The Benefits of Reviewing Your Tax Return

It seems that each and every year, when our firm reviews tax returns and consultations and second opinions, we find dozens of missed tax savings opportunities. Whether it be missed deductions, forgone strategies, less-than-ideal business entity or real estate structures, or simply improperly reported figures. This holds true whether you do your taxes yourself with an online software or if you use a professional. Sometimes these missed opportunities are due to honest mistakes. Other times it is due to tax documents with improper figures on them, such as 1099s from investment firms.

But more often than not, it is due to the complex tax code and the lack of awareness of the potential strategies that might be available to you and how to properly implement them or report them when filing. Every year, we are reminded of the importance of reviewing tax returns, preferably a draft version of those returns before they're actually filed, in order to make sure that these savings opportunities aren't continuously missed in future years and you pay more than necessary or have to pay penalties that could have been avoided.

Hello, and welcome to the Retired-ish podcast. My name is Cameron Valadez, certified financial planner and enrolled agent. As you likely know, tax season has recently come to an end, and today's discussion is going to be one that you will want to keep in mind for future tax seasons, and possibly even this year if you filed an extension, maybe for your individual return or your business as well. And I'm talking about the importance and benefits of reviewing your tax return in a little more detail than you're probably used to. This is crucial for tax planning, which has to do with making your financial situation as efficient as you possibly can to be sure that you aren't paying any more than necessary in taxes year in and year out. You won't be able to do that if you simply continue to do things status quo.

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Gathering up your documents, filing your return, then looking at the return each year to see whether you owe money or are to get a refund is not actually reviewing the return with intent. Don't get caught in the trap of only looking in the rearview mirror each and every year. In order to find tax savings opportunities, you need to be looking in the right places. Now, of course, it helps to know where to look, and due to the tax code being extremely complex, this can be quite difficult.

Today, I want to share with you some of the higher-level things to look out for, depending on your situation, and some examples for reference. All of the examples I reference stem from real-life consultations over my years in practice, as well as experiences that other tax attorneys, CPAs, and enrolled agents in my professional circles have run across.

The first and most basic things you will want to review should actually be reviewed before you begin the tax preparation process. Start by checking that the various tax documents you receive in order to help you prepare your return are correct. This may be documents like W2s for those of you who work for an employer and receive wages or bonuses, hourly pay, or what have you. Other documents could be K-1s from certain business entities or trusts in estates. Another common document is a 1099 from various investment custodians or a different form of 1099 if you’re something like an independent contractor. There are many versions of 1099s, and you may receive multiple for various reasons. What all of these documents have in common is that they show you what you need to report as income for tax purposes for the most part.

Now, what you need to be looking out for is that you actually have received those documents that you were supposed to and or know where to locate them. Now, this may sound very obvious and rudimentary, but these documents get missed all the time. Now you might be thinking, well, how can that save me in taxes if I find those documents and I'm just reporting more income?

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Well, the key here is that by missing an important and possibly substantial income source, you are not reporting income that you should have paid taxes on, and when you end up paying it later, you will owe interest and penalties, which is, you guessed it, basically more taxes. Not to mention the extra costs and headaches when filing an amended return. One common example of this is when you have tax documents such as 1099s for a particular investment account delivered electronically to maybe an old email that you don't regularly use or check. This is a common issue, and it often causes income that should have been reported to be missed. We have seen this issue on multiple occasions in new consultations.

When you receive these documents, you should also make sure that they are correct. Don't assume that the entities issuing them will always have the information correct or even be responsible for providing the highest level of detail. One common example of this is if you ever do what is called a qualified charitable distribution, or QCD, from an IRA, these distributions are not taxable. However, the 1099 R tax form that reports the distributions from these IRAs does not indicate any amounts for those QCDs. It is actually the taxpayer's responsibility to report it on the tax return properly in order to get those tax benefits.

If you simply put the numbers in on your tax software from that 1099, or you just hand the 1099 to your tax professional without any context, it will likely get reported as a fully taxable distribution, and therefore you miss out on the benefits. Another example of incorrect information on maybe a 1099 may be after the death of a loved one. If you are the beneficiary of an investment account, that is, a non-retirement account from, say, a spouse or a parent that passed away, you will typically receive what is called a step up in cost basis. This essentially has a chance to reduce or sometimes even eliminate a tax liability if and when the investments are later sold. However, some financial institutions will not automatically provide this step up in cost basis on those investments for you, and it must be done manually or requested.

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If this step is skipped, you will often receive 1099s with incorrect basis and likely pay more taxes than you needed to when selling a portion or all of the investments. Although we have seen this in more instances than I can count, one notable instance was where a woman's father passed away and had four investment accounts worth over $1 million worth of stock and the cost basis being reflected on the 1099 tax forms that she received were the same as when the father bought the stocks nearly 35 years ago. She had actually sold all of the stocks because she thought she had to in order to distribute the money amongst her and her siblings, who were all the beneficiaries. Now you could imagine how large the tax ramifications were to all of them. Had she not gone back and had the cost basis updated and the 1099s reissued in time, they would have given up nearly 25% of the money in taxes.

These reporting issues are not only limited to 1099 tax forms, but there are also many other tax document reporting mistakes that can happen before you even touch your tax return. The key is to understand what you are looking for and preferably get a second opinion on what your tax situation might look like should any major life changes occur during any given year. Next, once you've done the initial preparation of your return, whether that be in a software of some sort or you've provided your tax professional with the required documentation, you will want to double-check that you have truly provided all of the pertinent information. A tax return is only as good as the information you put into it. You know the saying garbage in, garbage out.

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In order to avoid paying more taxes than necessary, you will want to be sure that you don't get lazy about the information you provide. Now, there are literally countless examples of this, but here are some of the top ones or the most common ones that I see. One is that people assume that they will use what is called the standard deduction on their individual tax returns. So they neglect to input or gather information on amounts that might otherwise be an itemized deduction, such as property taxes, paid taxes on personal property, sales taxes, etcetera. Depending on your situation, in any given year, it may make more sense to itemize rather than use that standard deduction.

Another to watch out for is that the information you provide actually makes it onto the return. While somewhat rare, software and humans make mistakes. Make sure that you review a draft version of your return before actually filing it to make sure everything is good to go. I have seen situations where rather rudimentary deductions are missed because the line is blank and information is missing. In one particular case, a couple used the standard deduction on their federal return but itemized it on their state return.

However, their property taxes paid were missing in those itemized deductions for the state return, and they missed out on an additional $900 in tax savings, at least initially. And they had to pay to have their return amended in order to fix that, they had been using the same tax professional for 20 or so years, and that professional's office also uses professional tax software. So the key takeaway here is that it happens. You might also start paying closer attention to some of the other income lines on your return, such as the capital gains and losses line. If you have various investments that are not in retirement accounts and are not real estate, and you find that you consistently have sizable capital gains, there may be some ways to reduce that going forward.

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Usually, we see this when people own a lot of mutual funds in these non-retirement accounts. Oftentimes many mutual funds will have what are called capital gains distributions, sometimes every year, sometimes it's kind of random. They are essentially capital gains that those mutual funds spit out that you have to pay taxes on. And this is even if you didn't sell anything yourself at a gain. The potential size of these capital gains distributions is largely out of your control because they are decided by the fund companies, and depending on what they do, and in some years, they can be astronomical.

You will want to try to mitigate this as much as possible and take over your tax situation. I have seen instances where people had surprise distributions well over six figures. If this is something you consistently see on your return, it might make sense to reach out to a professional advisor to see how it can be reduced or eliminated moving forward. And while we're on the topic of investments and interest rates are now higher than we've seen for quite some time, I want to talk about certain types of interest that are not taxable at the state level. So if you are in a state that has a state income tax, this is for you.

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As of late, more and more people are trying to take advantage of higher interest rates by buying things like government treasury bonds or, more specifically, treasury bills. Or they are utilizing something similar, like government money market mutual funds, in order to put their idle cash to work. The interest derived from US government bonds is taxable at the federal level but not at the state level. In addition, some people might own what are called municipal bonds, either through something like a mutual fund or by owning the bonds directly. When you own a municipal bond that is issued in the state in which you live, it is generally not taxable at the state level either. The interest isn't taxable.

The issue I see time and time again, and guys, I mean almost every tax return I see for people who own these investments, is that they report all of the interest, or most of it, on their state returns when some of it should not have been included, which in turn generally means more taxes paid. You need to be careful here. This is one of those areas where you have to really read through and pay attention to those 1099 tax forms you receive. They typically have some sort of code or indication of what portion of interest you received was from government treasuries or municipal bonds from your home state. The tax software rarely catches all of these small details, and as I said, humans can miss it too.

Now the next examples I want to go over and things to look out for pertain to business owners. If you are a business owner, providing the right information and all of the information that is relevant is paramount to not paying more than you need to in taxes. This is because, as a business owner, you are generally able to take more deductions than someone else who doesn't own a business. That is one of the major benefits of being a business owner. Although there are just so many I could go over, one big one is choosing the wrong method for writing off expenses related to a vehicle that is used in your business.

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Generally, you can choose to deduct a mileage rate or the actual expenses that you paid for your vehicle throughout a given year. Depending on which of those methods you choose to use in the first year, you may be limited in what you can do in the following years. However, the biggest reason the wrong method is chosen initially is because lousy records are kept. Be sure to track both your business mileage as well as your actual expenses to help you make the right decision. Another potential deduction to look out for as a business owner or if you have rental properties would be the administrative home office deduction.

Now, I want to caveat that this deduction and the rules and eligibility associated with it can be quite convoluted. However, you should be aware that it exists. And yes, if you have rental properties, you technically have a form of business. So it may be possible for those of you out there with real estate investments to look into or take this deduction. I often see that this deduction is skipped by many people, including tax professionals, because there isn't an actual line on many of the tax forms that says administrative home office deduction, so they don't think that you can take it.

However, that is not always the case. If you are reviewing your return and don't see any deductions related to a home office, and you actually have an administrative home office that meets the IR's rules and requirements, you should be looking for a second opinion, especially if you are unsure whether or not you can take the deduction. And lastly, and this one applies to everyone, not just business owners, for those of you who are or may become the beneficiary of a trust or an estate, there may be certain what is called carryover losses that can flow through to you on your personal tax return. If sales of certain investment property or other investments incurred a loss in, let's say, the trust's final year, you, as the beneficiary, may be able to take advantage of certain carryover loss deductions.

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This one, too, can be quite complicated, but simply being aware gives you some ammo come tax time. Sometimes these losses can be significant and can help you offset some of your income for years to come. I have a good example of this where there was a little bit of good timing and luck when it came to getting the benefit from these lost carryovers. Now this may be slightly complicated, but I want to share it with you anyway so you can get an idea of what's possible.

There were two daughters who were beneficiaries of a trust investment account. Mom and Dad had passed away. The second parent passed right before COVID-19 struck, so they received a step-up in basis, as I talked about earlier, on those investments once the money moved into an irrevocable trust. This was still before the stock market had crashed. Then once the stock market had a rather large yet temporary decline, we sold the investments, generating a very sizable loss. We then distributed the proceeds to the beneficiaries, and then they bought back into the markets with that cash shortly thereafter.

Since stock prices were then around 20% to 30% lower, which then happened to reverse back to where they were prior to the major decline and then some. They were essentially able to take on those losses from the trust on their personal returns to help offset some of their income and any potential capital gains they might have moving forward while not actually having any losses in their personal investment accounts because they had reinvested and those investments had gone back up in price. So talk about a win-win. This was an awesome situation for these people.

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Now, situations like this are not very common and a lot of stars had to align in this situation. But the point is that it wouldn't have been possible without careful attention to the different tax returns involved and making sure eligible deductions were taken properly. As I mentioned, there are just so many different things you can learn or opportunities that you can spot when reviewing your tax returns each year, as long as you know what to look for.
Today, I have just scratched the surface, but what happens when you do start making adjustments and saving money in taxes? You will need to have a plan for those savings and help you preserve or continue to accumulate wealth. Otherwise, those savings will just become another one of those black hole expenses that we all have.

In addition, if you are successful in changing your tax situation for the better over the next year or two, you may need to adjust your tax withholdings or the estimated taxes that you pay throughout the year. Now, once you’ve done the heavy lifting on the tax side, determine the amount of potential extra cash flow you may now have to work with. Then, give your newfound savings a job. Maybe you start building your emergency fund, or maybe you start investing those dollars on a regular basis for a particular goal. Whatever the case is, make sure you try and automate as much as possible and keep it simple.

That's it for today's show. Remember to send in your questions, and I will do my best to answer them in a future episode. Questions are great because, most of the time, many others will have the same thoughts and questions as you do. Whether it seems basic or complex, ask away. You can use the link in the episode show notes to email it in or voice record it straight from your mobile device. I make it easy on you guys.

If you're concerned about your taxes and you're looking for a second opinion on what you're currently doing, feel free to reach out to our firm, Planable Wealth, for a consultation. You can find a link to do so in the episode show notes right there on your device.

And don't forget to sign up for the Retired-ish newsletter to get your free retirement planning quick guides for 2024 and useful and easy-to-digest information on retirement planning, investments, and taxes once a month, straight to your inbox. No spam. If you can spare a minute and find this information actionable and insightful, please subscribe to or follow the show on your podcast app and share it with a friend who you think might benefit.

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If you'd like to learn more about the topics discussed in today's show, you can find the links to the resources we have provided in the show notes right there on your podcast app, or you can visit us at retiredishpodcast.com/42. Thanks again for tuning in and following along. See you next time on Retired-ish.

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