I use a professional to prepare my tax returns each year, so there’s no point in me bothering to learn about taxes. In fact, that’s the entire reason I use an accountant.
I come across that line of reasoning all the time. And as a former tax accountant, let me say this: It’s a huge mistake–one that could cost you thousands of dollars each year. Even if you use a professional to prepare your tax returns, you still need to have a basic understanding of taxation.
To explain why, let me use an analogy:
You have a doctor, right?
And yet, you’ve still taken the time to learn the basics of how to live a healthy life, right? Why is that? As far as I can tell, the primary reason is this: You understand that ultimately you bear the responsibility for your health.
It’s the same thing with your accountant. Yes, he (or she) can prepare your taxes. And yes, there are many things he (or she) can do to help you save on taxes. But ultimately, it’s your money. And if you don’t understand the tax consequences of the financial decisions you make, you’re going to be throwing your money away.
Make the Most of Your Doctor (and Accountant)
You need to know the difference between your heart and your lungs if you hope to have any sort of meaningful conversation with your doctor. Similarly, you need to know the difference between a tax deduction and a tax credit if you want to understand (and get the most value from) your accountant’s advice.
Making Good Decisions
Your doctor isn’t available before every meal to help you decide which foods to eat. You need to know about the nutritional significance of protein, vitamins, fiber, etc. (as well as which foods contain them) if you want to make healthy eating decisions.
In the same way, you need to know how tax brackets work in order to make good financial decisions. For example, it’s important to understand that if you’re in the 25% income tax bracket, that doesn’t mean that all of your income is taxed at 25%.
Where to Find Tax Information
Luckily, there are plenty of good resources for finding information about taxes, and many of them are freely available online.
For example, the IRS publishes a series of plain-English tax guides. There are Publications on topics ranging from Investment Income and Expenses to Medical and Dental Expenses. (Or, if you’d like a list of IRS Publications, sorted alphabetically by topic, you can find that here.)
If you know very little about how income taxes work, I’d suggest starting with IRS Publication 17: Your Income Tax (pdf). It’s an excellent introduction.
Or, if you’re looking for the answer to a specific tax-related question, I’d suggest making the following Google query (without the brackets):
site:irs.gov [insert topic here]
What this does is use Google to search the IRS website for whatever keywords you entered. The reason I use this method is that the IRS’s site has tons of information, but its built-in search function is decidedly mediocre. Unsurprisingly, Google does a better job.
Be Proactive
If you sit at your computer all day and eat fast food 15 times per week, you’re going to have health problems. You won’t be able to visit your doctor and have her magically fix you (at least, not for the long-term). There’s no question that the best route to good health is to stay healthy in the first place.
When it comes to taxes, something very similar occurs. Every year, there are many things you can do to save on taxes. But if you wait until April 10th of next year, it will be too late to take advantage of many of them.
Don’t let that happen to you! Take the time to educate yourself by doing a little reading.
About the Author: Mike Piper is the author of Investing Made Simple. He also blogs at The Oblivious Investor.
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{ 17 comments… read them below or add one }
I seem to only pay attention to taxes once a year–when I ask “how much am I getting back?” Might be a good idea for me to take a more long-term, year-round approach. Great post.
I too fall in the trap of not caring about my taxes until April. Maybe I should talk to my accountant at least once a quarter to see if I should be doing something to reduce my taxes at year end.
Also, the search trick for the IRS site is pretty slick and creative. Thanks for letting us know!
Replacing Google search with pretty much any other search is awesome
Using it to look up tax information is very clever.
Sam: Yeah, that Google query can be used on any site. I’ve found it to be very handy.
I don’t really spend to much time dwelling on my taxes except to make sure that I minimize the amount of money that the government will owe me. The thing is that being single with little income to speak of, no kids, no home and almost no assets makes it really easy to plan.
Accountants are limited in the fact it is a backward looking analysis they give you so you may have moved into another tax bracket without them or you knowing. If you understand the tax system better you can make some adjustments mid-year.
I hate taxes and that’s probably why I don’t think of them enough. The accounting system is so complicated that only people who does this all day have a chance of understanding at least half of it.
What are people like me who have a job supposed to do? Read the tax code every time I get a break?
Jeffrey, you’re right that it’s complicated. (I for one would agree that it’s far too complicated.)
But you certainly don’t have to know all of it in order to benefit. Even a little knowledge can save you money.
My suggestion is to read a couple IRS Publications. They’re usually pretty short and quite readable. Read just a few of those and your tax knowledge will be far beyond that of most other citizens.
Like you, I have commitments but whenever I run across tax related articles, I stop and read them because of the implications. We all have chores, obligations and tasks that we don’t like doing but it is sometimes really beneficial to do them.
I hate exercising because I think it’s boring and a waste of time. However, I’m starting to do it because it’s healthy for me and the only way that will increase my energy level. Do what’s right for yourself and spend some time getting to know the tax implications of your actions.
Great post and advice. It is critical to begin making adjustments at the beginning of the year. Early tax planning can save you a large amount of money by the end of the year.
Sometimes your accountant doesn’t know all your details or your future plans, only you know what’s best for yourself.
I highly agree with this post. As a tax preparer with a small firm in New England, my clients prove this idea is valid. The people that are the most savvy and educated about tax issues are the easiest to work with, get billed the lowest, and get the results they want. The folks that decide to be clueless pay more, both to us and to the IRS (generally).
To that end, our firm decided to begin sending tax news and analysis to our clients (as well as publish it online). We think the investment in client education will be worth it for everyone.
Wherever you find tax info, first be sure its solid and then keep up to date on it. Being educated will help you get more from your accountant.
Hey Mike – Thanks for your post. Is there a certain income limit, or multiple income stream threshold one should have before your recommend going to a tax advisor instead of just doing it yourself on turbotax or with H&R Block?
If I make $500,000 a year, and have only one income stream and a mortgage, it’s no different from someone making $50,000 a year with a mortgage right?
Curious to know your thoughts on this.
Financial Samurai: In terms of preparing the return, I’d say it has far more to do with the complexity of the return than with the size of the numbers on the return.
That said, the greater your income, the more value you’re likely to get from an ongoing relationship with a tax professional. Still, I’m hesitant to give any sort of “magic number.”
Hi Mike,
Fair enough. Actually I’ve got a specific question which for some reason I can’t get a straight answer.
The mortgage interest indebtedness limit is $1,000,000 mortgage + $100,000 on a HELOC right? For arguments sake, let’s just say you can only write off interest on up to a $1mil mortgage. Say your interest rate on the $1mil is 6% i.e. $60,000 of mortgage interest you can write off your income. Is it therefore true that even if you had a $2 million dollar mortgage and a hypothetical 2% interest rate for $40,000 in interest, you can only write off half, or $20,000 of the mortgage interest?
I don’t understand how the Turbotax software can tell and cut off how much mortgage interest you can deduct when a big variable is the interest rate. From my example above, the guy with a $2mil mortgage is paying $20,000 LESS in interest but yet can deduct 1/3rd as much compared to the guy with a $1mil mortgage.
thnx!
Table 1 of Publication 590 has the step-by-step calculation for determining how much home mortgage interest is deductible.
The gist of the calculation is:
(qualified loan limit)
divided by
(total of average balance on all mortgages on all qualified homes)
times
(total amount of interest paid)
So yes, the greater the extent to which the mortgage balances exceed the limit, the lower the portion of interest the taxpayer can deduct.
Really, this concept isn’t terribly unique. Congress is simply saying, “if you’re well off enough to have $3 million dollars of mortgage, we don’t want to give you much of a tax break on it.” It’s not too different from “if you make enough money, we don’t want to give you a tax break for contributing to an IRA.”
Hey Mike! Thnx for that link. Sweet. I wish they wouldn’t make things so convuluted. Just like the tax structure. FLAT TAX I say! Why doesn’t every pay an equal share of their income to big brother?
Who’s to say someone making $500,000/yr for example is rich? Living in SF for example is 5X more expensive than living in Wyoming.
Flat Tax = maximum fairness, and I don’t understand how anybody could argue otherwise.