Episode 60

Understanding your tax return: Part 2

March 1, 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 continues taking 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:

  • The difference between “Box A” and “Box B” and when it’s not always the same
  • Ways to have an impact on your adjusted gross income and taxable income
  • What you need to be on the lookout for when it comes to rental properties.
Ideas Worth Sharing:

“If you are paying taxes on Social Security, especially if you’re currently making estimated payments, then looking into having withholdings taken from your Social Security benefits can be a great way to streamline and automate your taxes getting paid during the year” – Steven Jarvis

“Anytime I see additional income, I’m immediately looking for are we taking advantage of expenses that go along with them.” – Steven Jarvis

“If we don’t have that perspective of how much we’re currently paying in taxes or what tax rates we’re currently paying at, it makes it harder to stay committed and see the value of tax planning and make sure that we follow through on it.” – Steven Jarvis

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

Steven (00:06):

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, Steven Jarvis CPA, and this week’s episode is part two of me reviewing a tax return. Again, Ben is doing just great. He was just gracious enough to let me nerd out on a tax return. If you listen to part one, you’ll know that you’ll want to do this at a time when you can pull out your own tax return either for 2023 if you’ve already filed it or for 2022 because they are very, very similar in layout. But we’re going to continue on down the 1040 and talk about some relevant information as far as how we should look at and understand this tax return. So again, this is going to be most valuable if you’re looking at your own tax return and for those of you who are big fans of Ben as I am, don’t worry, he will be back in just a couple of weeks.


Alright, so we left off, we want to jump into lines four and five and we’re going to look at these together because they’re very interrelated. Line 4 is IRA distributions and line 5 is pensions and annuities. As we look at these two lines, we either remember that as far as the IRS is concerned, when they say pensions, what they really mean is employer-sponsored plans. For most of us when we think of pensions, we think of defined benefit plans, a pension that’s going to pay us a certain amount for the rest of our life, which if you have access to one of those, that is fantastic. They’re becoming less and less available. But the IRS on line 5, this is where 404Ks, 403Bs, 457s, all of those types employer-sponsored plans are going to go on this line. Lines 4A and 5A are both gross distribution amounts, so this is the total amount that came out of any of those types of accounts.


In contrast, 4B and 5B are just the taxable portion of those distributions. So for example, line 4A, if we had distributions from a Roth account that we are distributing after the age of 59 and a half and we’ve satisfied the other requirements, that amount would go in line 4A but not 4B. That’s why we funded a Roth so we could get tax-free distributions. Other things we commonly see that would go in the gross distribution, but not the taxable amount. Rollovers get reported on the tax return, but we want to make sure they’re not reported as taxable as specific to line 4, qualified charitable distributions get reported in box 4A as part of our gross distribution but not box 4B. And interestingly for me as a self-proclaimed tax nerd, the IRS has not set up a great system for reporting QCDs and so on your tax return in that blank space that doesn’t look like it’s meant for anything but between boxes 4A 4B QCD just gets typed in.


It looks like it was done on a typewriter in someone’s basement, but that is the way it’s supposed to look. That’s the same place that you’ll see rollover if rollovers were relevant. Some of the important things to keep in mind with lines 4 and 5 is that the 1099R, which is the tax form that custodians use to report distributions from qualified retirement accounts is not always super helpful for tax preparers. There’s a fun little box on the 1099R that says taxable amount not determined. That can lead to confusion. We want to make sure we’re paying close attention to these lines, particularly in years where we have rollovers, where we have Roth conversions, where we have backdoor Roth contributions, where we have qualified charitable distributions. These are all things that can get a little bit messed up if we’re just relying on the 1099R.


So we really want to pay attention to what should be on in box A of line 4 and 5 and what should be in box B. Now these are aggregate lines, and so if we have distributions from multiple different accounts, they’ll get aggregated here, but often tax prep software will have some kind of statement or worksheet that shows us the individual amounts that go into that line. So if you have any activity in retirement accounts, whether employer-sponsored or not, we want to make sure we’re paying attention to these two lines to make sure those got reported correctly. That is an area where especially if too much got reported as taxable, that is an area where I see amendments necessary at times. So keep going down, we get to line six. This is our social security benefits, which is going to be relevant for a lot of our listeners.


There’s not always a lot we can do here. Social security benefits are potentially taxable up to 85% of the benefit that we receive. So quite often line 6A, which is our total social security benefit and line 6B, which is the taxable portion, these are going to be different amounts. If our income is low enough, typically below about $44,000, it’s possible that less than 85% will be taxable. So that’s something we want to stay aware of in low-income years, but some portion of that social security benefit for most of us will be taxable and the portion that is taxable is taxed at our ordinary income rates. One thing that’s not going to be obvious on the tax return but is important to keep in mind as a potential opportunity related to social security benefits is that we can have taxes withheld from our social security benefits.


We do that using Form W4V. Now don’t feel bad if you’re taking Social Security and you don’t have withholdings done, it’s likely no one ever told you that you could or that you needed to when you start receiving your Social Security benefits. The Social Security Administration definitely does not make you aware of that. So if you are paying taxes on Social Security, especially if you’re currently making estimated payments, then looking into having withholdings taken from your Social Security benefits can be a great way to streamline and automate your taxes getting paid during the year. Next we have line 7, which is our capital gains and losses. This is a line where we want to make sure we’re looking at the underlying schedules as well. Schedule D, one of the things that always stands out to me on this line is if we have a nice even $3,000 loss, the reason we’ll commonly see that is because capital losses get capped at $3,000 that we can take in any one year.


If we don’t have capital gains to offset them, any additional capital losses can get carried forward. So that’s something we want to be aware of and pay attention to. So we make sure that we capture that benefit in a future year. We get to line eight, which is additional income, and it immediately points us to schedule one, which is one of the many underlying schedules to the 1040 to help us understand what’s going into our total numbers. Additional income can come from a lot of different places. The two most common places I see income on this line from are Schedule C, which is self-employment Income and Schedule E, which is rental income and income from passive activity. So this is where K1 activity from partnerships or S-Corp is going to come through as well. The biggest thing to keep in mind if you have an amount on line 8 is that the 1040 itself is not going to give us clear information on what these numbers really mean.


We have to go to the underlying schedules, we have to dive down to the schedule 1 and then onto the Schedule C or Schedule E if those are relevant. These are areas where there’s typically more nuance and detail that goes into the calculation of our tax. We start having additional deductions and expenses we need to track, and so we want to make sure that we are taking the time to look at the underlying documents and make sure that nothing stands out even if you’re not a tax expert yourself, even if all we do is a gut check, a comparison to the prior year, some sort of review to say, Hey, does this feel right? Especially if we work with a tax professional or a financial advisor, we’ll able to have someone on our team to help bounce things off of make sure that we really are capturing everything.


But anytime I see additional income, I’m immediately looking for are we taking advantage of expenses that go along with them. So something to keep in mind as we go through these different lines. Line 9 is our total income, which really is just a simple addition on the face of the 1040. This line does not get used for very much other places in our tax situation. Line 10 is a little bit more important. This is adjustments to income, which again is going to point us to an underlying schedule. Adjustments to income vary. There are a lot of different things that can go in here relevant to a Retirement Tax Podcast. Some of the things that might be most relevant for us to keep in mind, this is where we’re going to see things like deductible IRA contributions or if we’re making self-employed, retirement plan contributions, we have self-employed, health insurance deductions, these are all going to go there.


So those are some of the things that we want to be on the lookout for. Again, IRA contributions is a big one that if they are deductible, this is where they need to come out of our income. If we’re making backdoor Roth contributions where we’re intentionally making after-tax IRA contributions, then we want to look at this line to make sure that an IRA contribution is not included because we don’t want that upfront tax benefit because we’re trying to fill a tax-free bucket for the future. After line 10, we get to our adjusted gross income. This is a very relevant number for several different thresholds and factors for our tax situation. One of the things that comes up just as often when we talk, especially when we’re talking about planning for and getting into retirement, is modified adjusted gross income. You’ve heard Ben and I talk about that on a podcast regularly.


You’ll notice that nowhere on the 1040 is modified adjusted gross income actually listed, but for most people, adjusted gross income on line 11 is a very close approximation if not the exact same amount as modified adjusted gross income. The most relevant add-back that can be applicable is tax-exempt interest. There can be some other things related to student loans and foreign income. There’s also different definitions of modified adjusted gross income depending on what tax principle we’re talking about. The calculations for modified AGI for our IRMAA premiums is different than modified AGI for our ability to contribute to Roth. So these are areas where we want to make sure we’re taking that double look and some of these things might be indications of when it’s time to make sure that we have additional help and that we’re not just DIYing line 12 is our standard or itemized deduction.


Just a reminder that 90% of taxpayers, approximately 90% of taxpayers take the standard deduction. And so when we look at the standard deduction, it can feel disappointing if we don’t get to itemize if we don’t see our mortgage interest or our charitable deductions counting towards our tax situation. But what we have to keep in mind is that with such a high standard deduction for many of us, we’re getting a benefit above and beyond what we actually spent. So it can be a good thing. Now if we’re taking the standard deduction and are charitably inclined, there’s some other proactive ways that we can apply to our planning to make sure we’re still getting a tax benefit above and beyond the standard deduction. We’ve covered that in other podcast episodes. So if things like bunching charitable contributions or donor-advised funds or qualified charitable distributions, which I’ve mentioned on this episode as well, if those sound familiar, but you need a refresher check out other episodes that we’ve done, we’ve definitely covered those topics.


They can be great planning opportunities. If we do itemize deductions, we want to make sure we’re looking at Schedule A, which is where those get detailed out. The most common expenses that contribute to itemized deductions for taxpayers are state and local taxes, our mortgage interest, and then charitable contributions. I get questions quite often about deducting medical expenses. Unfortunately, in addition to needing to itemize, which only 10% of taxpayers do, the IRS has also instituted a floor for deducting medical expenses, which means that only medical expenses over 7.5% of our AGI, which was line 11, only the amounts over that seven and a half percent can count towards whether or not we itemize. So it’s a pretty high threshold for being able to get a tax benefit for our medical expenses. We definitely still want to track them so that in years where that’s relevant, we can get that benefit.


Next, we have line 13, which is qualified business income deduction. This is typically most relevant for business owners or self-employed individuals. It’s possible, and I see this quite often, that a very small amount of QBI can come out of your investment portfolio. There’s specific types of REITs real estate investments that produce QBI. So if you don’t have your own business and you have a small amount of QBI on line 13, don’t be concerned that’s on air. It’s something that the tax prep software is calculating on your behalf, is not an IRS red flag that you have a small amount of QBI but no business to go along with it. Line 14 again is a subtotal for us. And then line 15 is our taxable income. Taxable income is a really important amount on our tax return as the name indicates, this is the amount that our taxes are going to be calculated based on.


You’ll also notice that on the tax return, there typically isn’t any place that shows you the actual calculation to go from line 15, which is our taxable income to line 16, which is our total tax. Part of that is the fact that it’s not just a simple calculation. It’s not a simple multiplication of here’s our taxable income and here’s your tax rate. So now we have tax. The two biggest complications to that are one, we have what’s called the progressive tax system, which means as our income gets higher, each new block of income can be subject to a different tax rate. So I have a tax reference guide that I keep on my desk so I don’t have to commit these to memory, but for a couple that’s married filing jointly in 2023, the first $22,000 of taxable income is taxed at 10% and then after that, up to $89,450 is taxed at 12%.


And so we have these different buckets that are taxed at different rates, making it more complicated. The second piece of this is that we have certain types of income that get preferential tax rates applied to them, our qualified dividends that we talked about in the last episode, and then our capital gains that are on line seven of our tax returns, specifically our long-term capital gains. So it might not even be the total amount on line seven, it’s just the long-term capital gains. And for the qualified dividends and long-term capital gains, we have the potential to have those tax at as low as 0%. My favorite tax rate, again in 2023 for a married couple filing jointly up to $89,250 can be taxed at 0%. But again, the IRS doesn’t make this simple for us, and so we don’t get to separate out our qualified dividends and long-term capital gains and say, okay, up to that $89,000 is 0%.


We have to look at our ordinary income and our long-term capital gains and qualified dividends together. So the calculation starts with our ordinary income. We’re going to apply the relevant tax rates to all of our ordinary income, and then we’re going to put the long-term capital gains and qualified dividends on top of that to determine what tax rate is most relevant for our long-term capital gains and qualified dividends. Now, I know that’s a lot of numbers and masses throughout on a podcast that has no visuals to go along with it. My goal in this is not to have you commit this to memory or become an expert on it overnight. We’re building familiarity with it. We’re increasing your ability to ask questions and to think critically about the numbers that are on your tax return, especially if you do your own tax return. If you work with a tax professional, these are things that you’ll want to make sure that you’re asking questions about and that you understand.


And once we’ve filed the tax return, it might feel like, Hey, Steven, that’s done and in the past, why spend so much time on it. But as we talk about so often on this podcast, the way we get ahead with the IRS is by consistently taking action over time. One of the reasons I love being able to go through a tax return and help people understand these different pieces and then to take the time to focus on, okay, what’s your total taxable income and how do these tax rates work is so that we can understand and see the value of being strategic and intentional about the timing of our income and other planning that we can do. Because if we don’t have that perspective of how much we’re currently paying in taxes or what tax rates we’re currently paying at, it makes it harder to stay committed and see the value of tax planning and make sure that we follow through on it.


So even though we’re talking extensively across a couple of episodes about what’s on the tax return, you don’t need to spend hours and hours going through your return, but the people who are doing the best with their tax plan over time have someone in their life who is taking time every year to look through their situation. That might be you if you’re committed to spending the time learning and applying these things that might be a financial advisor or tax professional that you work with, but somebody needs to be reviewing your tax return every year to make sure that what was reported last year makes sense and fits with what went on during the year, and that we’re identifying opportunities to be proactive with our taxes moving forward. Alright, we’re running out of time for this week’s episode, so we’ll come back and do this one more time, review the second page of the 1040, talk about how taxes are calculated, how we can think about getting our taxes paid and avoid penalties and what we should do as far as how big of a refund we should get or whether we should leave it to being a payment at tax time.


So be sure and come back ready with your tax return again for the next episode in two weeks. And until then, remember to not let the tax man hit you where the good Lord split you. 

Disclaimer (18:07):

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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