Income Tax Mini-Manual

article image
Illustration by Jack Vaughn
Paying income tax makes many people feel like they're feeding their cake to a monster that always wants a bigger slice.

Over and over again the courts have said that there is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible. Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more than the law demands; taxes are enforced exactions, not voluntary contributions. To demand more in the name of morals is mere cant.

—Judge Learned Hand

No other single annual event causes so much anxiety among the U.S. public as the arrival of April 15. Let’s face it: Income tax strikes fear into the hearts of most people. It’s not so much the actual paying of the taxes that brings on the sweaty palms and chewed fingernails; it’s coming face-to-face (or, rather, face-to-form) with the awesome Internal Revenue Service and all its confusing directives and instructions. Intentional or not, the complexity of the tax system — not to mention the autocratic nature of the IRS itself — can intimidate. As a result, many people tend to avoid the subject altogether and because they’re not aware of their options, end up paying more income tax than they’re obliged to.

Granted, it’s our duty as citizens (or as resident aliens) to file and pay income taxes each year. But that doesn’t mean that anyone should pay more than his or her fair share. The U.S. tax system leaves it to each of us to assess our own taxes based on our income, adjustments, and deductions. This is cause for neither anguish nor celebration; it’s just the price we pay, in effort and dollars, to live here. The annual question we all wish were more easily resolved, though, is, How much do I have to pay?

One answer to that question can be calculated with relative ease by using either of the “short forms”: 1040EZ or 1040A. But for someone actively making the switch to a life in the country and self-employment, those short forms, though seductively simple to prepare, may not be the best route to a fair share. Besides, by its very nature, attempting to live a more self-reliant lifestyle fuses your personal and business lives and can make reporting your income and expenses a considerably more complicated process. What if you sell eggs to your neighbors? Or what if you trade those eggs for a bushel of corn, a pickup load of firewood, or help on your taxes? We may call it a back-to-basics, simpler lifestyle, but that’s not the way the IRS sees it.

We urge you not to look at this situation with too much frustration. The lifestyle you’ve chosen to pursue — as well as the changes you may go through on your way to it — can involve more complicated tax-filing procedures than most, but it may also afford you numerous deductions from and adjustments to your income, as well as credits against the tax you must pay. So we hope that, instead, you’ll view the situation as an opportunity — one that can keep more cash in your hands and make your transition to a self-reliant lifestyle all the more rapid.

In the following pages we’ll deal with some of the different tax situations that you may run into on your way to the better life. Most people make the transition in stages: The vast majority start off by working at a steady job to stash nest-egg money. Later, some aspiring homesteaders may work for two employers, or hold a regular job and dabble in self-employment on the side, to earn money faster. The ultimate goal, of course, is to establish and run a successful home business.

We’ve organized this mini-manual to give you a look at what each of those situations means to you in terms of tax opportunities and obligations. In addition, we’ve prepared special sidebars focusing on the special tax interests of particular groups such as the elderly, as well as on tax-related subjects that we feel require further explanation. We’ve also included a glossary to help you understand some of the terms you’ll inevitably encounter in preparing income taxes. (Try not to be intimidated by IRS-ese; although rather foreign- and formidable-sounding at first, it can be learned, just like any other language.) And, wherever appropriate, we’ve included references to specific IRS publications that can provide you with far more detailed information on a given subject than we can here.

We’ve done our best to make this primer on figuring and filing your taxes simple, but we’re sensitive to the fact that many of you may decide that we’ve failed. The first piece of damning evidence is that, before you even so much as raise a pencil, you’re going to have to read everything in this mini-manual — obscure terms and all — that may or may not have relevance to your particular tax situation. Once you’ve done that, though, and gained a general grasp of which tax factors may apply to you, we think you’ll find our approach to tax preparation easier to use, and more conveniently organized, than the IRS’s. And perhaps you’ll also take heart in knowing that our mini-manual is less than a tenth as long as than the IRS manual (Publication 17, “Your Federal Income Tax”), which is 180 pages.

We suggest this course of action: First, read the following sections on “Record Keeping” and “The Code and the Law.” Then move on and quickly read all the major sections that seem to apply to your particular situation. After that initial reading, go back and place a small check mark next to each area you need to investigate further. And finally, read any of the sidebars that seem to apply to those issues, or request the appropriate information from your regional IRS form center, or do both. Then you’ll be ready to prepare your 1984 taxes (and plan for 1985) to your best possible advantage.

One final note before you dive in: As this is written, rumors are flying regarding what may be done to the tax code in the 99th Congress. If sweeping changes are indeed made (our guess is that such revisions are at least a couple of years away), much of the information in this manual may become outdated. Perhaps you can view mastering the present tax system as a sort of training session for what may come.

Keeping Tax Records

There’s no way you or a tax professional can do a good job of filing your taxes unless you keep proper records. With the many different sources of income possible from self-employment, it’s all too easy to overlook one. Likewise, you can’t legitimately deduct expenses without some sort of proof of those expenses — even if your memory is unfailing for each and every penny you spend. Indeed, Congress specifies the type of records that must be maintained for travel, entertainment, and other sensitive deductions.

The best approach is to keep a daily log of activities: where you travel, what you spend, what you earn. Carry a small notebook dedicated to that purpose, and jot down items as they come up. Which ones? It may be difficult to say at the time, so you’ll do best to keep track of all the money that comes and goes, and to record all your travels. Keep the receipts you accumulate through the day, and stow them in a safe place periodically. A safe place is a container devoted exclusively to that purpose. It doesn’t have to be fancy. A manila envelope, a file folder, a coffee can, or a cigar box will work—as long as you use it!

At the end of each month, empty your receipt container onto a counter and tally your month’s activities by adding up income and expenses according to the receipts and the activities noted in your daily log. Write the total income and expenses on the front of a file folder or large envelope, and put the month’s records away for safekeeping, so that at any given time you can refer to the monthly totals to see where you stand. With this sort of planning, you can adjust your expenditures, and their timing, to put you in the best tax position. (For example, if you’re having a big year for income, you may want to buy a new job-related tool before the tax year ends, so that you can offset some of that income with a deductible expense.)

It’s not easy to get in the habit of keeping records, of course, but the procedure itself actually takes very little time. And you must do it if you plan to do a good job on your taxes. Come the night of April 15, if you’re furiously trying to figure out what you made and spent, there’s no way you’ll have enough energy to use those figures to your best advantage.

How long should you keep your tax records? The IRS routinely reviews tax returns that are up to three years old, and can go back six years in some cases. This situation is further complicated by the fact that you should retain records on property you’re depreciating, for the life of that property. A general rule? Keep all your records for six years, and retain depreciation records for the full period of depreciation. Also, retain all records of capital improvements (those expenses in excess of repairs), as well as buyer’s and seller’s settlement sheets, relating to all houses you have owned or do own.

The Tax Code and the Law

If this manual accomplishes nothing else, we hope it’ll be that you stop being intimidated by the Internal Revenue Service. As long as you make an honest effort to report your real income and take legitimate deductions, you have nothing to fear from the IRS. True, if you make a mistake on your return, you may be subjected to a civil audit from which you could end up paying more tax and an interest penalty on that amount. But you won’t go to jail just for making a mathematical error! A criminal investigation — the court case that sends an evader up the river — is an entirely different matter, one that’s reserved for people who willfully attempt fraud.

The IRS code is, at times, genuinely vague: On some matters there may be no hard-and-fast rule, no right or wrong. Of course, many aspects of filing income tax reports are spelled out clearly (if elusively) in IRS publications, and one major intent of this mini-manual is to help you find your way through the maze to that information. But a surprisingly large number of tax rules are purely judgmental: They’re not laws! The IRS commissioner guesses the intent of legislators or simply adopts a standard — and these decisions are nearly always biased in favor of greater federal revenue, and are often open to challenge.

In fact, the inside front cover of IRS Publication 17, “Your Federal Income Tax,” the primary guide to personal income tax filing, leaves no doubt as to the agency’s stance: “[This] publication covers some subjects on which a court may have taken a position more favorable to taxpayers than the position of the Service. Until these differing interpretations are resolved by higher court decisions or in some other way, this publication will continue to present the viewpoint of the Service.”

The degree to which you want to be aggressive about filing your taxes is up to you. Some people enjoy an annual sparring match with IRS auditors and are little concerned that they may invest more time and money arguing their point than they can hope to recover in taxes. (If you subscribe to the attitudes of this faction, you owe it to yourself to get professional tax consultation from someone who spends his or her life keeping up with the latest IRS stands.) Other people prefer to be more conservative, in hopes that they’ll avoid an IRS audit.

In the following articles we mainly talk to those of you who just want to pay no more tax than necessary. We can’t claim that this will be entertaining reading, but we do promise that it will be helpful and beneficial. Because regardless of whether you prepare your own taxes or rely on professional help, there is simply no denying a basic tax truth: A well-informed taxpayer pays less.

Off to the Mine: Tax Credits and Deductions if You Have a Regular Job
Off to Two Mines: Tax Advice for Those Working Two Jobs
How Do I File Taxes If I Am Self Employed?
Over 65: Tax Considerations for Senior Citizens
Taxes: Income Averaging
Taxes: The Office-In-Home Deduction
Taxes: Understanding Depreciation
Tax Audits: How Being Audited Works
A Glossary of Tax Terms 

Need Help? Call 1-800-234-3368