probably don’t need to worry about this. If your income is substantially higher than the previous year or if you did not pay in enough tax for self-employment or investment income, then you should look at making a payment when you file your extension prior to April 15. Penalty is 0.5% on your outstanding balance for every month or part of a month that you’re late. The longer you wait to pay, the greater the penalty, although the maximum penalty here is also capped at 25% of your outstanding balance. Your penalty rate could go up to 1% a month if you’ve been very delinquent and do not repay what’s owed within 10 days of getting a Notice CP504 from the IRS. That notice informs you that if you don’t pay what you owe, the agency will levy your bank account, wages or state refund to settle your account.

Failure to File Penalty

This penalty applies if a taxpayer doesn’t file by the April 15 deadline and also fails to file an extension or files an extension but doesn’t file by October 15. This penalty is larger than the failure to pay penalty, and is added to the failure to pay penalty, so even if you can’t pay your taxes, be sure to file by the deadline. Penalty is 5% of the unpaid tax you owe for each month or part of a month that your return is late. Max 25%. With smaller balances, you’re likely to pay more than 25% because you’ll be hit with a minimum penalty that applies when you’re more than 60 days late. That minimum is set at $435 or 100% of your tax due, whichever is less. So, on a $1,000 balance, you’d owe $435 at the six-month mark just for not filing on time.

Penalty for Underpayment of Tax

We have a pay-as-you-go tax system. Taxes are due to be paid as income is received throughout the year, with all taxes due by April 15. If you’re an employee, your employer takes care of this on your behalf. If you are self-employed or receive substantial investment income throughout the year, you are required to pay estimated taxes during the year by December 31. If you don’t pay at least 90% of your taxes by December 31, or 100% of what you owed the previous year (110% if you made over $150K), even if you pay your total taxes by April 15, you could receive this penalty. Typically, underpayment penalties are 5% of the underpaid amount, and they're capped at 25%. Underpaid taxes also accrue interest at a rate that the IRS sets annually.

Interest is also applied to all owed and unpaid tax.

Simply by ensuring you have adequate withholding and/or make estimated tax payments, you can avoid paying substantial penalties and interest to the IRS. Whatever you get hit with, until you pay your tax bill in full, interest will continue to accrue on both your unpaid tax balance and even on the subsequent penalties that get added to your tab if they go unpaid. The IRS adjusts its interest rates quarterly – and sets them at the federal funds rate, plus 3%.

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The Fine Print

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction. IRS Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in the entries in this blog (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.