What you can learn from a tax return

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).

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