Last month we discussed the basics of How to Read your Tax Return. This month we promised we’d do a bit deeper dive and review two of the most used schedules that impact your tax liability and flow through to pages 1 and 2.
After calculating your Adjusted Gross Income (AGI) the IRS allows you to deduct the higher of your total Itemized Deductions or the Standard Deduction, which is $6300 if you are single or $12,600 if you are married. The deduction is a little more if you are 65 or over. Itemized Deductions are calculated on Schedule A, which can be found right after page 2 of your tax return. If you can’t find a Schedule A, then the standard deduction was likely higher than your total itemized deductions.
As you look at the left-hand column of your Schedule A, you’ll see the seven categories the IRS allows you to deduct. Being familiar with these categories may make it easier to track deductions during the year and supply them to your tax preparer.
Let’s start at the top:
- Medical and Dental Expenses:
Many people diligently track their medical expenses each year thinking that they’ll be able to deduct them from their taxes. However, you can only deduct expenses in excess of 10% of your AGI if you are under 65 years old, or 7.5% of income if you are age 65 or over. 10% of AGI is a fairly high hurdle to overcome and so often medical expenses do not end up being deductible.
Take a look at your Schedule A. How much did you have in medical and dental expenses? What hurdle did you need to reach to be able to deduct those expenses? Also, remember that even if you do meet that hurdle, you can only deduct the amount ABOVE that hurdle. Note: Health insurance premiums and a portion of long term care insurance premiums can be deducted and may help you exceed this hurdle.
- Taxes You Paid:
For many tax payers this category ends up being their largest deduction.
- You can deduct the higher of local Income taxes or sales tax that you paid during that year. Most taxpayers in Wisconsin would deduct their Wisconsin Income tax payments.
- You can also deduct real estate taxes paid in that tax year on any home you owned that was not a business. That is why many people choose to pay their property tax bill before year-end. Note: If you are in AMT there may be a strategy as to when to pay your property taxes.
- Interest You Paid:
The most common deduction you’ll find in this section is the interest you paid on your first or second home mortgage. You’ll receive a 1098 from your mortgage holder detailing the deductible amount of interest.
- Gifts to Charity:
Most tax payers are aware that they should track their charitable expenses each year; and this is where you’ll find that total. Contributions can be in cash, property, or out of pocket expenses you paid to do volunteer work for charitable organizations. You can also deduct 14 cents/mile (in 2016) if you drove to and from the volunteer work. Be sure to maintain documentation of all charitable mileage and donations.
- Casualty and Theft Losses:
Fortunately, I rarely see this expense on a Schedule A. You can deduct losses caused by theft, vandalism, fire, storms, etc. only to the extent it is greater than 10% of your AGI and not covered by insurance.
- Job Expenses and Certain Miscellaneous Deductions:
This is another category that is limited by your AGI. You can only deduct the following expenses to the extent they exceed 2% of your AGI. Some of the most common deductions from this section are certain unreimbursed employee expenses, tax preparation fees, and investment management fees.
Whew! That was a lot of work. Now all we have to do is total these up and compare it to the standard deduction. If the total is higher, it should appear on line 40 of your 1040. Wait, did I forget to mention that under current tax law your itemized deduction may be limited? That’s a calculation for your CPA, but you can see if you were limited on line 29 of Schedule A.
Skipping forward a few letters, let’s take a look at Schedule D. Schedule D tracks any sales of capital gain property during that year, which would be reported to you on a 1099-Composite. In most cases you’ll see sales of mutual funds and ETFs held in your taxable accounts. Sales are divided into Part I – Short-Term Capital Gains, which would be assets held for less than one year, and Part II – Long Term Capital Gains, which are assets that were sold after one year. The distinction is important because under current tax law, long-term capital gains are taxed at a lower rate.
Note: ETFs avoid unwanted year-end capital gain distributions that occur with mutual funds. This is one reason we favor ETFs vs mutual funds, and another way we’re striving to control your tax liability.
Column (d) details the proceeds from the sale. Column (e) details the cost basis (the amount you paid) and column (h) calculates the difference. If that difference is negative, you’ve sold that security for a loss, which can be used to offset other investment gains this year or even carried forward into future years. Note: A loss on Schedule D is not a measure of investment performance for the overall portfolio.
Can you figure out how much gain or loss you had from capital gain income this year?
Most of our clients hire an accountant to prepare their taxes and hire us to interpret that return and apply it to their financial plan. However, you are the one ultimately responsible for the information on your return. While reading this blog, take a few minutes to look through Schedules A and D. Give us a call if you have any questions. We’d be happy to walk you through them in your next planning meeting.