Defining Tax Software

Investopedia: What is tax software and what should people realistically expect it to do?

Thomas: I think of tax software as something that automates the tax preparation process. Instead of having to fill out paper forms by hand and add things up myself, the tax software does it for us. 

It can also help us stay organized. For example, if my tax software will automatically import my W-2 or my 1099, I don’t have to keep track of the paper copies of those documents or spend time putting in the numbers. (Of course, in theory, we should double-check that the imported numbers match our paper copies.). In these respects, tax software can save us huge amounts of time. 

Many taxpayers may also find the “interview” feature of tax software to be helpful. By asking lots of interview-style questions, tax software can help taxpayers identify which parts of the return are relevant to their tax situation.

Tip "Tax software cannot and should not take the place of tax advice."

Investopedia: Conversely, what’s unrealistic to expect from tax software?

Thomas: Tax software cannot and should not take the place of tax advice when I don’t know how the law applies to me. If I know I can deduct my charitable contributions, the tax software does a good job allowing me to easily enter those numbers into the program and reporting them in the correct place on my tax return. It will also do “the math” and tell me if my personal deductions are high enough to itemize or whether I should take the standard deduction. 

But tax software can’t necessarily tell me if a donation I made is tax-deductible. This is a legal question. Similarly, imagine I paid for a lunch with a client and I’m not sure if this is a deductible business expense or a personal (non-deductible) consumption expense. The tax software can’t make the decision for me of how to properly characterize the expense (deductible versus nondeductible). 

Oftentimes software companies will publish summaries of the law to help taxpayers answer those legal questions on their own. The IRS also publishes summaries of the law, however, so it is not necessary to use tax software to find such written summaries.

Investopedia: For whom does self-preparation using software make the most sense?

Thomas: For many filers with relatively simple tax situations, self-preparing with tax preparation software makes a lot of sense. This would be particularly true for employees (people who get a W-2, rather than self-employed people/independent contractors) without a lot of itemized deductions. If my primary or only source of income is wages, and I claim few other deductions other than the standard deduction, self-preparation is simple. 

Even for those with more complicated tax situations (for example, people with a number of itemized deductions, or people with self-employment income), tax software might work well if those people are willing to spend extra time preparing their own return and feel confident doing so. 

As long as there aren’t complex legal questions involved, self-preparation with software is a fairly straightforward process.

Investopedia: Is there a learning curve involved for the average person to use tax software?

Thomas: I think many programs are intended to appeal to people with no experience with the tax system. If one’s tax situation is relatively simple, I don’t think it’s a steep learning curve.

Tip "I view the biggest potential pitfall [of tax software] as paying too much for unneeded features."

Investopedia: Are there any potential pitfalls of using tax software?

Thomas: I view the biggest potential pitfall as paying too much for unneeded features. The software companies advertise upgrades and other services like audit protection, and I’m not sure the average tax software consumer knows whether those upgrades and additional services are useful or necessary for their individual tax situation.

For example, if you are a wage earner (who receives a W-2 and no other source of income), and you claim the standard deduction, your odds of being audited by the IRS are incredibly low (likely less than 1 percent). It probably isn’t a good investment for you to purchase audit protection. 

I also worry about tax software companies promising taxpayers they will “maximize” their deductions. After Congress enacted tax reform in 2017, the standard deduction is now very high [over $12,500 for single taxpayers and over $25,000 for joint returns as of 2021]. As a result, only a small minority (around 10 percent) of taxpayers itemize their deductions. 

For the majority of taxpayers who claim the standard deduction, unless they own a business, they are unlikely to have any special deductions that the tax software will help them maximize.

Investopedia: Are any add-on services actually useful?

Thomas: I’m not sure if any of the add-on services are useful. However, software programs often charge higher fees for more complicated tax returns. 

For example, if you have to prepare a Schedule C because you are self-employed, you probably have to pay an extra fee that an employee with a W-2 does not. 

Tip "The majority of taxpayers are looking at the choice between self-preparing with software or hiring a tax return preparer, ideally a licensed CPA."

Investopedia: How does a person decide between DIY tax software, a human tax preparer, and a tax attorney?

Thomas: You almost certainly don’t need a tax attorney to prepare a tax return. Usually, individuals don’t need a tax attorney unless they are already in a dispute with the IRS that may end up in court. Or, high-income taxpayers may hire attorneys to help them manage their affairs in a tax-efficient way. 

But the majority of taxpayers are looking at the choice between self-preparing with software or hiring a tax return preparer, ideally a licensed CPA. As to why one would self-prepare or hire a professional—it’s partly about how complicated your tax situation is and partly about personal preference. 

Some people may just feel better using a professional and knowing there won’t be mistakes or avoiding the hassle of self-preparation, even if they have simple tax situations. Other people might want to use a professional because they have complicated tax situations that are better managed by an expert.

For example, someone who runs a business or owns investment properties might be better off using a professional to help them track and correctly report income, self-employment tax, and deductions. It is likely cheaper to use self-preparation software, but more time-consuming to prepare a complicated tax return yourself. 

However, returning to the relatively simple tax situation: wage earner, few or no itemized deductions—these people would probably save money by self-preparing. 

Tip "Receiving a stimulus payment will require an extra step on this year’s (2020) tax return, but it shouldn’t be overly complicated and likely would not require assistance from a preparer."

Investopedia: One new wrinkle for the 2020 tax year has to do with stimulus payments received in 2020. What should taxpayers know about reporting this income and how tax software will handle it?

Thomas: Receiving a stimulus payment will require an extra step on this year’s [2020] tax return, but it shouldn’t be overly complicated and likely would not require assistance from a preparer. The stimulus payment is not taxable and generally does not change an individual’s tax liability. However, if an individual did not receive a stimulus payment in 2020 but was eligible, or did not receive as much as they were eligible for, they can claim the additional amount as a credit when they file their 2020 return. 

I have not yet seen how this will be reflected in software, but it should be a matter of simply reporting how much (if any) total stimulus payments were received in 2020.

Tip "Filers below a certain income threshold [$73,000 in 2021 adjusted gross income] should go to the IRS Free File site to find free filing options."

Investopedia: Are there any free alternatives for certain tax filers? 

Thomas: Yes, yes, and yes. Filers below a certain income threshold [$73,000 in 2021 adjusted gross income] should go to the IRS Free File site to find free filing options.  

It is important they access software from this site, not directly from the software company’s website. If they do the latter, they may end up being unexpectedly charged for a service they thought would be free.

Investopedia: What are some things people should look for when shopping for tax software?

Thomas: Cost—shop around. Look first for a Free File option (from the IRS website) that works for you. 

Does it have adequate security safeguards—e.g., two-step verification—to protect you from having your information stolen?

Ease of use: is it well designed and user-friendly? 

Are there easy-to-reach customer support services?

Does it securely store your tax return information for use next year? 

Can you log in and access a prior year’s return if you need it? 

Will it import information from your last year’s return onto this year’s return?

Investopedia: Is there a regulatory agency for tax software?

Thomas: Software companies are subject to minor regulation from Treasury and the IRS that requires them to e-file returns and not disclose confidential information. They are also subject to FTC rules regarding privacy. 

The biggest software companies have a contractual arrangement with the IRS (that provides some consumer protections). I have tweeted about it extensively.

But as I argue in Regulating Tax Return Preparation, taxsoftware companies are not heavily regulated in terms of content. 

I am unaware of any specific consumer protection regulations that protect consumers from being oversold on tax software products. I am not an expert on non-tax regulations though, so I may be missing something on the consumer protection front.

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3. Determine Your Filing Status

Your filing status is based on what your marital status was on the last day of the tax year, and it applies to all of the tax year. There are five possibilities:

  • Single
  • Married filing jointly
  • Married filing separately
  • Head of household
  • Qualifying widow(er) with dependent child

If you legitimately fit into more than one category, pick the one that requires you to pay the least amount of taxes.

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Filing by Hand vs. Using Online Software

If you choose to file your taxes by hand, you’ll download and fill out relevant IRS forms and mail them to your local collection address. Tax forms are available for free at IRS.gov, and you may need to fill out more than 1 depending on your deductibles, employment situation and marital filing status.

To make a payment, you may mail a check to the IRS directly or you use a debit card, credit card or same-day wire transfer by using the IRS online payment system.

Filing your taxes by hand may take a little longer, but it can be a good option if you have a simple return. If you aren’t interested in learning more about tax process or have a complicated return, a tax prep software can help guide your way.

This is especially true if you own rental properties or make regular income through the stock market with investment taxes. Tax prep software can also walk you through the process if you’re a business owner who needs to calculate capital gains taxes. Software can navigate the myriad of tax laws, deductibles and exemptions you need to detail.

Steps Before Filing Your Taxes: What Youll Need

There are several steps you need to take before you file your own taxes. They include the following:

1. Determine Your Filing Status

It is imperative that you choose your filing status before you can prepare your tax return.

If you don’t understand your filing status, the IRS can help you figure it out by asking you a few questions.

Here are five common filing statuses that could apply to you:

  • Single
  • Married filing separately
  • Married filing jointly
  • Unmarried head of household
  • Eligible widow or widower with a dependent child

2. Have Your Documentation in Order

Before you start preparing your tax return, get all the pertinent information required for filing your taxes. These may include:

  • Your W-2s
  • School taxes
  • Interest statements
  • Receipts for deductible expenses
  • Property taxes
  • A copy of your last year’s return, if applicable
  • Other applicable forms like Form 1099 if you receive some kinds of income, such as a taxable interest of at least $10

You should keep all of your documentation safe and conveniently accessible. You might need them when you prepare taxes for future years or for other reasons like applying for a loan.

3. Find the Right Tax Filing Software

There are numerous tax software products to choose from. Take your time to review your options and determine which one suits your situation the best. These software products can easily be found online.

While some programs are designed specifically for personal tax filing, others are ideal for business tax preparation, and others can effectively handle both.

Some of the popular tax preparation software include TurboTax, TaxAct, H&R Block, and TaxSlayer.

When you use tax filing software, you will typically be asked questions that are designed to ensure that you pay the right amount of taxes.

Moreover, most paid versions of these software products are packed with valuable information and education that will walk you through every step of the tax filing process.

If you have more questions or don’t seem to understand some things, you can always find help from the IRS website. You also have the option of calling the IRS directly to seek help.

The customer service representatives at the IRS usually are very hospitable and helpful.

10. Deduct Travel for Medical Treatment

If you drove in 2021 to get to a hospital, doctor’s office or dentist’s office for the purpose of medical treatment, the cost of getting to and from the facility or office is deductible at 2 cents per mile.

How to file your own taxes

Once you’ve collected your paperwork and determined your filing status, you are ready to do your own taxes. There are three different ways for you to do this. Each of these options offers a slightly different way to prepare, but the basics are all the same. Choose the option that best suits your lifestyle.

1. File manually

You can download the forms you’ll need to fill out from the IRS website. It is completely free to download these forms. If you choose to print them, you can complete them by hand and mail them in.

In most cases, this manual method for doing your taxes is only a good option if you have a fairly simple tax situation. Although you can work through a more complex financial picture with these paper forms, it might become tedious after a few forms.

2. File your taxes with the IRS online fillable forms

The IRS offers free file fillable forms on their e-File site. With the fillable forms, you’ll have line-by-line instructions to help you complete the form. If this is your first time filing your own taxes, then the instructions can be helpful to follow.

3. Using an online tax software program

As a final option, you can use online tax software programs to file your own taxes. Although you may need to pay to use an online software program, it might be worth it if you have a complex tax situation.

Most tax software programs walk you through the filing process with prompts along the way. It can be helpful to see these prompts. You might see something that helps you notice easily forgettable details of your tax year.

A few good options include:

Credit Karma Tax

In addition to their free credit monitoring, Credit Karma offers free tax filing via a simple and easy-to-use interface.

TurboTax

You can use TurboTax to file your basic return for free. However, you may need to upgrade to a paid version if you have a complicated situation.

H&R Block

H&R Block is another well-known tax software program that can help you file basic returns for free. However, their paid options are very affordable if you need more help.

Simply choose the software that you are most comfortable working with. Doing your own taxes will be much easier if you pick a method that feels easy to you.

Step 5: Get Organized for Next Year

If you end up with a big tax refund or a large tax bill, you probably want to go ahead and adjust your withholdings so that you’re not taking too much or too little out of your paycheck for taxes. 

And one more thing: Once your taxes are signed, sealed and delivered to the IRS, you might be tempted to celebrate by starting a bonfire and burning all those receipts and tax forms in a blaze of glory … don’t do that.

Instead, promptly file any tax documents and important receipts when you receive them so you don’t have to search the house for them next spring. Buy a few manila folders, an accordion file or a filing systemthat will hold your tax documents and save those documents for at least three years. You might need them if the IRS comes knocking.

Should I do my own taxes?

Now that you know the steps you may still be contemplating “Should I do my own taxes?” To be honest, the process of taking care of your own taxes is not for everyone. Let’s take a closer look to see if it is a good option for you.

When is it a good idea to my do my own taxes?

Preparing your taxes can be time-consuming and somewhat tedious, but it is completely possible to tackle this annual task on your own. You might be able to save some money, but you’ll also feel more in control of your finances.

If you choose to do your own taxes, then you’ll need to pay close attention to details along the way. It will likely take several hours to work through your forms, so make sure to set aside the right amount of time.

When should you consult a professional?

If you don’t have hours to set aside for this task, then you should seek out a professional. Another good reason to consider a professional is if you have a complicated tax situation.

If you have a complex situation with multiple W-2s, 1099s, and your own side hustle, then you might want to consult a professional. They can help you clarify your filing and make sure that you don’t miss out on any savings.

Step 2: Choose Between the Standard Deduction or Itemizing

When you file your taxes, you have two choices: Take the standard deduction or itemize your deductions. This is a pretty big deal, because tax deductions lower your taxable income—and the lower your taxable income is, the smaller your tax bill will be!

So, how do you decide which option to take? Well, the standard deduction for the 2021 tax year for single filers is $12,550 and $25,100 for married folks filing jointly.1 Those numbers get bumped up for the 2022 tax year (the taxes you'll file in 2023) to $12,950 for individuals and $25,900 for maried filing jointly.2 If your individual deductions add up to more than that for the year, you’re better off itemizing. If not, save yourself the hassle of digging through filing cabinets for old receipts and just take the standard deduction.

If you do plan on itemizing deductions, you’ll need proof to back up your claims. So, don’t forget any receipts for deductions and tax credits like:

  • Childcare
  • Education costs
  • Charitable giving
  • Medical expenses

When in doubt, it never hurts to reach out to a tax pro and get their advice on how to do your taxes this year.

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