Episode 59

Understanding your tax return: Part 1

February 15, 2024

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Welcome to The Retirement Tax Podcast, where hosts Steven Jarvis, CPA, and Benjamin Brandt, CFP, work together to bridge the gap between tax professionals, financial advisors, and their mutual clients to help reduce most people’s largest expense in retirement: taxes. Each week, they will dive into conversations around taxes, focusing on what you can truly control (instead of what you cannot) and how to set yourself up financially for your future.

In this episode resident “Least Boring CPA” Steven Jarvis takes you through the first part of a 1040 providing insight and information to make sure you understand your tax return. Steven covers both technical details as well as reminders on what might be most relevant to you and changes to watch out for from year to year. This is as “hands on” as a podcast episode can get so be sure and follow Steven’s recommendation to have your own tax return handy as you listen to this great episode.


What You’ll Learn In Today’s Episode:

  • Why the “digital assets” question might be more important than you think
  • Your “choices” on filing status
  • Insight into individual line items on the 1040.
Ideas Worth Sharing:

““While the goal is proactive tax planning where we’re intentionally doing things ahead of time to minimize our taxes over our lifetime, we have to make sure those things get reported correctly.” – Steven Jarvis

““ If we are married, when it comes to deciding whether we want to file jointly or file separately, again, from a tax standpoint, it’s almost always more advantageous to file jointly.” – Steven Jarvis

“When we talk about filing status, we’re looking at our status on 12/31 and we’ve got to start with the facts, not our preference.” – Steven Jarvis

Resources In Today’s Episode:
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Read The Transcript Below:

Steven (00:08):

Hello everyone and welcome to the next episode of the Retirement Tax Podcast, AKA The Least Boring Tax Podcast. I am one of your co-hosts, Stephen Jarvis, CPA, and my other, much more intelligent and better looking co-host. Benjamin Brandt is gracious enough to let me nerd out for a couple of episodes on the tax return itself. Don’t worry, Ben is doing great. If you’re missing his voice, you can of course go over to his podcast Retirement Starts Today and get your fill of Benjamin Brandt, but he’ll be back in a few episodes to get back into some other topics. But for today and for the next couple of episodes, it’s going to be a great idea to actually have a copy of your tax return in front of you. If you’re just really proactive and you’ve already filed your 2023 tax return, great. If not, pull out your 2022 tax return.


Thankfully, they are very, very similar. There haven’t been a lot of significant changes in the last year as far as what is reported on the 1040 and we want to take the time to do this because while the goal is proactive tax planning where we’re intentionally doing things ahead of time to minimize our taxes over our lifetime, we have to make sure those things get reported correctly. And I know for a lot of our listeners, DIY is a huge area of focus, especially when it comes to tax preparation, but even for our listeners who work with a tax professional, it’s good to have a basic understanding of your own tax return. So I’ve got a tax return in front of me and we’re going to go through and talk about this, the 1040 in particular in a few different chunks over the next couple of episodes.


So I’ve got the 1040 out, we’re going to start right at the top. It might seem like a silly step to review your personal information, especially if you’ve been preparing your tax return yourself, but we do run into issues at times. I would say in particular if you switch tax preparers or you go from DIYing to using a tax preparer or you decide to switch tax software, data entry errors are real and can cause problems and unfortunately just because something’s been accepted by the IRS for years doesn’t mean it’s right. Worked with clients before who had no issues for years and then it turned out that their social security number had been reported incorrectly for multiple years and it only came up when the IRS sent a nastygram to the clients that actually was for a different taxpayer. The social security numbers had been confused.


So especially for people doing their own tax returns, there probably isn’t a lot of issues you’re going to find in that top portion of the 1040, but it’s always worth just taking that quick look to make sure name, address, particularly if we’ve moved social security number. All of those things are done correctly. The next section of the 1040 is our filing status. Now I get questions a lot about which filing status should a taxpayer choose. Now, the problem with this question and that is how it’s typically worded is that our filing status is very rarely actually a choice. The IRS cares about our legal marital status on December 31st when it comes to deciding whether we are going to file single or married filing jointly or have the option to file married filing separately, we’ll cover ahead of household and qualifying surviving spouse as well.


But out of the gate when we talk about filing status, we’re looking at our status on 12/31 and we’ve got to start with the facts, not our preference. Now at the end of the day, for most tax situations, married, filing jointly is going to be the most advantageous. There are some rare exceptions, but typically there isn’t a reason we would want to select something else if we’re eligible for that. If we’re not married or marital status has changed or is expected to change. Again, we want to focus on December 31st. If we are married, when it comes to deciding whether we want to file jointly or file separately, again, from a tax standpoint, it’s almost always more advantageous to file jointly during COVID with some of the credits and rebates that went on. There were some just real weird exceptions where a very specific of circumstances it made sense to file separately.


But typically the only time I’m seeing it be a good idea for taxpayers to file separately is potentially not every time potentially for taxpayers who have student loans that are eligible for public service forgiveness and that case the student loan repayments are based on income and then will eventually be forgiven. And so it’s still an analysis and assessment we need to do. It’s not an automatic, the only other place I see married filing separately coming into play is in relationships where to be totally honest, there are currently or expected legal or marital problems that will eventually lead to divorce or there’s a suspicious activity going on by one of the partners. So hopefully that’s not something that we’re dealing with often. Thankfully it’s not something I have to deal with often, but even in that case, that doesn’t become a tax question that becomes a legal question.


So if we’re married, filing jointly is almost always going to be the most advantageous filing status. Now if we’re not married, there are a couple of things that we need to keep in mind as far as what our filing status might end up being. If we’re married and our spouse has passed away the year that our spouse passes away, regardless of the date during the year, we still get to claim married filing jointly. Whether we get to continue having the tax benefits of married filing jointly after that, which would be the qualifying surviving spouse status is really tied to whether we have dependents that we can claim. Now, there are very specific definitions of who qualifies as a dependent for claiming a qualifying surviving spouse and we’re potentially eligible for it for up to two years after our spouse passes away. So that’s one of those situations that if your spouse passes away and there are, whether that’s children or grandchildren or other dependents in your life, it’s worth looking into in those two years following the death of a spouse to see of qualifying surviving spouse is applicable.


And if it is, you get the same tax status essentially as if you are married, filing jointly. The last one we could potentially look at is if we are single, whether we qualify for filing as head of household, which again is completely tied to whether there are dependents that we can claim and there’s a little bit more nuance to that. But if we are not legally married on December 31st and we don’t have any kids or other dependents, then single is the status for us. Alright, continue to move down the front of the 1040. The next section you’re going to see is digital assets. I do get questions about this quite often. This was added to the tax return a couple of years ago now and is still just very simply a yes or no question. More broadly, this refers to cryptocurrency, bitcoin, those kinds of things.


But the IRS has defined this question very broadly. Now, there isn’t a lot of definitive guidance on how the IRS is going to use this data, but this is one of those areas where I strongly encourage that we are reporting accurately and that we are making sure we’re setting ourselves up for success if the IRS comes and asks us questions in the future. Now, if we are purchasing and selling digital assets on any kind of reputable platform, then this is going to get reported to the IRS anyway. So we may as well accurately and transparently report this. My best guess is that at some point in the future when the IRS decides to put a little more scrutiny on digital assets on cryptocurrencies, that this is going to be one of the criteria they pull for who they decide to go and ask questions of.


But every area of the tax return we want to make sure we are reporting accurately. So this isn’t a place to try and play games. If you have digital assets and you’re thinking, well, I’m just going to mark notes so they never come and ask me questions, you’ve now committed fraud on your tax return and the statute of limitations on which years the IRS can look at get extended basically indefinitely. If the IRS can prove that you committed fraud, the statute of limitations goes away and they can look at any tax return where that might be relevant. So it’s not a game worth playing if you were involved in digital assets, mark this box correctly on your tax return. The next section on the 1040 is whether we get to have some additional amounts added to our standard deduction. This is where we would mark if we are over the age of 65 and if we are blind.


Now, for me, this really is just a reminder that there is no logic in the tax code that there are lobbying groups behind everything that goes on here because why is the age 65 and not 60 or 70? Why is it blind and not deaf? But those are questions that Congress doesn’t ask me and that I don’t get to give input on. But it’s just something to be aware of, especially on the age side because there’s nowhere on the 1040 that actually reports our birth date. Most tax prep softwares are going to ask us for that are going to prompt us for that. But especially in the year we turn 65 and thereafter, this is something we want to double check to make sure that that was input correctly. It does increase our standard deduction and 90% of taxpayers are taking the standard deduction because of how high it is.


But when we’re over the age of 65, it gets bumped up just a little bit more and that’s for each taxpayer for a married couple. So we want to make sure those are getting reported correctly. The next section as we’re going down is our dependence. And as we look at this section in particular, we want to be paying attention to changes that might happen in our life. Again, from year to year, tax prep software is going to carry over the information just fine on its own, but as kids get older and move out, as they go to college, as they come home from college, maybe later in life, as we support grandkids or other family members, the definition of a dependent for tax purposes can move beyond strictly biological children. And so as a litmus test, as I’m talking to clients, I start with, is there someone that you are providing more than half of their support during the year?


And that’s the route we’re going to go down. That’s not the only criteria, but that at least gets us in the right direction. There’s some other things we need to look at, but if there’s someone that you’re providing over half of their support, it may be worth at least looking into whether they can potentially qualify as a dependent for tax purposes. There are also some income limitations on the dependent you’re claiming. So especially for adults, this gets pretty challenging to qualify for dependence, but it is worth looking at and making sure that we understand. Alright, so we’re halfway through this episode and we haven’t even gotten to any tax numbers, but that is what’s so important about looking at our tax returns, making sure that we’re looking at all of the information provided that we understand and know what is relevant to us and our situation and how that changes over time, especially as we move into and through retirement.


Some of these things might not be exactly the same every year. Then we get to the more fun stuff. I say that as a tax nerd, as a numbers nerd, we get to line the first place we’re reporting actual numbers. Line one a few years ago got broken out into all these different sublines. We have line 1A all the way through 1Z. Thankfully they skipped a bunch of letters in between. So it is not 26 lines long for most taxpayers. We’re going to have an amount on line 1A and line 1Z and very few people have anything in between, but that depends on your personal situation. But line one is where we are reporting W2 income. One of the most common pieces of education I have to provide around this line item is helping taxpayers understand why their line 1 wages don’t match the total salary that they get paid from their employer.


So just for easy math, if our base salary is $200,000, almost never is $200,000 actually going to be reported on line 1A because this is after any pre-tax deduction. So this could be health insurance, this could be 401k contributions, it could be vision and dental insurance, it could be deferred compensation plans. There are all sorts of things that take us from our base salary to what is reported on line 1, but this is a good reminder to take a look at our W2 and make sure we’re taking advantage of and that we understand the employer benefits that are offered to us. The other place that this can potentially create issues is when we have equity-based compensation because many types of equity-based compensation are going to be reported as wages on our W2. And then when we go to sell things like non-qualified stock options or RSUs, they will also get reported by the custodian on a 1099B and they can potentially get reported as capital gains or losses.


And we’ve got to just pay really close attention in those years because we’ve had situations unfortunately fairly common that income will get double reported that the way the 1099B is reported at times the full amount of that sale will get reported as income even though a portion of that sale was already reported as wages. So we’re getting a little bit into the weeds there, but if you have equity-based compensation, that’s something that’s worth double checking. As we look at line one of the tax return we get to line 2- interest. So we have tax-exempt interest and taxable interest, and as we go through these different lines, you’re going to see that boxes A and B are a little bit different for each line. So for line 2, boxes A and B are completely separate from each other. These are two completely different buckets.


We have tax-exempt interest in box 2A and then taxable interest in box 2B. A big reason that tax-exempt interest is still reported on the tax return, even though it’s not subject to income tax, is that tax-exempt interest is one of the add-backs that we use to get to modified adjusted gross income. Now, modified adjusted gross income is something we talk about fairly regularly on this podcast because it impacts things like IRMAA, our income-related monthly adjustment amount for our Medicare premiums. It also affects things like our ability to contribute to a Roth IRA. So tax-exempt interest is one of those things that gets added back. So it is important that we’re making sure that is accurate and it’s being correctly reported. We don’t want to skip over things like this just assuming, well, it’s not included in our taxable income.


So what’s the point? There are a lot of interconnected pieces of our tax return, so we want to make sure these things are as accurate as possible. So in contrast to line two when we get to line 3, which is dividends are qualified in ordinary dividends, lines 3A and 3B are related to each other. Ordinary dividends is all of our dividends and qualified dividends is just going to be a portion of that. So ordinary dividends should be larger than qualified dividends or they potentially could be equal, but ordinary dividends is never going to be less. So just some things to be on the lookout for there. When we talk about qualified dividends, this is an important distinction because this affects the tax rate that’s applied to our income. Qualified dividends get preferential tax treatment. They get taxed at the same rate as long-term capital gains, which means they could potentially be taxed at 0% depending on our income or potentially 15 or 20%, but that’s still going to be better than our ordinary income tax rates.


Now what qualifies as a qualified dividend is dependent on the type of investment and the length of time that we’ve held the investment. And that gets a little bit more nuanced than we’re going to cover in this podcast, but it’s a great question to be asking either of the financial professional that you work with or if you’re a DIYer, this is worth taking the time to review just so that you understand what goes into this line item because again, qualified dividends over ordinary dividends get preferential tax treatment and can potentially be very advantageous from a tax standpoint. Now before we get into line four and line five, this impacts a lot of things that we do for planning and as we’re in retirement. And so that is what we’ll cover in the next episode as we keep going down the 1040 and look at these things together.


Now, this episode’s coming out in the middle of February, so again, like I said, you may be super proactive and have already filed your 2023 taxes. If not, that’s not a problem at all. As I’m recording this podcast, there are still pending tax updates going through Congress that would potentially affect the child tax credit and bonus depreciation. And so if either of those are relevant to you, waiting and making sure we know how those settle out might not be a bad idea. Also, in general, I like to remind taxpayers that there are no awards for being the first to file. Personally, I like to take the approach of getting my documents together and making sure I have everything I need, potentially even drafting my tax return early in the filing season. But investment custodians in particular are notorious for issuing amended 1099s late in February or into March.


And just by giving ourselves a little bit of extra time before we hit that file button, we just make sure that we really have all of the information that we need and is going to be relevant for this tax year. So I don’t advocate waiting until April 14th. I like to have at least a little bit of a cushion. But again, there are no awards for being the first to file. We want to make sure we’re keeping some balance there. Alright, hopefully you were able to follow along with your tax return. If you didn’t have your tax return in front of you, go back and pull out your tax return and listen back through this when you get a chance. It’s a great way to make sure you really understand what gets reported to the IRS each year and be sure and come back in two weeks as we keep moving through the 1040 and learning these line items together. Until then, remember to not let the tax man hit you where the good Lord split you.


Hi everyone. Quick reminder before you go. While Ben and I feel very strongly about the information we’re sharing on this podcast, it is for educational purposes only and should not be taken as specific tax, investment or legal advice. You need to make sure that you are working with a professional to evaluate how these concepts apply to your specific situation before you take action.

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