With all of the hubbub surrounding a certain presidential candidate’s unreleased tax returns, I thought it would be fun to talk about what you can really learn from a 1040. Most financial planners will agree that reviewing a client’s tax return gives tremendous insight into their financial life. So here’s a quick rundown.
- Income, and sources. W-2 wages? Self-employment? Investment income? Alimony, retirement income, rental income, business dividends, annuities, bank interest, tax refunds, capital gains, unemployment, Social Security benefits, on and on. Each tells a lot.
- A good planner can use this information to derive more information – lots of bank interest means lots of cash on hand, maybe not enough, maybe too much? Lots of capital gains might mean a tax-inefficient portfolio structure. So could lots of ordinary vs. qualified dividends or taxable bond interest vs. municipal interest. Big tax refunds might mean poor planning of estimates throughout the year.
- Participation in a retirement plan, amount saved in that plan.
- Participation in a Health Savings Account.
- Self-employment taxes, which tells us the structure of self-employment income vs. business entity income.
- Deductible or non-deductible IRA contributions and eligibility, Roth IRA contributions and eligibility.
- Payment/deduction of tuition and fees, tells us if the client might be supporting a student (or putting themselves through school!).
- Itemized deductions tells us:
- How much mortgage the client is carrying, or, if we know that, if the rate is competitive.
- If there has been large medical expenses in the past year, which might be a key planning topic.
- Payment of state/local income, sales and property taxes.
- Charitable giving, leading to lots of planning topics surrounding effective giving.
- Payment of absurdly high investment management fees (can’t help myself).
- Eligibility and receipt of child tax credits, child care tax credits, tuition credits, etc, etc.
This is not even remotely an exhaustive list. This is a list that I came up with in roughly 13 minutes. So when I or some other financial planner asks to review your tax return, it’s not because we think your CPA is an idiot (s/he’s not) or that you’re an idiot(you’re not), it’s because I can draw a decently accurate financial picture based on just this one document. A good review of a tax return often leads to many great planning conversations (and just every once and a while a chance to make a significant change to save you some money).
Bason Asset Management 