A Taxing Problem

In case you haven't been paying attention, the topic of taxes has been in the news a lot recently. One reason for the interest in taxes revolves around the following question:

Can you learn anything by studying someone's tax return? (Spoiler: You can)

He Who Shall Not Be Named once said, "There's nothing to learn from them". I disagree, but this post isn't meant to start a debate about whether or not candidates for president should be required to release their tax returns. With that in mind, let's explore what we can learn by reviewing someone's 1040:

  • Income, and sources. W-2 wages, self-employment earnings, investment income, alimony, retirement income, rental income, business dividends, annuities, bank interest, tax refunds, capital gains, unemployment, Social Security benefits, on and on. That's a long list!
    • 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. Here you can find out just how much someone saved for retirement during the year.
  • Participation in a Health Savings Account. This lets us know they participate in a high-deductible health plan.
  • Self-employment taxes. This 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. This tells us if the client might be supporting a student (or putting themselves through school!).
  • Itemized deductions tell us many things, such as:
    • How much mortgage the client is carrying, or, if we know that, if the rate is competitive.
    • If there have 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.

I could go on, but I won't. Sorry, I know you were hoping for a longer post about taxes, but I'll save that for a future post.

The takeaway is that financial planners - or anyone - can learn a lot by looking at a tax return.

I can't take full credit for this week's post. I had planned to write about this topic but a colleague of mine, James Osborn of Bason Asset Management in Colorado, beat me to it.

Listening / Reading / Watching

Here's what's got my attention this week:

  • How the Education Gap is Tearing Politics Apart by David Runciman, writing for The Guardian. This is an interesting piece focusing on education (or lack of) and its effect on politics.
  • Revolution Radio by Green Day. Okay, so this isn't at all related to personal finance. Green Day's albums have been in constant rotation at our house since Monday's amazing concert at the 9:30 Club. They just happened to release a new album today and I've had it on repeat since I woke up.