Your tax return contains a ton of valuable information that can be quite helpful with it comes to tax planning and managing your finances. The problem is it’s not the most intuitive document and extracting that valuable information can be difficult to do. In this episode, we walk through a checklist for reviewing your tax return. We go line by line, explaining the key items, how to find and interpret the useful information, and some of the important things to check on your tax return as they pertain to your overall finances and potential planning opportunities. Our goal is to help you decipher your tax return so you can use and apply the valuable information it contains.
Outline of this episode
- The basic checklist items [2:39]
- Salary, wages, and retirement contributions [4:14]
- IRA distributions and backdoor Roth IRA contributions [6:11]
- Investment gains and losses [10:40]
- Total income, deductions, and AGI [13:50]
- Refund or payment [20:22]
What to know from the top of your 1040 to line 4
The first thing to check when reviewing your return is at the very top of Form 1040—which is the form for the U.S. Individual Income Tax Return and is page one of the actual tax return for most people—this is where you will find your tax filing status. You'll see different options like single, married filing jointly, married filing separately, etc. so make sure the correct box is checked. Your filing status is important because it impacts how taxes are calculated for your household.
Moving down the tax return, line 1 is where your wages and salary are listed. If you work for someone else rather than being self-employed, this is where your compensation from your employer is reported and a big thing to check in this area is your contributions to your employer retirement accounts.
The next item on our checklist is line 4, which lists IRA distributions. This is important for a number of reasons, but one of the big ones is its relevance for anyone making backdoor Roth IRA contributions. When done correctly, there are no taxes owed on that Roth IRA conversion so what you want to check in line 4 is whether it was in fact reported correctly. The way to do this is to look at line 4a which lists IRA distributions and compare it to line 4b, which lists the amount of IRA distributions that are taxable. If you made a backdoor Roth IRA contribution and conversion during the prior year, that amount should show up in line 4a but there shouldn't be anything in line 4b.
Looking at lines 7 to 9
Moving down to line 7, this is where gains or losses from the sale investments are reported. This is an important line to check for multiple reasons and can cause some confusion or a surprise tax bill if the figure is higher than anticipated. When you sell investments at a gain, you have to pay taxes on that gain and report it on line 7. The reason this can result in a surprise tax bill is that there are no automated taxes withheld for any investments you sell at a gain. The responsibility is on the taxpayer to account for this by either making quarterly estimated payments, increasing your tax withholding through your employer, or paying the additional taxes come tax time. On the flip side, if you sell an investment at a loss during the calendar year, there is the potential for tax benefits, either by offsetting other investment gains or potentially lowering your taxable income.
Line 9 is total income, which might be the most straightforward line to understand because it's the overall sum of your income from the prior year that is subject to taxes. This includes everything, such as wages, taxable interest, dividends, taxable IRA distributions, pension and annuity distributions, the taxable portion of Social Security income, gains from the sale investments, and any other income such as self-employment income.
The lines we all care about
Line 10 is where some confusion can set in (if it hasn't already) when looking at the "above the line deductions," which simply refer to deductions before arriving at your adjusted gross income on line 11. After subtracting any above-the-line deductions from your total income, you arrive at line 11 or your AGI. This is one of the most important numbers to be aware of because it's the starting point for many different phase-outs or additional taxes that are tied to income.
The last three lines we'll touch on are essentially the punch line and determine if you'll owe taxes with your tax return or if you'll receive a refund. Line 15 is a big one for understanding your tax bracket and also determines what tax rate you pay on long-term capital gains from selling investments you've held for more than a year. Then there is line 24, your total tax based on your taxable income with a few adjustment items, where you get to the bottom line number of total tax. This number is the summation or final figure of tax you should have to pay to the government for the year and factors in all your income and deductions. Another term for this number is your tax liability. The next step is to look at line 33, which shows the total tax payments you actually made for the year.
From there, you can finally calculate what most people care about, which is the difference between line 33 (your total tax payments made throughout the year) and line 24 (your total tax liability for the year) to see if you'll receive a refund or owe taxes.
Resources & People Mentioned
- Podcast Episode #23: 5 Strategies for Tax-Efficient Charitable Giving
- Download our guide: The Toolkit for Optimizing Your Finances as an Employed Physician
- Download our guide: The Financial Checkup