The past three months have been busier than normal in the Shakespeare office. In addition to the financial planning and investment management we are always busy with, we’ve also been fielding many tax questions from clients and CPAs. We aren’t saying we have it as bad as CPAs, but our phones have been ringing too! We have been able to find time to have some fun! Did you notice that we completed the Climb for Air sponsored by the American Lung Association? Here is Kevin crossing the finish line! (See more pictures in our Photo Gallery).
Anyway, back to taxes. Even if you hire a professional to prepare your taxes, gathering all the tax forms you need and completing your accountant’s tax organizer can be exhausting. I’ve helped several clients work their way through the tax organizer and the various 1099s, W2s, and charitable donation documentations. Soon we’ll start to receive completed returns from our clients, which we will use to update financial plans.
As I was meeting with a client and walking her through her return, it occurred to me that others may be interested in learning the basics of how to read a tax return. Reading your return is probably easier than collecting all the data that goes into it; but many people don’t review the completed return because by that time they are so “over it.”
HERE’S A QUICK PRIMER:
The meat of your tax return can be found on Pages 1 and 2 and Schedule A.
On Page 1 double check your basic demographic information including Social Security number.
Lines 6a – d will document your total exemptions and include you, your spouse (if married) along with any dependents. Note: Are you claiming everyone you should be claiming? Is there anyone you shouldn’t be claiming? In some cases it may be beneficial to NOT claim someone on your return. Talk with us or your CPA to discuss.
Line 7 will include any wages you earned from a typical employment situation. W2 income should be reported on this line. If you are retired, this line may very well be blank.
Then, we have additions to your income on lines 8-20:
(+) Lines 8 a – b will include interest payments you received from things such as bank accounts or investments that pay interest. This income was reported to you on a 1099-Int. Note: if you have a large amount of taxable income there may be a way to modify your portfolio to receive less taxable interest, thereby reducing your tax liability.
(+) Lines 9 a – b document dividends you received from investment accounts that is reported to you on a 1099-Div. NOTE: If you have accounts at Charles Schwab, the 1099 is referred to as the 1099 Composite and contains both the 1099-Int and Div.
(+) Line 10 generally includes any state refund you received in the prior tax year (that’s right, you are taxed on your tax refund).
(+) Line 12 will include income from a business you own. If you are 100% self-employed your income would be on this line and not on line 7.
(+) Line 13 shows capital gains you incurred in the past year. Capital gain income occurs when you sell a security for more than you purchased it for. If you harvested tax losses during the year, this number may be negative, but only up to $3000. Note: This line does not indicate the performance of your portfolio in the prior year.
(+) Lines 15 a – b are important if you are retired. They detail income you received from retirement plan distributions, which is reported to you on a 1099-R. Note: This is also where you would find a note indicating that you made a qualified charitable distribution in that tax year. You’ll see a QCD printed right on the line. You should also notice that the taxable amount of your retirement plan distribution Line 15b will be less than line 15a by the amount of the QCD. This is an important fact to check because the QCD strategy is new to both CPAs and custodians, and easy for a CPA to miss as your 1099-R will not specify that you made a QCD during the year.
(+) Lines 20 a – b contain your Social Security income. Depending on your income level, up to 85% of your Social Security income can be taxed (yes, another tax on a tax).
(=) Add lines 7- 21 and you’ll find your Total Income on line 22.
Next, we have any subtractions from your Income on lines 23-35:
(-) Common subtractions are HSA (Health Savings Account) deductions. Note: if you contributed to your HSA through payroll deduction, it may already be reflected on your W2.
(=) AGI Your total income less your total subtractions equals your Adjusted Gross Income. Your AGI is used for many tax calculations deeper in your return. It is also used to determine if you pay higher Medicare premiums. To the extent you are able to control AGI, you want to keep this as low as possible.
Turning the page, you start with your AGI and then subtract the following to figure exactly how much tax you owe:
(-) On line 40 you subtract the larger of the standard deduction or the expenses you itemized on Schedule A (more on that in our next blog).
(-) Line 42 subtracts the exemptions from line 6 multiplied by $4050.
(=) This will give you your Taxable Income on line 43, which is used to calculate your actual tax. Line 43 can also tell you which tax bracket you are in using a standard tax table. https://www.irs.com/articles/2016-federal-tax-rates-personal-exemptions-and-standard-deductions For instance, if you are married filing jointly and your taxable income from line 43 is $155,000, you were in the 28% tax bracket for 2016. That doesn’t mean that all of your income is taxed at 28%. It’s important to understand that moving into a higher tax bracket does not mean that all of your income will be taxed at a higher rate. Instead, only the money that you earn within a particular bracket is subject to that particular tax rate.
Lines 64-74 should document how much you paid in Federal income taxes during the year. Tax payments come from withholding or in the form of estimated payments you made, which are usually made quarterly. If you paid more than you owe, congratulations, you receive a refund! You can either have that refund paid to you on line 76 or applied to your next year’s tax return on line 77.
Lines 78 and 79 will show any tax bill you may have. Make sure to pay this by the filing deadline or you’ll be charged a penalty and interest by the IRS (no, the IRS does not pay you interest if you overpaid during the year).
Now that you know the basics, take 10 minutes and review your tax return. Do all of the numbers make sense? If not, give us a call and we can walk through the tax return in an upcoming meeting. The better you understand the outcome of your tax return, the easier it may be to answer your accountant’s questions and pull together documentation. Happy Tax Season!