Tax Relief

How to Read a Tax Return to Uncover Financial Planning Opportunities

You might expect that your accountant would do the following exercise, but don't. Most are not proactive--they simply fill in your tax return AFTER the year is already finished when its too late to save you money. Here’s what to look for to uncover opportunities and help ask yourself the right questions (the following may be more valuable if you take out a copy of your tax return).

Form 1040, page 1 & 2

Line 8a – Is taxable interest high? More than $10,000? Right now, taxable interest from CDs and money markets is maybe 3%, so if you see $10,000 taxable interest, you may have too much in low interest account. Flip to Schedule B, and it’s all detailed right there. A listing of every penny of interest you get. You can quickly determine how much is invested in each asset by estimating the yield and dividing that number into the amount you see on Schedule B. If its mostly from low yield investments, then it's an opportunity to get into higher yielding bonds or preferred shares.

Line 8b– Do you have tax-exempt income? Should you? Look at line 42 on page 2 "taxable income" to determine if you are in a high bracket and should be investing for tax-free income. Look up your income on the attached tax rate schedule (below). If it’s below 15% you should NOT own tax-free securities. Since tax-free bonds usually yield about 80% of taxable securities of similar quality, you only come out ahed if your tax bracket is at least 25%. An immediate annuity is also a tax saving option if in fact you need the cash flow (otherwise, a deferred annuity may meet your objectives).

Line 9 – Are there a lot of dividends? Are you getting A competitive rate? Many people don't figure this correctly.They invest ed $10,000 years ago in a stock now worth $100,000. They collect a $2,000 annual dividend and think "I'm getting 20% on my money!" But they get only 2% on the current value of their stock.

If you have stocks that don't perform well but don;t sell because you don;t want to pay gains tax, there are solutions like a Charitable Trust or Charitable Gift Annuity.

Line 12– Do you have a business? If so, there may be multiple opportunities—establishing a pension plan or 401k, deductible group benefits: life, health, LTC, key man insurance, disability, etc.

Line 13 – Did you sell an asset and generate capital gains? If not, but you see a fugure here its because the funds you own generate gains you must pay tax on (even though you did not sell--see details on Scedule D). These may not be senisible assets to hold outside a retirement plan.

Line 15a and b – Are you taking large IRA distributions? More than you must? Make sure you take no more than the schdeule in publication 590 from IRS.

Line 17, 18 – Any real estate holdings and any plans to sell soon (and free up some cash)? If cash flow is not high and neither is appreciation, convert the property to cash using a Charitable Trust, foundation or donor-advised account. Or, don’t forget about 1031 exchanges for like-kind property that may be easier to manage, for example triple-net property.

Line 20a – Social Security income. Some people can reduce or eliminate taxes on Social Security income completely by moving investments from tax-free bonds or taxable investments to annuities (because deferred annuity income is one of the only items not included when calculating the tax on Social Security income). The calculation is not so simple and your best consulting an advisor.

Line 25 & 32 – Did you make an IRA or qualified plan contribution—should you have? If you have eraned income or a business, you can likely make tax deductible contributions.

Schedule A - Deductions

This schedule is where people list their itemized deductions. Many seniors use the standard deduction rather than itemize as they have too little to itemize (their mortgage is paid off; medical costs are covered by insurance, etc.). Here’s what you can learn from Schedule A:

Lines 1-4 – Medical Expenses. If you don’t have your medical expenses covered by health insurance and you are able to take a deduction, it’s an opportunity to get better health insurance. Also, if you were deducting medical expenses (or close to being able to do so), your long-term care insurance premium would be deductible (some limitations apply). So you may have an opportunity to get an LTC policy and have the IRS share the cost.

Lines 15-18 – Gifts to Charity. If you make significant gifts (e.g., more than 2% of income) there may be more efficient ways to do this and increase your tax benefits.An advisor can explain.

Locate a Certified Retirement Financial Advisor that can hep you reduce taxes.

2005 Tax Rate Schedules

Schedule X — Single

Schedule Y-1 — Married Filing Jointly or Qualifying Widow(er)

Schedule Y-2 — Married Filing Separately

Schedule Z — Head of Household