Episode 61

Understanding Your Tax Return: Part 3

March 15, 2024

Down arrow

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 wraps up his walkthrough 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:

  • How to better understand the amount of tax you pay in a year
  • The different approaches to actually getting your taxes paid
  • Why underpayment penalties are a terrible way to “tip the IRS” and how to avoid them.
Ideas Worth Sharing:

“There isn’t one right answer as far as how big of a refund or how small of a payment you should be making at tax time.” – Steven Jarvis

“The only reason we’re going to have underpayment penalties is if we don’t plan ahead accordingly.”- Steven Jarvis

“It comes down to being intentional and understanding what the outcome is going to mean for your personal situation.”
– Steven Jarvis

Resources In Today’s Episode:
Share The Love:

If you like The Retirement Tax Podcast… Never miss an episode by subscribing via

Read The Transcript Below:

Steven (00:07):

Hello everyone and welcome to the next episode of the Retirement Tax Podcast, AKA the least boring tax podcast. I am what feels like your new host, but I promise Ben is coming back. This is of course Steven Jarvis, CPA, and we’re going to do one more episode reviewing a tax return together and then for all of you worried about Ben’s safety and wellbeing, he is doing great. I promise we’ll be back for the next episode. We’ll get the dynamic duo back together so if you listen in to the last two episodes, you know that we’ve been going over a tax return, preferably your tax return if you have it out in front of you so that we can make sure we’re understanding what goes into the different line items here. We’re just staying fresh and on top of what we need to know about our own tax return every year, that wonderful time of the year where tax are top of mind because of aunt IRS’s lovely deadline coming up. 


Now as this episode airs, more of you have probably already filed your taxes, so we could be looking at your 2023 tax return, but if we’re looking at 2022, it’s just fine. There weren’t a whole lot of changes to the layout of the form year to year, so in part two we finished up two weeks ago, we finished out the first page of the 1040, so now we’re on the backside of the 1040. Now, of course, we all know that there are many, many more pages to a tax return. Sometimes these can be 50, 75, a hundred-plus pages. When we add states and all the underlying schedules, if we have business returns, they get even longer. The reason that we’ve just been covering the 1040 is that that’s where everything gets accumulated and summarized, and that’s what’s most common for all of us to have.


We have to at least file at 1040, for most of us there will be underlined schedules as well. And as much fun as it is to talk for 20 minutes at a time about the tax return, I would need days or weeks to go through every page of your tax return and explain every line item in detail because there are something like 80,000 pages of the IRS tax code. So let’s dive into the second page of the 1040 and give you some more context for how we can look at this. Line 16, which is our total, this is our initial tax calculation. This isn’t even necessarily our total tax. We talked about this a little bit in the last episode, so go back and review that if you’d like some more context on how we go from taxable income to the tax that gets calculated now between lines 16 and 24, which is our total tax there are a couple of things that can come into play here. 


There are still some underlying schedules that we might need to take a look at, and then the one I get the most questions on is actually line 23, which is other taxes including self-employment tax from Schedule 2 line 21. And where I most typically get questions is from taxpayers who are not self-employed. Most people at least intuitively understand that if I’m, I have some extra taxes that makes sense. We have other taxes coming through, it’s everyone else who says, hold on a second. The IRS already told me I owe them a bunch of tax. Why is there even more taxes? Just generically called other taxes. I wish I had a better answer for how they name things, but what it essentially comes down to is Congress has decided that at certain income levels, the taxpayer should be subject to additional taxes.


The two most common are what we call the net investment income tax or NIIT, which again, is above a certain level of income and then only applicable to certain types of income, investment income as the name would indicate. The other one that comes into play is additional Medicare tax and there are underlying forms that will show the calculation for each of these if they are relevant. Typically in my experience, while it’s unfortunate to pay more in taxes, these additional taxes are small enough that it’s not the primary driver of our decision-making on other planning. They’re more a reality of just what we have to deal with. And so as I’m working with clients on Roth conversions or other income-accelerating activities, we don’t suddenly stop the plan for moving forward just because of these other taxes. We want to be aware of them so that we know what our tax liability is going to be, but for these, it is more of an awareness as opposed to a conscious decision to avoid them.


At the end of the day, one of the costs of making more money is that we’re going to pay additional taxes. Now, we skipped right to line 23. There are some tax credits that fall in here as well, including the child tax credit. That can be very beneficial. That’s something we’re eligible for, but we just want to make sure that as we look through this that we really know what’s on line 24 of our tax return each year. The way I describe this is the amount of your hard-earned money. The IRS kept, and every time I review a tax return with a client, I stop on line 24 and say, here’s the amount of your hard-earned money the IRS kept, and the reason I do that is not to pour salt in the wound because no one particularly cares about paying taxes. It’s so that we keep perspective on just how much of an impact taxes have on our financial life and highlight the importance of proactively doing something about it.


The other reason I do that is because the marketing of all of the biggest tax prep is out there and as I record this, we’re leading up to the Super Bowl. I’m positive, I would bet a lot of money there will be Super Bowl commercials about tax prep that all focus on, hey, you should get the biggest refund possible. And so a lot of taxpayers get really hung up on, well, hey, did I get a refund or not? And for a lot of people, as long as they get a refund, they feel like they’ve won and they don’t think is hard about tax planning and that’s the wrong way to go about it because regardless if you’ve got a refund or made a payment at tax time, line 24 is going to tell you how much of your money the IRS kept and those can be drastically different numbers.


You could have paid a hundred thousand dollars in taxes and still gotten a $10,000 refund. That doesn’t necessarily mean you won. It might not mean you lost, but we want to make sure there’s an intentional approach. We don’t want the refund or payment at tax time to distract us from our overall tax situation from that overall picture of just how much of our hard-earned money the IRS is keeping each year. So we’ll talk more about refunds and payments in just a minute. We want to talk about the taxes that get paid in during the year. This is lines 25 through 33 of the tax return. So we start with line 25, which is broken up into a couple of chunks and this is our withholdings. Now, I appreciate that the IRS starts with withholdings and not estimated payments because withholdings actually get preferential treatment from the IRS and where possible we want to start with withholdings as our primary source of how taxes get paid.


Now, when I say the IRS gives preferential treatment, unfortunately, they don’t give us a discount. It’s not that every dollar withholding is worth $2 of taxes. Wouldn’t that be nice? What I mean by that is the IRS expects that taxes are paid throughout the year and so by default, the IRS is going to assume that we earned our income evenly throughout the year and that we should have paid taxes evenly throughout the year because there are four quarterly estimated tax payment deadlines and the IRS will start calculating interest at each of those quarters if we’re not paying enough in taxes. Now the preferential treatment withholdings is that regardless of when the withholding happens, the IRS will treat it as though it had been paid in evenly throughout the year. So especially when we have a little bit more control over what those withholdings can look like, we can do some things to make sure that we always avoid underpayment penalties, especially as we talk about planning for and getting into retirement.


One place that this can become an issue is if we’re doing large Roth conversions towards the end of the year because in an ideal situation, we’ve done a Roth conversion, which is a distribution from our IRA creates taxable income and we’ve paid the taxes from another source so we didn’t have a withholding. Now if we do a Roth conversion in December and make the estimated payment before the January 15th deadline, we should be all set. But what will happen by default is the IRS will say, Hey, that IRA distribution for your Roth conversion. We’re going to treat that as if you had earned that evenly throughout the year. And so that tax payment in January really should have happened in four installments throughout the year. And thankfully there are ways that we can communicate to the IRS, Hey, that’s not in fact the case, but that won’t happen by default.


The other thing that can come up related to this is if for some reason, we end up at the end of the year with a large amount of taxes due. We started a business and weren’t making estimated payments. We had unexpected amounts of capital gains income. Maybe we sold a property or it was a great year for our investment portfolio and we had large amounts of dividends or capital gains. It’s possible that we can end up close to the end of the year without having paid all of our taxes Now instead of our Roth conversion example where we’re not withholding from that distribution so that we can pay it separately, we could intentionally use an IRA distribution just to increase our opportunities for withholdings. Of course, assuming we’re over the age of 59 and a half and we’re not going to be subject to penalties, but we could go ahead and do an IRA distribution and have 99 to a hundred percent of that distribution withheld for taxes.


The only reason I say 99% is there are some custodians who frown on, and by that I mean they logistically make it impossible to have a 100% withholding. So we want to make sure either working with our financial advisor or directly with our custodian if we’re DIYing this, that we understand what is possible. But that’s one way if we get to the end of the year and realize that we owe a lot in taxes, that we can still avoid underpayment penalties even though we didn’t make estimated payments during the year. So all of that aside, in general, when we’re looking at lines 25 through 33 on how our taxes are getting paid if possible, we want to start with adjusting withholdings. If we have W2 income, that’s going to be a great source for saying, Hey, is there a way that we can increase this or reduce it if we’re getting a big refund every year?


We can also see if we’re getting withholdings from any 1099s, which this can be a variety of things. In the last episode we talked about form W4 V, which allows us to have withholdings from our social security if that’s applicable to us, but again, we get preferential treatment or withholdings, so we want to make sure we’re starting there if we can. After our total withholdings, we go on to our estimated payments and any amount that was applied from the prior year because we can take our refund and apply it forward a year in lieu of making estimated payments. So that will all come through on line 26. One quick tip. If we are making estimated payments, a little bit of a hack if we want to call it that, I strongly encourage all of my clients to end their estimated payments in a dollar amount that corresponds with the quarter it’s applicable to.


So if we need to make a thousand dollars quarterly estimated payments instead of making four equal payments of a thousand dollars, I would strongly recommend you make a payment of $1,001 for Q1, 1,002 for Q2, and so on for the rest of the year. The reason for this is that at times estimated payments get forgotten, they get misapplied. If you are sending them through the mail, which I would strongly discourage, they can get lost in the mail by having our estimated payments end in a dollar amount that corresponds with the quarter, it’s going to be immediately apparent which quarter got missed. Because if we get to the end of the year and we can see that only two payments were made and somehow one got missed, if we make three identical payments of a thousand dollars, we don’t know which one it was, we don’t know which payment we need to go back and sort out what seems like a simple thing that can make a big difference if those issues ever come up.


After line 26, we have a couple of different lines for various credits related to education primarily, and they’re earned income credit. These are not ones that I come across often with the clients that I work with, but if they’re applicable, this is where they will come through line 31. That’s the amount from Schedule 3 line 15. This typically is any amount paid with your extension. We’ll talk more about extensions in a future episode. We’ve talked about it before on the podcast. If you file an extension, your taxes are still due at the April 15th deadline, and so if we’re filing an extended return, any payment we made with the extension will go on this line to get to our total payments, which includes all sources of payments, whether applied from the prior year, withholdings, estimated payments paid with the extension, wherever they’re coming from, they all get totaled up and added to line 33.


And then to figure out if we get a refund or have to make a payment. We’re just thankfully doing real simple math that the tax software will do for us. We’re taking our total tax and then subtracting any payments that were made during the year. And so this becomes just a simple subtraction problem to decide if we’re going to get a refund or have to make a payment. So going back to this conversation of having a refund doesn’t necessarily mean you’ve won. The way I think about this is I’ve got a family, we really enjoy going to Costco, and when I go to Costco, if I pay in cash and intentionally give the cashier extra money, if my bill is $200 and I give them a thousand dollars, I’m not going to leave the store and brag about how I got an $800 refund from Costco.


That would be silly. No one would do that. I’ve never heard someone leave a store and brag about how big of a refund they got. That probably all intuitively makes sense to you, but we turn around and do the exact opposite with our tax returns. People get so excited, they brag so heavily about the giant refund they got, and in most situations all that means is that you significantly overpaid the IRS and they’re giving you back your own money. In fact, that’s what this line says. Line 34 says, this is the amount you overpaid. And so again, this isn’t something to be proud of. This isn’t something that indicates you’re winning. There isn’t one right answer as far as how big of a refund or how small of a payment you should be making at tax time. Some of this is personal preference as long as we’re not incurring underpayment penalties, which means we didn’t pay enough throughout the year.


So the IRS is going to charge us some interest. So for me personally, I shoot for having a refund of less than a thousand dollars. I prefer getting a refund over making a payment at tax time, but I don’t want it to be a huge refund, and I know that that refund isn’t indicating whether I did a great job of tax planning overall for the year, just whether or not I did a good job of making my estimated payments and getting my withholdings dialed in. So we’ve got to move beyond simply getting on, hey, did I get a refund or did I make a payment? If we do have a payment due at tax time, that’ll show on line 37 the amount you owe, and then line 38 is where any penalties will come into the equation. Now, line 38 is a little bit deceptively named.


It says estimated tax penalty. The number reported on line 38 is not an estimate or approximation or a guess. What it’s saying is that this is the tax penalty for basically not appropriately estimating your taxes during the year. And this is one of my least favorite ways to see people tip the IRS. So anytime I see an underpayment penalty, it’s something I’m going to work on with my clients to make sure we avoid the next year, which we’re going to do by adjusting our withholdings or making larger estimated payments. The only reason we’re going to have underpayment penalties is if we don’t plan ahead accordingly. Now, thankfully, we don’t have to get this exactly right. The IRS has what are called some safe harbor provisions that mean that we just need to get close with the amount of tax we paid during the year, and there’s a couple of different ways that that safe harbor provision works.


The first is that if we owe less than a thousand dollars a tax time, we’re not going to have any underpayment penalties. The next is if we pay 90% of the current year tax liability. So if I owe $10,000 for the whole year, if that’s my total tax for the whole year and I’ve paid in $9,000 throughout the year, then I’m still not going to owe any estimated payment penalties and the 90% is more significant than just a thousand dollars because that works at any level. So if my tax bill is a hundred thousand dollars for the year as long as I paid in 90,000, I’ll be safe. The other way that the Safe Harbor provision comes in is compared to our prior year tax balance, the percentage gets a little bit higher. If we’re comparing to our prior year’s tax liability, as long as we pay at least a hundred percent of our prior year tax liability, we won’t be subject to underpayment penalties.


So what this means is that in 2022, if my tax liability was $50,000, as long as I’ve paid in $50,000 throughout 2023, I’m all set. So if 2023 was the year I retired and I had a huge severance, and for that one year my income tripled and now my tax liability for the year is $150,000. Not that the math works out that easy when it comes to taxes, but let’s just for the sake of the podcast, let’s assume that it does. My safe harbor still allows me to only pay in $50,000 throughout the year to avoid those underpayment penalties. I still have to pay the total balance due, so it’s not like I somehow get a discount by applying that safe harbor provision, but it does give me some more flexibility on when those taxes get paid. The only caveat to using the prior year as our baseline for doing the safe harbor is that if our income is high enough, which in this case for married filing jointly couples, the IRS has said, if our income is over $150,000, then it goes from a hundred percent to 110%.


So if we’re dealing with the safe harbor, that’s not something we want to try to dial in within a dollar or two because there’s going to be a little bit of leeway. We want to make sure we’re a little bit on the high side to really make sure we’re avoiding those underpayment penalties. So again, whether you should get a refund at tax time or make a payment. I’ve got clients that are adamant on both sides of this. I just want to make sure that we have a proactive approach and that we’re avoiding those underpayment penalties. I have a handful of clients who have had really bad personal experiences with the IRS in the past before we started working together, and so their preference is to receive 10 to $20,000 refunds just to make sure they never have a penalty. Again, that wouldn’t be my first choice, but I totally get their preference, given their experience.


I also have clients who say, you know what? I don’t want the IRS holding onto any of my money. I would rather have a payment due. And so we can work together to make that happen as well. It comes down to being intentional and to understanding what the outcome is going to mean for your personal situation. Alright, there you go. We’ve reviewed your entire 1040. Hopefully, this has been helpful context for you to make sure you understand the different pieces that go into your 1040. Come back in two weeks, Ben will be back on the show with me and we’ll go back to our regular conversations helping you to sand off the rough edges of your retirement tax bill. So until the next episode, good luck out there, and remember to not let the tax man hit you where the good Lord split you.

Disclaimer (19:19):

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.

Leave a Reply

Your email address will not be published. Required fields are marked *

But if you want to press the “easy button” with one of our personally-vetted Tax-Wise Retirement Guides, click below.