When you want to save money in a safe place over a longer period, you generally have two main options: a savings account or a certificate of deposit account.

CDs usually offer higher interest rates in exchange for your commitment to keep your money in the account for a specified number of months, which is referred to as the “term.” At the end of the term, when the CD matures, you can withdraw the money you originally saved plus the interest it earned.  

But if you want to withdraw money before the CD matures, you could face a penalty. Let’s take a look at what a CD early-withdrawal penalty is, when you might face one and how to avoid getting penalized.

• What is a CD early-withdrawal penalty?
• How much can I withdraw early from a CD?
• How do I calculate my early-withdrawal penalty?
• When might the CD early-withdrawal penalty be worth paying?
• Next steps: How to avoid CD early-withdrawal penalties

What is a CD early-withdrawal penalty?

Opening a CD is like promising the bank or credit union that’s holding the account that you’ll leave the money there for the entire term of the CD. If you break that promise and withdraw some of the principal early, the financial institution may charge you a penalty.

The amount of the penalty can vary from bank to bank and depends on multiple factors. But it’s common for financial institutions to withhold a certain amount of interest on the money you withdraw as a penalty. Some financial institutions may also tack on an additional fee. And, if the early-withdrawal fee is more than the interest your CD earned by the time you made the withdrawal, the financial institution could take some of the principal to make up the shortfall.

Just how early is the withdrawal?

How long before the CD’s maturity date you make a withdrawal also matters.

If you withdraw the principal within the first six days after depositing the money in a CD, federal law mandates a minimum penalty of at least seven days of simple interest. But banks and credit unions can — and typically do — charge a higher penalty.

In addition to the penalty, you’ll also lose future interest earnings if you withdraw the entire principal. So depending on your bank’s early-withdrawal penalty and how soon before the maturity date you make the withdrawal, you could potentially lose all earnings for the CD.

For example, if you withdraw all of the principal from a six-month CD during month three of the term, and the bank charges a penalty equal to three months’ worth of interest, you’ll have lost all your earnings on the principal.

How long is the CD term?

Financial institutions often determine how much interest to withhold as a penalty based on the CD’s term. For example, if your CD has a one- to five-year term, a bank may charge you 180 days of interest on the amount of principal you withdraw. For a three-month CD, another bank may charge an early-withdrawal penalty of 90 days of interest on the amount you withdraw, but no more than the total interest you would have earned throughout the fixed term.

Typically, the longer the term, the more interest you’ll forgo. For example, some banks may charge a penalty of 12 months of interest on a 36-month-term CD. Others may just charge a set fee of $25 plus 3% of the amount withdrawn.

Since the penalty can vary by bank, it’s important to read your financial institution’s account agreement carefully before you open a CD.

How much can I withdraw early from a CD?

Whether you can withdraw all or only some of the principal from your CD will depend on your financial institution. Some banks don’t allow partial withdrawals of a CD’s principal.

It’s also important to remember that some CD accounts may automatically renew. In these cases, your bank will notify you and give you a certain time frame to make withdrawals, completely cash out or close the account. If you miss this window and the CD automatically renews, the early-withdrawal penalty will once again apply.

How do I calculate my early-withdrawal penalty?

First, check with your bank and look at your account agreement to determine what the bank’s penalty policy is. An online early-withdrawal calculator may also help you get a better idea of how your bank’s early-withdrawal penalty will affect your CD’s proceeds. You may need to enter information such as your bank’s name, your CD term, annual percentage yield and the penalty amount outlined in your account agreement (such as 12 months’ interest).

Depending on how your bank calculates interest, you can also use this standard formula to calculate your early-withdrawal penalty (for interest penalty calculated on a monthly basis).

Penalty = Amount withdrawn x (interest rate/12) x number of months’ interest

In this formula, 12 equates to 12 months in a year, since interest rates are typically calculated on an annualized basis. The number of months’ interest is equal to the number of months of interest you’d forgo by making an early withdrawal.

As an example, let’s say you have a one-year CD with a 1% interest rate and you want to withdraw $2,000 from your account. And there’s a withdrawal penalty of three months’ worth of interest. Your calculations would look like this.

$2,000 x (.01/12) x 3 = $5 penalty

In this scenario, your penalty would equal $5. But some banks may charge an additional minimum fee, such as $25, for an early withdrawal. If your bank did in this case, you’d have to pay the minimum fee plus $5 to withdraw from the account.

Image: mned_cdearly

When might the CD early-withdrawal penalty be worth paying?

Depending on the amount of the penalty and how much you need the cash you’ve put in the CD, you may decide it’s worth it to just pay the penalty so you can access your money. In the example above, paying either a $5 or $25 penalty may make sense to access $2,000 you can use to pay for an emergency home repair, or if you decide you’d rather put that money into a different investment account that offers a higher interest rate.

You may even decide you’d rather transfer this money to a high-yield savings account, which offers a higher interest rate on your deposits while giving you more flexibility to withdraw your savings.

Or maybe you need the money to pay off a high-interest-rate credit card, which is probably charging you much higher interest than what you actually earn on your deposits in a CD account. For example, if you’re only earning 1% interest on your CD account, but paying 23.99% interest on your credit card balance, the benefits of using the money to pay off your credit card balance may outweigh any early-withdrawal penalty you’ll incur.

As you decide whether to take the CD early-withdrawal penalty, consider whether you’re doing so based on a true financial need versus a financial “want.”  This may help you make the best financial decision for your situation.

Next steps: How to avoid CD early-withdrawal penalties

CD early-withdrawal penalties are largely avoidable, though emergencies can happen that may force you to withdraw money and take the hit. Consider these options before taking the penalty.

• Wait until the CD matures. Take advantage of the grace period after your CD term ends to make withdrawals without penalty or to completely cash out your account. Details about the grace period should be included in your account agreement, but it’s also a good idea to call your bank and confirm when this period begins and how long it lasts.
• Look for no-penalty CDs. Also known as a liquid CD account, a no-penalty CD allows you to withdraw money from this account without penalty. The rules around this vary by bank, but you can often make withdrawals within seven days of your original deposit, after a set time period or throughout the entire term based on what’s outlined in your account agreement. The trade-off is that these accounts may offer lower interest rates than traditional CDs. Some may also require a higher minimum deposit to open the account. Still, this may be a worthwhile option if you’re looking for more flexibility and to avoid penalties.
• Set up a CD ladder. A CD ladder allows you to divide your savings across several CD accounts with different terms and interest rates. For example, you could deposit $2,000 into a 12-month CD at a set interest rate, another $2,000 into a 24-month CD at a slightly higher interest rate and another $2,000 into a five-year CD at an even higher interest rate (generally, the longer the term, the higher the interest rate). With this strategy, you can access some of your money earlier without incurring a penalty if you don’t make withdrawals before the end of the term. 

CD accounts are great savings vehicles if you want to keep your money in a safe place and earn interest on your savings. But you have to sacrifice some flexibility in return for these benefits. If you already have a solid emergency fund and are making maximum contributions to your retirement savings, a CD account may be a good option, since you may not be as tempted to withdraw the money if you experience a financial emergency.

Before you open a CD, consider your short-term and long-term financial goals and make sure you understand all the potential penalties and fees associated with CD early withdrawals. Taking these steps beforehand could ensure you maximize the interest you earn by using this type of account.

Has this happened in your family? Grandma gives your son a $100 check for his birthday, but he’s unbanked, unemployed — and only 5 years old.

How is your kindergartener (or any minor, for that matter) supposed to cash that gift check? He’s not, of course. It’s up to their parents to get the money into an actual bank account.

Each bank can have different rules for how to cash a check for a minor. Let’s take a look at some ways to cash or deposit a check made out to someone too young to sign it for themselves.

• Can I cash or deposit a check made out to my child?
• How do I endorse a check for a minor?
• Can I deposit my child’s check into my personal account?
• Next steps: Tips for age-appropriate conversations about banking

Can I cash or deposit a check made out to my child?

The simple answer is yes, depending on your bank’s or credit union’s rules.

Each financial institution has its own requirements for how to deposit a check made out to a minor. Typically, banks will require you to have your own account with them before they’ll cash or deposit a minor’s check for you. You may also be able to open a custodial account jointly owned by you and your child, which allows you both to make deposits and withdrawals.

How do I endorse a check for a minor?

To endorse a check made out to a child who can’t yet sign their own name, you should first call your bank or visit its website to understand its requirements.

With some banks and credit unions, you may not need to endorse the check if it will be deposited into the child’s account or a joint custodial account. If you plan to deposit the check into your own bank account, you’ll typically need to sign your child’s name on the back of the check followed by the word “minor” — and then endorse it with your signature right below the minor’s name. You may also need to include additional information like your account number.

If your child is old enough to endorse the check themselves, you may not need to sign their name. But you’ll probably still need to provide your signature under theirs, followed by the word “parent,” depending on the rules of your bank.

If your child’s name is misspelled on the check, you may need to bring proof of identification, such as their birth certificate or state ID, to the bank and show it to the teller. Again, every bank will have its own rules, so this documentation may not be enough to get the check deposited. In this situation, you can contact your bank to determine its policy. Or you might consider asking whoever sent the check to send a new one with your child’s name spelled correctly.

Can I deposit my child’s check into my personal account?

This will all depend on your bank, but usually a parent can deposit a child’s check into their own account — especially if the child doesn’t have an account in their name. Some banks might allow you to deposit the check if you follow their requirements for endorsing the check and include your child’s name or signature as well as your own. It’s also not a bad idea to bring extra documentation or your child’s identification with you, just in case.

Rather than making a deposit into your own account, consider opening a custodial account for your child. Talking to your kids early about money — even if they’re in elementary school or middle school — can help them develop a better understanding about finances and banking basics and lay a foundation for them to build better money habits in the future.

Next steps: Tips for age-appropriate conversations about banking

Getting a check from a loved one is a great opportunity to teach your kids about money management and how banking works.

Once your kids are in grade school and begin learning math, you can start helping them understand simple concepts like saving. When they get money from relatives, help them count it and provide a piggy bank or jar they can use to set aside some of the money for a special treat or purchase of their choice — even if it’s as small as candy from the local convenience store, a new book or a toy they’ve seen on TV.

Older children may be able to grasp more advanced money concepts, like opportunity costs. Explain to them that if they spend their money on one thing, they may not have enough to make other purchases. When they become tweens and teens, consider giving them an allowance and talking to them about budgeting. This can help them learn about money management and how to better allocate the money they’ve earned.

Teenagers can get part-time jobs, open accounts and learn about how to use mobile apps to manage their money and even make mobile deposits.

But more than anything, leading by example is one of the best ways you can help your kids build better money habits. Learning to manage money is a lifelong process, but starting when your kids are young and receive their check may be the best way to build these habits — even if it takes some extra steps to deposit the check.

Just as lenders consider your credit history when you apply for new credit, banks look at your banking history when you want to open a new account.

And just as negative information in your credit report can make it difficult to get new credit, negative banking information may give you trouble opening new bank accounts. If you’ve been turned down for a new bank account, a second chance checking account may be an option for you.

Second chance checking accounts can help you build positive banking history, but there’s a trade-off. They often have higher fees and restrictions than traditional accounts.

Let’s look at how second chance checking accounts work and what you should know if you’re thinking of applying for one.

• What is a second chance checking account?
• How to find a second chance checking account
• What are the pros and cons of second chance checking accounts?
• What are some alternatives to a second chance checking account?
• Next steps: Tips for healthier banking

What is a second chance checking account?

When you apply for a new checking account, the financial institution may check your banking history with a consumer reporting agency like ChexSystems. Past accounts closed by a financial institution, payments made with insufficient funds, unpaid bank fees and other negative information can appear in consumer reports — and banks may refuse people with negative banking history.

Second chance checking accounts can provide a banking alternative for people who can’t get a traditional account because of negative banking history. Second chance checking accounts generally allow you to make payments and deposits like a traditional account. Using one wisely could help you build a better banking history.

But second chance checking accounts generally come with some limitations and fees.

How to find a second chance checking account

Not all financial institutions offer second chance checking accounts. But if you’ve been turned down for a traditional account it’s probably worth asking the financial institution if it has a second chance alternative.

You can also visit a financial institution’s website to see if it offers a second chance checking account and find out what terms and conditions apply. Just as with any financial product, it pays to comparison shop for a second chance checking account. Here are some points to consider.

• Monthly fees — Second chance accounts often come with monthly maintenance fees.
• Overdrafts — Second chance accounts may prohibit overdrafts, meaning if you make a payment without sufficient funds in the account, the bank won’t cover the payment. Or, it may charge very high overdraft fees.
• Savings account requirement — Banks may require you to open and maintain a savings account with them for a few months before you’ll be allowed to open a second chance checking account.
• Minimum opening deposit — Second chance checking accounts may require you to deposit a minimum amount to open the account. A minimum opening deposit of $25 is common, but it’s possible a financial institution could require more. Check to be sure it’s an amount you’re comfortable with.
• Other requirements — From requiring you to attend a free financial management class to placing a dollar limit on daily withdrawals, financial institutions can place other restrictions on second chance accounts.
• Other fees — Watch out for other fees. Financial institutions can charge fees to send you a paper statement, if your account goes dormant, if you close your account before a certain number of days, and for other reasons.

Before you sign up for an account with one of these banks, do your research and compare their offerings. You’ll also want to find out when and if you can upgrade to a regular checking account after a set period of keeping your second chance account in good standing. 

What are the pros and cons of second chance checking accounts?

Second chance checking accounts have certain advantages for people with less-than-perfect (or little) banking history. Along with building a positive banking history, you can safeguard your money with an FDIC-insured financial institution, which protects deposits of up to $250,000. This is a much better alternative than just keeping money in your wallet or a lockbox.

Typically, you can also access online banking features, like real-time alerts for every transaction and budgeting tools that could help you better manage your money. Plus, you get the benefit of establishing a banking relationship with a financial institution, which might be helpful down the road if you want to apply for a mortgage or car loan.

But second chance checking accounts typically don’t come with some other benefits you’d get with a standard checking account.

For example, second chance checking accounts may feature overdraft restrictions, meaning you can only spend what’s in your account. In some cases, you may have to pay additional fees if you do have an overdraft. Your bank may not provide paper checks with a second chance checking account, and you may have to pay a monthly service fee to keep the account open.

What are some alternatives to a second chance checking account?

If you can’t get approved for a second chance checking account for some reason, or if this type of account isn’t the right fit for you, you might have other options.

You could get a prepaid debit card. Prepaid cards allow you to load a specific amount of money onto a card and use those funds to make purchases. You can buy these cards at major supermarkets or retailers or online. Think of it as cash, but in card form.

A secured credit card is another alternative. Secured credit cards give consumers who can’t get approved for a traditional credit card the opportunity to access credit. With a secured card, you typically provide a cash security deposit that’s equal to the credit limit on the card. For example, a $500 deposit gets you a $500 credit limit. One of the major drawbacks with a secured card is that most, if not all, credit card issuers require you to have a bank account for your security deposit. If you already have a savings account, a secured card may be an option for you.

Next steps: Tips for healthier banking

A second chance checking account gives you the opportunity to put bad banking history behind you. Here are some additional steps you can take toward healthier banking.

1. Automate keeping tabs on your balance

Online banking features like low balance reminders can alert you when your balance is low. Check your bank account regularly to make sure there aren’t any unauthorized charges and contact your bank if you see something that doesn’t look correct. Monitoring your account could also help you stay ahead of any minimum balance requirements your bank may have.

2. Automate bill payments

If you have the financial flexibility to do so, set up automatic bill payments to help ensure you never miss a payment. But remember that automating payments isn’t “set it and forget it.” You’ll need to monitor your bills to ensure you’re paying the correct amount every month for products and services you actually purchased.

3. Consider overdraft protection

Overdraft protection allows you to link your checking account to another account, such as a savings account. Your bank then automatically transfers money between accounts if there aren’t enough funds in your checking account to cover your charges. Be aware, though, that some financial institutions may charge an overdraft transfer fee for moving money between your linked accounts.

You can also pull your ChexSystems report to see what’s on your record and make sure it’s accurate. The company allows you to pull one free report every year, so use this to identify items that you can resolve right away — like paying old fees — and help improve your banking history. Taking this extra step could mean you might not need a second chance checking account after all.

More people reach for their debit cards when making a cashless payment than any other type of card, according to the Federal Reserve.

It’s not hard to understand why people like debit cards. A debit card can allow you to make purchases without carrying cash or writing a check, help you avoid paying interest on purchases and possibly help reduce the risk that you’ll overspend.

But because debit cards are directly linked to a bank account — and the money in that account — it’s especially important to keep them secure.

Let’s look at a common security measure that card issuers use to help protect debit cards — the debit card security code.

• What is a debit card security code?
• How does a debit card security code work?
• What are other ways to fight debit card fraud?

What is a debit card security code?

Like a credit card, your debit card has multiple sets of numbers printed on it. There’s the card number, which is a 15- or 16-digit number that’s usually on the front of your card. And your card may also have issued and expiration dates on the front.

A debit card security code is a three- or four-digit number located in the signature box below the magnetic stripe on the back of the card. You may also hear this number referred to as a card verification code, or CVC, or a card verification value, or CVV.

Both debit and credit cards can have a card security code. Some card issuers, like American Express, feature this code on the front of the card.

But there are key differences between what happens in terms of security when you swipe that magnetic strip with a debit card versus a credit card.

When you use a debit card to make a purchase or pay a bill, you’re using your own money, drawn directly from the bank account the card is linked to. Using a credit card is essentially using the card issuer’s money, which it’s agreed to loan to you, to make a purchase or pay a bill.

How does a debit card security code work?

Because your debit card is linked directly to your bank account (or a specific sum of cash if you’re using a prepaid debit card), it’s important to protect it as vigilantly as you would cash.

Generally, debit card security codes are just one layer of security for card transactions — you may be asked for yours if you’re making a purchase online or over the phone. By asking you for this code, along with your account number and other information, the merchant is trying to verify that you’re the cardholder or authorized user. That’s because you’ll typically need to have the card in your possession to share this code. 

A debit card security code works differently from the personal identification number, or PIN, that you selected when you got your card and that you enter when you withdraw money from an ATM or make an in-person debit purchase.

It also works differently from the unique code generated by EMV chip cards to help prevent fraud. These cards have a chip on the front that is read when you insert your card into the card reader. The reader scans the chip, you enter your PIN or use your signature, and the chip produces a unique code for that particular purchase. Unlike the security code on the back of your card though, you never see this unique code.

Along with your card number and expiration date, it’s important to protect your debit card security code, because someone can use this information to make a fraudulent purchase with your card — even if they don’t physically have the card in their possession.

What are other ways to fight debit card fraud?

Credit card issuers and financial institutions aren’t the only ones responsible for protecting your debit card. There are also steps you can take to help keep your card secure.

• Never tell anyone your PIN. And don’t write it down or carry it with you.
• Avoid using a debit card to make online purchases — a credit card may be safer.
• If your financial institution offers them, sign up for email or text message alerts that tell you about activity on your account.
• Monitor your bills, bank account statements and credit reports for any signs of fraudulent activity, like withdrawals you didn’t make or purchases you didn’t authorize. 

Along with not sharing your card number or security code with anyone, it’s important to contact your bank, credit union or card issuer immediately if your card is lost or stolen.

If you notify the debit card issuer within two business days after you discover your card is missing, you can only be held liable for $50 or the amount of any fraudulent transactions that happened before you notified the issuer — whichever is less. But if you take up to 60 days to notify the issuer, your liability could be up to $500. And keep in mind that if you report the loss more than 60 days after your statement, you may lose everything that was taken out of your debit account.

Bottom line

Debit card use continues to grow, and so does card fraud. Understanding how security features like a debit card security code can help protect your debit card — and what steps you can take to reduce the risk of fraud — can help you safely enjoy the convenience of paying with a debit card.

If you’ve ever opened a savings account or applied for a credit card or mortgage loan, then you’ve probably seen the terms APY and APR.

While these initialisms look similar, they have some distinct differences that can affect how much you pay in interest when you borrow money or use credit, and how much you earn in interest when you open a deposit account with a bank or financial institution.

Here are things to know about the differences between APY and APR.

• What is APY?
• How do you calculate APY?
• What’s the difference between APY and APR?

What is APY?

APY typically applies to deposit accounts and investment products, like savings accounts, certificates of deposit and money market accounts. And when you open a savings account with a bank or credit union, they’ll likely use the deposits you make into these types of accounts to fund the loans they issue to other customers. To incentivize consumers to open these accounts, banks offer interest on your money at a specified rate, which is expressed as the account’s APY.

APY is the annual rate of return — expressed as a percentage — that you get on your money once you factor in compound interest. Compound interest is interest you earn on both the principal dollar amount in your account — and the interest that’s already accumulated on the principal balance.

How do you calculate APY?

To determine your APY, financial institutions use this formula.

Image: Infographic showing how to calculate APY

In this formula, the letter “r” represents the annual interest rate while the letter “n” represents how often the interest compounds every year. Interest can compound daily, monthly, quarterly, semiannually or annually. The more often interest compounds, the better since you earn money more quickly. You can learn more about how financial institutions calculate APY on the FDIC website.

To make things simple, here’s an example. Let’s say you open a savings account with a 0.03% APY and make an initial deposit of $5,000. If the APY is 0.03% and compounds daily, at the end of the year you’d have $5,001.50 in your account if you didn’t deposit any additional money. By the end of year two, you’d have $5,003, since the total amount of interest would be calculated based on the balance of $5,001.50 rather than the $5,000 you initially deposited.

With each compounding period, you earn some interest on your money. All of this interest adds up based on your account’s APY rate. Finally, keep in mind that the interest you could earn can vary based on how much you deposit into your account; how often and how much you contribute or take out; and what kind of account you open.

How can I get a better APY from my bank?

Some banks and financial institutions offer a higher APY if you keep higher balances in your account. Shopping around and comparing rates from different banks — both online and in person — may also help you land a better rate.

What’s the difference between APY and APR?

While APY indicates the rate at which your deposit account can earn money, APR is the annual cost of borrowing money — including certain fees. You’ll hear about APR if you take out a loan or credit card.

APR is the yearly interest, plus any applicable fees, a financial institution charges for lending you money. The APR is often higher than the stated interest rate for the loan since it includes these additional fees. And APR is also expressed as a percentage.

The APR of a loan doesn’t typically include compound interest. But credit card issuers may use compound interest when calculating how much to charge you for using the credit they extend to you.

Here’s the formula to calculate the APR of a loan with fees.

Image: What's the difference between APY and APR?

APR has a huge impact on the cost to borrow money, so it’s important you understand what this rate means — and how much in interest and fees it’ll cost you — before you apply for a loan.

What fees are typically included in an APR?

The fees included in an APR can vary depending on the type of loan. Generally, fees such as loan origination and transaction fees, which are tied to a specific loan, are included in APR.

Bottom line

Understanding APR and APY can help make you a more informed consumer when it comes to borrowing money or deciding what bank to do business with.

If you’re trying to get a mortgage, credit card, auto loan or another consumer loan, pay close attention to not only the interest rate and APR. A lower rate means lower costs over the life of the loan. Read the fine print on your loan or credit card terms and calculate what borrowing that money will truly cost you.

It’s the inverse with APY — the higher the rate, the greater the amount of interest your money could earn. If you’re choosing between savings accounts at different banks, look at this all-important number and whether the interest compounds daily, monthly or annually to determine how much you’ll earn on your deposits. From there, you can make the best decision about where to keep your money.

This article was fact-checked by our editors and a member of the Credit Karma product specialist team, led by Senior Manager of Operations Christina Taylor.

An S corporation is one way to structure your business, if it qualifies for the status — and not all small businesses will. If your business operates as an S-corp, your corporate income, losses, deductions and credits pass from the business to your personal return (and the returns of any other shareholders) for tax purposes. That’s why S-corps are also called “pass-through businesses.”

You, along with any other shareholders in the S-corp, will report this passed-along information on your personal tax return. But you’ll also need to file a business tax return for your S-corp — and that’s Form 1120S.

Let’s look at the form and some things you should know about filing federal income taxes for your S-corp.

• What is an S-corp?
• What is Form 1120S?
• What information is on tax form 1120S?
• How do I fill out tax form 1120S?

What is an S-corp?

An S-corp is more of a tax status than a business structure. S-corps are pass-through entities for corporations, which means that certain income and losses from the business “pass through” onto the shareholders’ personal tax returns. But the S-corp is still responsible for some other taxes, such as tax on passive income.

Because the business income is reported on the shareholders’ personal tax returns, it’s subject to tax at their personal income tax rates. This is one of the main advantages of an S-corp — avoiding double taxation. Your business income typically isn’t subject to tax at both the personal income and corporate level.

S-corps have other tax advantages, too. Because of the 2017 tax reforms, if you have an S-corp and are below a certain income threshold, you may qualify for a 20% tax deduction on qualified business income on your federal income tax return. In 2018, the income threshold was $157,500 for single filers and $315,000 for married couples who file jointly.

But not all types of business qualify to be S-corps. If you’re unsure about which business structure to choose for your business, the Small Business Administration offers information that could help.

What are some advantages of S corporations?

Business income is reported on each shareholder’s personal tax return. So if you’re a shareholder, it’s subject to tax at your personal income tax rate. As an S-corp, your business typically won’t have to pay taxes at both the personal income and corporate levels.

If you have an S-corp and are below a certain income threshold, you may qualify for up to a 20% tax deduction on qualified business income.

These tax advantages can reduce the amount of taxes you owe overall. But keep in mind: Once you file form 1120S and your personal tax return, any tax payment or refund due will be through your individual income tax return and in proportion to your share of ownership in the S-corp.

What are other types of business structures?

Here are some of the business structures that the IRS recognizes.

• Sole proprietorships: Sole proprietorships are unincorporated businesses owned by one individual.
• Partnerships: A partnership is a business owned by two or more people who contribute money, property, labor or skill. They expect to share in profits and losses.
• Corporations: Also called C corporations, these businesses are incorporated and recognized as a separate tax-paying entity for federal income tax purposes.
• S corporations: These corporations pass the company’s income, losses, deductions and credits to their shareholders, who report income and losses on their personal tax returns.
• Limited liability companies: States set laws and regulations for establishing LLCs, which can have owners who are individuals, corporations, other LLCs or even foreign entities. For federal tax purposes, LLCs may elect to be treated as corporations, partnerships or as part of the owner’s tax return.

What is Form 1120S?

Just as many individual taxpayers must file a federal tax return every year, so must companies.

If your business has an S-corp tax classification status, you must file form 1120S, which is essentially the annual tax return for your business. Use this form to report deductions, gains, income and losses from the business during the current tax year.

What information is on tax form 1120S?

The information on Form 1120S falls into three general categories: income, deductions, and taxes and payments.

Here’s an overview of some of the main information the IRS requires you to provide.

• Your business’ gross receipts and gross profits
• Compensation of officers and salaries and wages
• Returns and allowances (cash or credit refunds issued to customers)
• Cost of goods sold (cost to manufacture the products or services your business sells)
• Estimated tax payments
• Any refundable tax credits carried over from previous years

Form 1120S also has multiple schedules that you may need to include when you file.

• Schedule B: Schedule B includes any canceled or forgiven non-shareholder business debt, whether a qualifying subsidiary’s S-corp status was terminated or revoked, and any 1099 payments to independent contractors that worked for your business during the year.
• Schedule K: Schedule K lists each shareholder’s share of income, deductions, credits and other items from the business. This form will also detail the amount of pass-through income that will be reflected on your personal tax return.
• Schedule L: Schedule L provides an overview of your business’ balance sheets, including cash, inventory, loans to shareholders, liabilities, mortgages and capital stock.
• Schedules M-1 and M-2: Schedule M-1 reconciles the business income (or loss) shown in its accounting records with information that’s been reported on Schedule K. Schedule M-2 details any adjustments, including reductions, distributions, accumulated earnings or profits, that are part of your business’ financials.

How do I fill out tax form 1120S? 

To complete Form 1120S, you’ll need, among other things, information on your business’ gross sales and profits, business expenses and any estimated taxes you owe. This is why good recordkeeping throughout the year is so important. Whether you use accounting software or keep all this information in an Excel file, gather all of the relevant documents on your business financials to complete Form 1120S.

For 2019, S-corps must file Form 1120S by the 15th day of the third month at the end of their tax year. So if you operate on a calendar year basis, the deadline is March 15, 2020.

Bottom line

If your business operates as an S-corp, the income you gain from it as a shareholder will pass through to your personal federal income tax return. But you’ll still need to file a separate tax return for your business — Form 1120S.

You may not be able to file your business tax return for free through an online tax filing service, but you may still be able to file your personal federal income tax return for free. But you may still be able to use it to do your personal income taxes and claim a pass-through deduction if you’re eligible for one.

Christina Taylor is senior manager of tax operations for Credit Karma. She has more than a dozen years of experience in tax, accounting and business operations. Christina founded her own accounting consultancy and managed it for more than six years. She codeveloped an online DIY tax-preparation product, serving as chief operating officer for seven years. She is an Enrolled Agent and the current treasurer of the National Association of Computerized Tax Processors and holds a bachelor’s degree in business administration/accounting from Baker College and an MBA from Meredith College. You can find her on LinkedIn.

This article was fact-checked by our editors and Jennifer Samuel, senior product specialist for Credit Karma It has been updated for the 2020 tax year.

If you live or work in California, you may love the state’s miles of sparkling blue beaches, redwood forests and Hollywood glitz. But, your California dreaming may turn into nightmares if you don’t understand the actual tax costs associated with living and working in the state.

If you’re weighing a move to this West Coast haven or already live there, here are some things to know about the different types of taxes you may face in California.

• The basics of California taxes
• California income taxes
• California sales and use taxes
• California property taxes
• California estate taxes

The basics of California taxes

Tax revenue funds many public initiatives in California.

For example, income tax revenue collected by the Franchise Tax Board helps pay for the state’s roads, schools, parks and law enforcement services. The California Department of Tax and Fee Administration oversees the state’s sales and use, fuel, and tobacco taxes, which help support things like local criminal justice, local health and social services programs, and county transportation and operations.

Here’s an overview of some of the taxes you might encounter.

California income taxes

California has a progressive income tax system. Personal income tax, which is the state’s largest revenue source, is based on taxable income (income after allowable deductions) from sources like capital gains, dividends, interest, pensions, tips, wages, and other income that isn’t considered exempt from state taxation.

As of 2020, the state’s maximum tax rate on individuals is 12.3%, though people who have a taxable income of more than $1 million in a given tax year also are subject to an additional 1% tax, which is used to pay for mental health services.

Here are California’s individual income tax rates and corresponding brackets for 2020.

Tax credits and deductions in California

If you have taxable income in California, it may be possible to reduce your tax obligation through tax credits and deductions. Here are some to consider.

• California earned income tax credit — The state has a cash back tax credit for low-income earners. Filers who earn less than a certain threshold may qualify for the credit.
• Renter’s credit and other credits — For 2019, California’s nonrefundable renter’s credit ranged from $60 to $120, depending on a taxpayer’s filing status and adjusted gross income. The state also has a senior head-of-household credit, which maxed out at $1,434 for qualified filers in 2019, and a joint custody head-of-household credit/dependent parent credit that can’t exceed $484 for qualified filers.
• Standard deduction — Californians can benefit from standard deductions that can reduce their taxable income. Deductions also vary by filing status. For 2020 the deductions are $4,601 for single filers or married/registered domestic partners filing separately; and $9,202 for married/registered domestic partners filing jointly, head of household or qualifying widow(er).

Filing income taxes in California

In 2019, if you were a full-year resident of California, you probably used Form 540 2EZ or 540 to file your state income taxes. If you were a nonresident or only lived in California for part of the year, you likely used Form 540NR. The form has short and long versions.

You have multiple ways to file your California state tax return.

• File online. You can use CalFile, the state’s online tax-filing system, to file your return for free. You must create an account on the Franchise Tax Board’s website to use this service. Other free-filing options may also be available, based on income limitations. And of course you have the option of using a fee-based e-file provider.
• File by mail. Once you complete your tax return, you can mail it to the Franchise Tax Board. The agency provides the relevant mailing address for each tax form on its website.

California sales and use taxes

California applies a state sales tax to all retail sales of goods and merchandise, though there are some exemptions. The state has a use tax that applies to the storage, use or other consumption of goods not subject to the sales tax — including items purchased in another state by mail, phone or internet and then shipped into the state.

The sales and use tax rate in any locality in California is composed of the state tax rate, a local tax rate (if any) and any district tax rate that may apply.

California property taxes

Property taxes are typically levied at the county and municipal level.

In California, property tax rates are limited. Counties and municipalities are allowed to tax 1% of a property’s assessed value, plus an additional rate needed to fund local voter-approved bond debt. But property owners in California may also face local taxes, such as for school districts, for the tax year.

According to the Lincoln Institute, California ranks 23rd in the nation for per capita property tax obligation, while its average per capita property tax levy is slightly lower than the U.S. average.

Bottom line

No matter where you live, your total tax burden is made up of much more than just your federal and state income tax obligation. States like California often fund their operations through other types of taxes, like sales or property taxes, that can directly affect your financial well-being. That’s why it’s important to understand all the state-level taxes you may be subject to.

Relevant sources: California Franchise Tax Board: Understanding California Taxes | California Department of Tax and Fee Administration | CDTFA: Tax Rates — Special Taxes and Fees | California Department of Community Services and Development: California Earned Income Tax Credit | Cal EITC: What Is the California Earned Income Tax Credit (CalEITC)

Jennifer Samuel, senior tax product specialist for Credit Karma, has more than a decade of experience in the tax preparation industry, including work as a tax analyst and tax preparation professional. She holds a bachelor’s degree in accounting from Saint Leo University. You can find her on LinkedIn.

A Roth IRA allows you to save after-tax dollars in a retirement account. Roth IRAs work a bit differently than traditional IRAs or employer-sponsored savings plans like 401(k)s. But they also have some unique advantages.

Let’s look at some things to know about Roth IRAs, who can contribute to them, and the Roth IRA income limits for the 2020 and 2021 tax years.

• What is a Roth IRA?
• Can I open and contribute to a Roth IRA?
• What happens if I exceed my contribution limit?

What is a Roth IRA?

Like a traditional IRA (or individual retirement arrangement), a Roth IRA allows you to contribute money into an account to save for retirement. But Roth IRAs differ from traditional IRAs in several important ways.

• Contributions are post-tax (meaning you pay income tax on the money in the year you make the contribution), and you can’t deduct those contributions on your federal income tax return.
• You can contribute regardless of your age, as long as you (or your spouse if filing jointly) have taxable compensation and you meet certain income limits.
• Your qualified withdrawals are not taxable in the year you take the distribution. A qualified distribution is any money you withdraw after your account has been open for at least five years, and you’re at least 59 ½, are disabled, are using the money to purchase your first home (as defined by the IRS), or if the money is withdrawn after your death to pay your beneficiaries or estate.
• You’re not required to take a minimum distribution by a certain age as long as you’re the original owner of the account.

“[With a Roth IRA], you have complete accessibility to your contribution,” says René Nourse, a certified financial planner and founder and CEO of Urban Wealth Management. “It’s a dual manner of saving for now and saving for the future.”

As long as you’re 59 ½ or older and your withdrawals are qualified distributions, “you can pull out the principal and these contributions aren’t taxable because you’ve already paid taxes on them,” Nourse says. But if you’re younger than 59 ½, you may need to pay a 10% additional tax on withdrawals, unless you qualify for an exception.

Can I open and contribute to a Roth IRA?

You can open and contribute to a Roth IRA on two conditions: You (or your spouse if filing jointly) have taxable compensation and your modified adjusted gross income (your income after adjustments like deductions) meets the limitations. But contribution limits can prevent certain people from contributing to a Roth IRA.

If you meet the income limitations, you can make a maximum contribution of $6,000 to a Roth IRA if you’re younger than 50 (up to $7,000 if you’re 50 or older) in both 2020 and 2021.

But if your taxable compensation for the year was less than the maximum contribution limit, your taxable compensation amount for the year then becomes your maximum contribution limit. For example, say your taxable compensation for the 2020 tax year was just $5,000 and you’re younger than 50 — the most you could put into your Roth IRA for the year would be $5,000.

How much you can contribute also depends on your tax-filing status.

Here’s a chart that details 2020 and 2021 Roth IRA contributions and how they phase out depending on your filing status and income.

While your contribution limit is clearer if you’re at the bottom of these ranges, figuring out your reduced contribution if you’re in the middle can be tricky. Fortunately, the IRS provides worksheets to help you sort this out. Once you’ve determined your modified AGI, you can use Worksheet 2.2 in IRS Publication 590-A to help determine your contribution limit.

Do Roth IRAs have age limits for contributing?

Unlike traditional IRAs, you can continue to make contributions to a Roth IRA even after age 70½.

What happens if I exceed my contribution limit?

While a Roth IRA can help you save for retirement, it’s also important to stay within your annual contribution limit. If you don’t, you could be hit with a tax penalty on the extra contribution amount.

For example, if you use Worksheet 2.2 and find that you’re only allowed a $3,000 contribution for the year and you’ve already contributed $5,000, Nourse says the best thing to do is withdraw your excess contribution. Otherwise, the IRS will apply a 6% tax to the excess.

“If you discover it before you file your tax return, you can pull it before your tax-filing deadline,” she says.

Bottom line

Maybe retirement seems as if it’s years away, but the choices you make today can help secure your future tomorrow. A Roth IRA can be a valuable retirement savings tool, if you’re eligible to participate in one. Consider maximizing your contributions and stay within the limit designated for your income and filing status.

Nourse says it’s important to remember that you can make contributions to your Roth or traditional IRA up until the federal filing deadline for a given tax year (excluding extensions). So even if it’s Dec. 31 of the tax year and you haven’t made your full Roth IRA contribution, you still have some time to save as much as possible and potentially grow your retirement savings.

A senior product specialist with Credit Karma, Janet Murphy is a CPA candidate with more than a decade in the tax industry. She’s worked as a tax analyst, tax product development manager and tax accountant. She has accounting degrees and certifications from Clemson University and the U.S. Career Institute. You can find her on LinkedIn.

This article was fact-checked by our editors and reviewed by Tolla Tu, tax specialist with Credit Karma. It has been updated for the 2020 tax year.

Owning and operating a vehicle isn’t cheap — the average cost to keep rolling is $9,282 per year, according to a 2019 study by AAA.

Depending on the type of vehicle you own, your annual costs to drive 15,000 miles per year could vary substantially — from a high of $10,839 for a pickup truck to a low of $7,114 for a small sedan, AAA reports. Wouldn’t it be great to recoup some of the money you spend every year on gas, maintenance, repairs, insurance and other vehicle-related expenses?

If you meet certain qualifications, you might be able to take a driving-related tax deduction for using a car or other vehicle. The standard mileage rate for 2020 can help you calculate how much you may be able to deduct when you file your 2020 federal income taxes next year.

But not everyone can deduct vehicle-related expenses, and even if you’re qualified for a vehicle-related tax break, you may need to itemize to take the deduction. Here’s what you need to know about the standard mileage rate and how it can affect your tax obligation.

• Standard mileage rate defined
• Who can use the standard mileage rate?
• Taking a deduction for mileage

Standard mileage rate defined

The standard mileage rate is a set amount of cents per mile that qualifying taxpayers can use to calculate a mileage-related deduction from their federal income tax. Every year, the IRS sets standard mileage rates for using your car for business, charitable, medical and moving purposes. If you qualify for the deduction, you have the option to calculate the deduction based on the actual costs of using your vehicle or by using the standard mileage deduction method.

Different purposes have different rates, and each rate is calculated differently.

For example, the business mileage rate is based on an annual study of the fixed and variable costs of using a car, while the mileage rate for medical and moving purposes is based on only the variable costs. Federal law determines the charitable mileage rate, which you only can deduct for unreimbursed out-of-pocket expenses related to using your car while doing charity work for a charitable organization.

Here’s a look at standard mileage rates for 2019 and 2020.

Who can use the standard mileage rate?

Not everyone with vehicle-related expenses will be able to use the standard mileage rate to take a tax deduction. You’re only eligible for it under very specific circumstances.

Business

If you use your car to drive for business purposes, you may be able to deduct some vehicle-related expenses. You can either calculate your deduction based on actual expenses or use the business standard-mileage rate.

Businesses or self-employed people who use their vehicle for business may be able to take this deduction. If you’re an employee traveling for business and your employer doesn’t reimburse you for your travel expenses, you can’t claim an itemized deduction for unreimbursed employee expenses, including business travel costs.

Other rules apply to when and how a business person can take this deduction. IRS Publication 535 has more information about deducting business expenses.

Medical

When you use a car for medical reasons, like driving to or from a doctor’s office or hospital for necessary medical care, you may be able to take a vehicle-related deduction. You can either track and deduct actual out-of-pocket costs for expenses like gas and oil, or you can use the standard medical-mileage rate to calculate your deduction.

But remember — you can only deduct medical mileage if you take a medical-expense deduction, and you can only deduct medical expenses that exceed 7.5% of your adjusted gross income.

IRS Publication 502 has more information about deducting medical and dental expenses.

Charity

If you used your car to volunteer with charitable organizations, you may be able to take a vehicle-related deduction. You can either use your actual expenses, like the cost of gas, to calculate your deduction, or use the charitable mileage rate.

IRS Publication 526 has more information on deducting charitable contributions.

Moving

If you’re an active-duty member of the military and you moved due to a military order or permanent change of station, you may be able to deduct certain expenses related to your move. If you used a car, van, pickup or panel truck to move, you may be able to use the standard mileage rate for military purposes to calculate a deduction.

The moving expense deduction is only available for active members of the U.S. armed forces. Tax reform suspended the deduction for everyone else for tax years between Dec. 31, 2017, and Jan. 1, 2026.

Taking a deduction for mileage

Individual filers use Form 1040 to file their federal income taxes, but any additional forms you need to take a mileage-related deduction will depend on the purpose of the deduction — and your individual tax situation.

For example, if you’re taking a mileage deduction related to volunteer work for a qualified charity, your charitable deduction would be reported on Schedule A as part of your itemized deductions. You would use the same form if you’re claiming a medical-expense deduction.

But if you’re self-employed, you would take a business deduction on Schedule C — Profit or Loss From Business.

Bottom line

The standard mileage rate can help qualified filers who itemize their deductions reduce their tax obligation. If you qualify to take a vehicle-related deduction, remember that you can either use the standard mileage rate or base your calculations on your actual costs. It may make sense to calculate your deduction both ways to see which one will give you the greater tax benefit.

A tax specialist with Credit Karma, Tolla Tu has international experience in accounting, tax, finance, banking and consulting. She holds a bachelor’s degree in financial management from Beijing University of Chemical Technology, a master’s in corporate finance from Central University of Finance and Economics as well as a Master of Professional Accountancy from Montana State University. You can find her on LinkedIn.

Tax Day is on the horizon, and you may not be sure if you’ll be getting a refund … or if you’ll owe more federal tax instead.

Whether you owe Uncle Sam, or he owes you, depends on a number of factors, like your deductions, your income, and whether you paid enough tax on your earnings throughout 2018. Calculating your federal income tax obligation can be complicated. So the IRS makes it easier to understand the amount of tax you’re expected to pay by providing federal income tax tables.

Let’s take a look at what tax tables are, how they help make figuring your federal income tax easier and what you should know about how to read 2018 tax tables.

• Calculating tax: Why’s it so difficult?
• What is a federal income tax table?
• Using the federal income tax table
• Calculating your federal income tax
• But there’s a catch …

Calculating tax: Why’s it so difficult?

Federal income taxes are complicated.

There are thousands of  forms and publications related to federal income taxes. The Tax Cuts and Jobs Act of 2017 — legislation meant to help simplify the federal tax code — is more than 500 pages long.

And the new shorter Form 1040 does manage to reduce the essential tax return to a single, double-sided page. But it does so by moving a lot of essential information off the original form and onto six new schedules that you may need to file along with the 1040.

What’s more, tax calculations can seem downright arcane. They depend on far more than just knowing your tax bracket and rate. And a number of factors can influence your tax obligation — like your filing status, whether you take a standard deduction or itemize, adjustments to your income and more.

Tax preparation and filing services can help you calculate your tax when you use them to  prepare and file your taxes. But if you’d like to get a rough idea of how much tax you should have paid last year — and your taxable ordinary income was $100,000 or less — the 2018 federal income tax table is a good place to start. If your taxable income was $100,000 or more, you can check out the IRS tax computation worksheet.

What is a federal income tax table?

A tax table is basically a chart that shows how much tax you should pay based on your taxable income and filing status. The 2018 federal tax table starts on Page 67 of the Form 1040 instructions for the 2018 tax year.

It’s important to note that the tables use taxable income to predict your taxes, so you’ll need to do some calculations to figure out your taxable income before you can use the tax table effectively.

Using the federal income tax table

The federal income tax table allows you to calculate how much tax you owe by using information about your filing status and taxable income (the income the IRS can tax after you make all the deductions and adjustments for which you qualify).

The IRS publishes a new tax table every year. Tax reform also led to several changes that affect the tax rate you pay and your final taxable income this year, including updates to tax brackets and a standard deduction that’s nearly double what it was for 2017.

Calculating your federal income tax

To use a tax table to determine your federal income tax, first you need to know your filing status and taxable income.

There are five filing statuses: single, married filing jointly, married filing separately, head of household and qualifying widow(er) with dependent child. The IRS has guidelines that determine what filing status you can use. For example, if you’re unmarried, divorced or legally separated, you may be able to file as a single person. If you’re unsure of your filing status, you can use the IRS Interactive Tax Assistant to determine your status.

Once you know your filing status, follow these steps.

1. To determine your taxable income, you’ll need to know your adjusted gross income (or AGI), which is your gross income (all the income you receive in a year) minus adjustments. There are many possible adjustments you may qualify for. Examples include certain business expenses, contributions to health savings accounts, IRA contributions and student loan interest.
2. Once you know your AGI, subtract your qualified business income deductions (if applicable) and determine whether you’ll take the standard deduction or itemize. Subtract these deductions and then you’ll get your taxable income.
3. Next, find the tax bracket on the tables that corresponds to your income. The 2018 federal income tax table is divided into three vertical boxes on each page. For each box, the first two columns of numbers represent the range of taxable income that corresponds to each amount of tax.
4. Then, find your filing status in the top row of the tax table.
5. Finally, determine your tax. Where your income row and filing status meet, that’s your tax for 2018.

For example, if you and your spouse use the filing status of married filing jointly and your combined total taxable income is $95,040, your 2018 tax would be $12,785. A single filer with the same income would pay $17,096 in taxes. If you had at least this amount withheld from your paycheck or paid this amount in estimated taxes throughout the year, then you wouldn’t owe anything when you file your federal income tax return. If you paid more than this amount, you would probably get a refund.

But there’s a catch …

Using the 2018 federal tax table to get an idea of your tax is fairly easy … but there’s a catch.

The IRS tax table is only for filers who have a taxable income of less than $100,000. If you make $100,000 or more, the IRS provides a tax-computation worksheet that you can use to calculate your tax. In the instructions for the 2018 1040, this worksheet is on Page 79.

If using the tax table or the worksheet is still too cumbersome, consider using an online tax calculator or a do-it-yourself tax-preparation and e-filing service.

Bottom line

Once you know your tax obligation and determine whether you’ll owe or get a refund, take several steps to ensure you’re in good financial shape.

If you’ll be facing a tax bill, plan ahead for how to cover your underpayment when taxes are due (usually on April 15 every year). If you expect a refund, consider how to use the money to achieve your overall financial goals, whether that means increasing your emergency fund, saving for a house or paying off student loan debt.

Or you could begin planning for 2019 taxes. If you’ll owe, adjust your W-4 withholdings to increase the amount you withhold from your paycheck so that you’ll owe less, or get a refund, at tax time next year.

Filing your tax return shouldn’t come with unexpected surprises. With a few pieces of information, including your filing status and taxable income, you may be able to use the 2018 income tax table to be better prepared financially come Tax Day.

This article was fact-checked by our editors and CPA Janet Murphy, senior product specialist with Credit Karma. It has been updated for the 2020 tax year.

Paying taxes every year may not be your favorite pastime, but you still have time to reduce your tax bill and certain out-of-pocket expenses.

One way is to contribute as much as you can now to a tax-advantaged health savings account — an account where you can set aside pretax money to pay for qualified medical expenses not covered by insurance. If you’re eligible to participate in an HSA, you can contribute right up until April 15, 2021, the expected deadline for filing and paying your 2020 federal income taxes (unless the deadlines changes, as it did in 2020 for 2019 returns). Putting money into this account over the next few months can count toward your 2020 federal income tax return.

But that’s not the only benefit: An HSA can also lower your healthcare costs. Here’s how to use an HSA to save money throughout the year, especially come tax time.

• What is an HSA and who can qualify?
• How an HSA works
• Tax benefits of an HSA
• HSA deadlines and contribution limits

What is an HSA and who can qualify?

An HSA is a type of tax-exempt savings account that allows eligible taxpayers to set aside pretax dollars to pay for qualified medical expenses not covered by insurance. Not everyone qualifies to have an HSA.

You could qualify for an HSA if …

• You’re covered by a medical insurance plan classified as a high-deductible health plan, or HDHP.
• You can’t have any other insurance besides your HDHP (though there are exceptions, such as a policy covering only a particular disease).
• You aren’t enrolled in Medicare.
• You can’t be claimed as a dependent on any other person’s federal tax return.

An HDHP is a plan that has a deductible of at least $1,400 if you’re single or $2,800 for a family in 2020, meaning you may have to pay at least this amount out of your own pocket before your health insurance starts paying for covered services. In addition, the total of annual deductible plus other out-of-pocket expenses can’t be more than $6,900 for self-only coverage, or $13,800 for family coverage. For 2021, the deductible amounts will remain the same as the 2020 limits, but out-of-pocket maximums will increase to $7,000 for self-only coverage and $14,000 for family coverage.

If you qualify to have one, you can use HSA funds to pay for copayments, monthly premiums, coinsurance, deductibles and other qualified expenses. Qualified medical expenses can also include medical and dental expenses you paid during the tax year — even if the services were provided before this tax year. Nonessential healthcare services (for example, certain cosmetic surgery) don’t qualify, but healthcare costs related to treatment to prevent or reduce symptoms of a physical or mental disability or illness may qualify.

How an HSA works

If you qualify for an HSA, you can sign up for the account through your employer, if it offers the plan, or through a health insurance company. Banks and other financial institutions also offer individual accounts. You can sign up for an HSA at any time during the plan year as long as you meet the eligibility requirements.

Once your HSA is set up, you can make contributions to it and withdraw money to pay for qualifying healthcare costs or to reimburse yourself for qualifying costs you’ve already incurred. At the end of the year, the account’s trustee will send you an IRS Form 1099-SA, which will detail your total HSA distributions. You may also receive a Form 5498-SA if you made any HSA contributions on your own. You’ll then need to file IRS Form 8889 with your tax return to report all the distributions you’ve taken from your HSA for qualified medical expenses and other expenses that may not be tax-deductible.

Keep good records of all your expenses throughout the year to help ensure the information you provide the IRS is accurate and that you aren’t hit with a surprise tax bill later on.

What medical expenses can you pay with an HSA?

You can typically use an HSA to pay for the same types of expenses that would be included in a medical and dental expense deduction (if you could qualify to take one). Here are some of the things that an HSA may cover.

• Over-the-counter drugs prescribed for you
• Birth control pills prescribed for you and vasectomies
• Medical supplies such as bandages and lactation expenses such as breast pumps and other supplies
• Dental visits, tooth cleanings, fillings and other treatment
• Costs of inpatient treatment for drug addiction
• Vision care such as exams, glasses and contact lenses needed for medical reasons, and saline solutions and enzyme cleaners for lenses
• The expenses involved in buying, training and maintaining guide dogs or other service animals that help people with hearing, vision or other physical disabilities
• Lab fees that are part of medical care
• Costs of special education for children with learning disabilities (with a doctor’s recommendation)

Learn more about HSA rules.

How long do you have to use the money in your HSA?

Unlike a flexible spending account, HSAs aren’t use-it-or-lose-it accounts. You can withdraw the money from an HSA at any time, though only the amount used to pay for qualified medical expenses is tax-free. Any amount left over in the account at the end of the year rolls over to the next year.

Tax benefits of an HSA

HSA contributions are typically tax-deductible. Even if a family member or spouse contributes money to your HSA, you can claim it as a deduction, which will reduce your adjusted gross income. And you can claim this deduction even if you don’t itemize your deductions.

If your employer contributes to your HSA, you may not have to include the amount in your gross income while calculating taxes.

The money in the account is yours to keep even if you change jobs or stop working. Withdrawals may be tax-free as long as you use them to pay for qualified medical expenses.

Another advantage is that HSAs earn interest, which isn’t taxed.

HSA deadlines and contribution limits

Of course, HSAs come with rules and limitations. For example, you can’t just contribute however much you want to your HSA.

Contribution limits

For 2020, the maximum amount you’re allowed to contribute to an HSA is $3,550 if you’re single and $7,100 for a family account. For 2021, the limits will be $3,600 for self-only coverage and $7,200 for family coverage. You may be able to add an extra $1,000 to your account as a catch-up contribution if you’ll be age 55 or older at the end of the tax year. If your employer contributes to your HSA, the total of employer contributions and your own contributions can’t exceed the annual HSA contribution limits.

If your total HSA contributions exceed the annual contribution limit, you won’t be able to deduct the excess amount. Plus, you may face a penalty of 6% on the excess contributions unless you withdraw the money and any income earned on the withdrawn contributions by the April 15 filing deadline. If you don’t withdraw the excess amount and are subject to the penalty, you’ll need to file a Form 5329 to report it to the IRS.

Contribution deadline

There’s also a deadline for making HSA contributions that will count toward the current tax year. The good news: It’s a longer deadline.

The deadline to make contributions to an HSA for a tax year is typically April 15 of the following year. This means that for 2020 taxes, you can contribute until April 15, 2021. If you haven’t maximized your HSA contributions yet, consider using the extra time to do so and to get as big a tax break as possible.

When you can make changes

If you’ve enrolled in an HSA through an employer-sponsored health plan, check with your HR department about whether you can make midyear changes to your contribution. If your employer does allow changes, you may be able to increase your HSA contribution by adjusting the amount of your payroll deduction or the pretax amount that’s withdrawn from your paycheck and deposited into your HSA.

If you have an HSA through a bank or financial institution, it may allow you to change your contribution at any time during the plan year. Some banks allow you to do a one-time rollover or transfer of funds from your IRA or even multiple transfers from another HSA into your existing HSA.

What is the tax penalty for withdrawing money from an HSA that isn’t used for qualifying healthcare costs?

You pay an additional 20% tax on money you use for anything other than qualified medical expenses.

But if you’re 65 or older, there is no tax penalty on any money you withdraw from your HSA to cover non-healthcare costs.

Bottom line

If you’re dreading a potentially high tax bill in April, remember there’s still time to take some action to minimize what you might owe. Use the next few months to take advantage of any tax deductions available to you.

An HSA is a great option if you’re eligible, because the contributions typically are tax-deductible for qualified medical expenses. There’s also the bonus of not paying taxes on money coming out if withdrawals are used for qualifying medical expenses. If you have a high-deductible healthcare plan, you can use the money in your HSA to pay your deductible, which will reduce your out-of-pocket costs.

So, if your HSA isn’t funded to the maximum contribution limit, consider setting aside as much money as possible between now and the tax-filing deadline in April to hit that threshold and reap the highest tax savings you can. You can learn more about HSAs in IRS Publication 969.

Relevant sources:

Internal Revenue Bulletin: 2019-22 | IRS Notice 2004-2 | HealthCare.gov, Health Savings Account (HSA) | HealthCare.gov, Deductible | IRS Publication 502, Medical and Dental Expenses | IRS Form 1099-SA, Distributions from an HSA, Archer MSA or Medicare Advantage MSA | IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans | IRS Form 8889, Health Savings Accounts (HSAs) | IRS: Credits and Deductions for Individuals | IRS: Filing and Payment Deadlines Questions and Answers

A senior product specialist with Credit Karma, Janet Murphy is a CPA with more than a decade in the tax industry. She’s worked as a tax analyst, tax product development manager and tax accountant. She has accounting degrees and certifications from Clemson University and the U.S. Career Institute. You can find her on LinkedIn.

This article was fact-checked by our editors and reviewed by CPA candidate Janet Murphy, senior product specialist with Credit Karma. It has been updated for the 2020 tax year.

It can be all too easy to put off getting your financial ducks in a row for retirement, especially if you’ve just started on your career path and retirement is decades away.

But saving in an individual retirement account can give you some tax benefit while you’re building a nest egg for the future. You can put money into an IRA even if you’re already participating in an employer-sponsored 401(k) retirement plan. And you may be able to deduct the IRA contributions from your taxable income, which can reduce your overall income tax bill.

The government limits how much you can invest in these tax-advantaged IRAs each year. But the good news is that you have until April 15, 2021, to contribute for the 2020 tax year and maximize your annual tax break as well as your future savings.

• What is an IRA?
• When is the IRA contribution deadline for 2020?
• Who can open a traditional IRA?
• What are the tax benefits of a traditional IRA?
• What are traditional IRA contribution and deduction limits?

What is an IRA?

An IRA — also known as an individual retirement arrangement — is a kind of savings account that offers tax benefits as an incentive to help you save for retirement. The money you contribute may be partially or entirely tax deductible, depending on your situation, and you don’t pay tax on the interest earned while the money is in your account. You only pay tax when you withdraw money from your IRA, assuming it’s a traditional IRA (more on that in a moment).

You can open the account on your own through a stockbroker, bank or other financial institution. You have the option of managing the account’s funds on your own, choosing which stocks, bonds and mutual funds to invest in. If you wish to withdraw the accumulated funds without incurring a penalty, you have to meet certain requirements.

There are four major types of IRAs that you can deposit pretax or after-tax dollars into.

• Traditional IRA — This type of account allows you to make tax-deductible deposits and tax-deferred investments. You only pay tax on the money when you withdraw it in retirement.
• Roth IRA — With a Roth IRA, contributions aren’t tax-deductible. But qualified distributions from a Roth IRA are tax-free, so you won’t pay any tax on the money in retirement. There are also other differences between traditional and Roth IRAs.
• Simple IRA — A savings incentive match plan for employees allows both employees and employers to contribute to employer-sponsored IRAs set up for employees. Small businesses with fewer than 100 employees typically use this IRA.
• SEP IRA — A simplified employee pension plan allows businesses and self-employed people to contribute up to 25% of an employee’s pay to an individual retirement account set up for each employee. Only an employer can contribute to an employee’s SEP IRA.

For the purposes of this article, let’s focus on traditional IRAs, how they work and the extended deadline for making contributions that will count toward your 2020 taxes.

When is the IRA contribution deadline for 2021?

The deadline to contribute to an IRA is normally the same as the deadline to file your tax return: April 15. Because of the coronavirus pandemic, the federal government extended the tax filing and payment deadline for 2019 taxes to July 15, 2020, which gave everyone 90 extra days to make IRA contributions.

If you haven’t yet maxed out your IRA contribution for 2020 (more on contribution limits later), you have some time to put money away. Many brokers, banks and other financial institutions will allow you to make contributions online.

Who can open a traditional IRA?

You can open a traditional IRA if you or your spouse (if you file a joint return) received taxable income during the year, such as wages or income from work, and if you are younger than 70½ by the end of the tax year.

If you’re married and you and your spouse both fulfill these conditions, you each can open separate accounts, not a joint IRA. Employed spouses can also contribute to the IRA of their nonworking spouses, with limitations.

You can open an IRA at a bank, brokerage firm, insurance company or other financial institution. Many companies also allow employees who enroll in a retirement plan to designate how much they’ll contribute to a traditional IRA via a payroll deduction.

What are the tax benefits of a traditional IRA?

Nearly two-thirds of 40-year-old Americans have less than $100,000 in retirement savings, according to a January 2020 TD Ameritrade poll. And 20% of people in their 70s have less than $50,000 in retirement savings.

So it’s important to save as much as you can, especially when you have a tax-advantaged way of doing it through IRAs.

With a traditional IRA, you may be able to deduct qualified contributions to reduce your taxable income. You also benefit from tax-deferred growth of your investments in an IRA account: Your contributions — and earnings on these contributions — aren’t taxed until you withdraw them.

The amount of income tax you’ll pay when you withdraw the money will depend on your tax bracket and age at the time of withdrawal. Generally, if you withdraw money from your traditional IRA before you’re 59½, you’ll pay an additional 10% tax. If you wait until you retire to begin making withdrawals from your traditional IRA, your investments and other sources of income (such as Social Security or income from a rental property) may be less than when you were working, and you could be in a lower tax bracket than you were during your working years. This could help you save taxes on your retirement income and keep more of your savings.

What are traditional IRA contribution and deduction limits?

The IRS sets contribution and deduction limits for IRAs every year. The contribution limit determines the total dollar amount you can put into your retirement account during the year, while the deduction limit determines the portion of this money that you can deduct to reduce your taxable income.

Contribution limits for traditional IRAs

For 2020, you can contribute a total of up to $6,000 to all your IRAs — both traditional and Roth if you have them — if you’re younger than 50. If you’re 50 or older, you can make a catch-up contribution of an additional $1,000, bringing your annual contribution limit to $7,000. But you can’t contribute to a traditional IRA for 2019 if you’re 70½ or older.

There is no age limit for IRA contributions as of the 2020 tax year. The Setting Every Community Up for Retirement Act of 2019 eliminated the age limit for traditional IRA contributions.

Deduction limits for traditional IRAs

The deduction amount you can take depends on your modified adjusted gross income, or MAGI, as well as your filing status and whether you or your spouse are covered by a workplace retirement plan such as a 401(k). Income phaseouts apply.

If you’re covered by a retirement plan at work, here’s what you can deduct — or not deduct — for the 2020 tax year.

If neither you nor your spouse participated in a workplace retirement plan — such as a 401(k) — you can deduct the full amount of your contributions.

Just make sure you don’t exceed your IRA contribution limit for the year. If you exceed your contribution limit, the IRS will impose a 6% tax each year on the excess above $6,000 that you put into your IRA, or $7,000 if you’re 50 or older. For example, if your contribution limit is $6,000, it may be in your best interest to stick to this number or to withdraw any excess contributions before the tax filing deadline so you can avoid this penalty.

If you exceeded your contribution limit, you must report it on Form 5329 and file it along with your annual tax return. And if you aren’t able to deduct any portion of the amount you contributed to a traditional IRA, you need to file Form 8606.

Bottom line

IRAs help you grow your retirement nest egg, boosting your savings to give you a chance to enjoy the same — or close to the same — quality of life in your golden years as you have during your working years.

Unfortunately, many Americans don’t take full advantage of these tax-advantaged accounts. If you haven’t yet funded your traditional and Roth IRAs to the contribution limit, consider using the next few months to make sure you hit your contribution limit by the extended April 15 deadline.

Relevant sources:

IRS: Retirement Topics – IRA Contribution Limits | IRS: Individual Retirement Arrangements | IRS: IRA Deduction Limits | IRS: 2020 Contribution and Deduction Limits Effect of Modified AGI on Deductible Contributions if you are Covered by a Retirement Plan at Work | IRS: Traditional IRAs | IRS: Individual Retirement Arrangements: Getting Started | IRS Publication 590-A: Contributions to Individual Retirement Arrangements (IRAs) | IRS: Choosing a Retirement Plan – SEP | IRS: IRA FAQs – Contributions | IRS: Payroll Deduction IRA | IRS: IRA Year-End Reminders

A senior product specialist with Credit Karma, Janet Murphy is a CPA candidate with more than a decade in the tax industry. She’s worked as a tax analyst, tax product development manager and tax accountant. She has accounting degrees and certifications from Clemson University and the U.S. Career Institute. You can find her on LinkedIn.