Click Here To Listen To The Retirement Tax Services Podcast
Are you trying to learn how to deliver massive tax value to your clients? Then look no further. Retirement Tax Services Podcast, Financial Professional’s Edition is a show hosted by Steven Jarvis, CPA. Steven aims to bridge the gap between tax professionals, financial advisors and their mutual clients in their quest for reducing tax expenses in retirement.
Welcome to the Retirement Tax Services Podcast! On this Tax Q&A Friday, Steven answers a question from an advisor at Edward Jones. A client’s Form 1040 showed a large amount on Line 5a… but zero on Line 5b.
Where did it go? The advisor knew some situations could cause this. However, nothing he’d handled for the client seemed to correlate. Steven has specifics on the answer for you in today’s podcast.
Spoiler alert: The 2020-specific version of Form 1040 is the culprit. Nonetheless, you need to understand the means and the motive, so here’s some background, first.
Note that a given year’s pension and annuity payments are totaled on a 1040’s line 5a. It is usually derived from Box 1 of their 1099-R.
“Usually” doesn’t mean “always,” though. As a matter of fact, that amount has to be from a pension or annuity; not an IRA or simple IRA.
In fact, “pension” doesn’t necessarily mean a defined benefit plan where Line 5a is concerned, either. Note that the IRS’ definition can include 401ks, 403bs, and 457bs.
So, if it’s an employer-sponsored retirement plan, it counts. Line 5a is the gross distribution. That gets reported on the client’s 1099-R. As a result, the taxable portion of that amount goes onto 5b.
Sometimes the taxpayer’s made a rollover. As a result, expect differences between the gross and taxable distributions. Similarly, if the distribution was from a Roth or after-tax account, expect different amounts.
In simple situations, the distribution’s taxable portion is reported on line 2a of Form 1099-R. Look for it on Line 5b of the Form 1040.
However, there are situations in which a 1099-R won’t match what should be reported on the 1040. For example, Steven often sees Qualified Disaster Plan Retirement Distributions listed for the 2020 tax year.
This type of distribution gets reported on Form 8915-E. In other words, it’s an election made on your tax return. You don’t have to communicate it to your custodian. Therefore, a 1099-R won’t necessarily show it.
Meanwhile, the IRS has expanded the definition of a Qualified Disaster for 2020 distributions. COVID-19-related circumstances now qualify. Previously, this category only applied to natural disasters for limited time periods.
COVID-19 entries are allowed for all of 2020; throughout the entire year. Additionally, the IRS’ definition of who is impacted has broadened, due to Coronavirus.
This means many taxpayers are technically eligible to claim taxable distributions as Qualified Disaster Retirement Plan Distributions.
Accordingly, tax preparers are helping clients use their 8915-Es to take advantage of the opportunity. Don’t let it surprise you.
This means that someone can spread the taxation of a 2020 distribution over 3 years. However, it doesn’t have to be taken all at once.
Expect the difference between lines 5a and 5b to appear in 2021 and 2022, as well. Keep your eyes open.
This is why Steven frequently recommends getting every client’s tax return every year. Make it a repeating part of your process. Review all forms and schedules, too; not just the 1040.
At the same time, remember: The first 2 pages of a Form 1040, alone can provide multiple potential opportunities. Uncover that value for clients.
Thank you for listening.
Hello everyone and welcome to the next episode of the Retirement Tax Services podcast: Financial Professionals Edition. I’m your host, Steven Jarvis CPA. And in this show, I teach financial advisors how to deliver massive value to their clients through retirement tax planning.
Today’s episode is tax Q&A Friday once again and our question today comes from a conversation I was recently having with an advisor from Edward Jones. My guests at this point have been in the independent advisor space, but independent advisors do not have a monopoly on being able to talk about taxes, regardless of whether you are independent with a broker dealer, a wire-house or a hybrid model, your clients are impacted by taxes and you should be considering taxes in your planning. To make sure you are delivering value to your clients, you do need to make sure you are staying in the lines with compliance. But don’t let compliance be your excuse to not even try. I have talked with advisors in many different situations who have been able to provide value through tax planning with their compliance department’s approval. From the conversations I’ve had with advisors, the trick seems to be working proactively with your compliance department and treating them as part of your team, not treating them like some kind of adversary. The approach you take is going to your compliance department and saying, how do we get this to work? What I’m hearing from advisors is there almost always is a way to figure that out. Maybe you have to put an extra disclaimer or word something slightly differently, but this shouldn’t be a fight over which words you use. This should be a collaboration on how you ensure that you’re delivering value to your clients.
Okay, back to my conversation with the advisor from Edward Jones, as we were talking about various ways to deliver value through taxes, he mentioned he had a client return come across his desk recently, that left him with a question. On the client’s 1040 there was a large amount on line 5-a, but the amount on line 5-b was zero, and he didn’t know why that was. He definitely knew some of the situations that could cause that to happen, but nothing stood out about the work he had done with the client that might cause the situation. The point of our conversation was not solving this problem, but I thought it would be a great topic for today’s episode.
If you have a 1040 from, uh, from 2020 and a 1099-R you can look at it while we go through this, it might be easier to follow along, but it is certainly not required. It is really important to keep in mind that what I am talking about today is based on the 2020 form 1040, uh, because it can change from year to year. For 2019, we would have been talking about lines 4-C and 4-D and for 2021, the 1040 hasn’t been released yet. So anytime I’m referring to line numbers, I’m talking about the 2020 form 1040. Okay, so let’s start by putting context to lines five A and five B on the 2020 1040. And then we’ll talk about what will cause them to be different at times.
Line 5-a of the 1040 is labelled pensions and annuities, and it’s where distributions from pensions and annuities are reported. The amount included online 5-a is typically taken from box one of a taxpayer’s 1099-R if the distribution is from a pension or annuity and not an IRA SEP or simple IRA, which would be indicated in box seven of the 1099-R. It’s important to remember that for many taxpayers, the word ‘pension’ is thought of as a defined benefit plan, but that is not the definition the IRS uses. Pensions for purposes of line 5-a, can include 401(k)s, 403(b)s and 457(b) retirement plans as well. Pension really just means employer-sponsored retirement plan. So line 5-a of the 1040 is the gross distribution reported on the 1099-R. That part is usually very straightforward, just matching one to the other. Line 5-b is to report the portion of the amount online, 5-a that is actually taxable and will get included in a taxable income.
The gross distribution and taxable distribution might be different because the taxpayer made a rollover during the year, or because the distribution was from a Roth or after-tax account. So we want to be aware that while at times they can be the same number, that’s not always going to be the case, but it’s something that we can look at as we’re reviewing tax returns that we’re getting for our clients every year, to make sure that what’s been reported is consistent with what we expected.
In simple situations the taxable portion of the distribution is reported on line 2-a of the 1099 R, which will then come through on the 1040 on line 5b. But there are situations where the 1099 R does not match what should be reported on the 1040. For the 2020 tax year, the most common situation I see this come up in is for qualified disaster retirement plan distributions, which are reported on form 8915 E. Now this is an election that gets made on your tax return and not something you have to communicate to your custodian. So it won’t be reflected on a 1099 R. Since the IRS expanded the definition of what qualified disasters were in 2020. And now it includes COVID-19, which in contrast to prior years, it only included certain, very specific natural disasters for very limited time periods. Uh, for 2020, uh, COVID was added to this list and it covered the entire year. Not only that, the IRS very generically defined who was impacted, which means that many taxpayers, um, are technically eligible to claim a taxable distribution as being a qualified disaster retirement plan distribution. And what I’m finding is that a lot of tax preparers are helping their clients use that form 8915-E uh, to take advantage of this opportunity that one of the key provisions of which is being able to spread the tax on that distribution, uh, over three years, instead of taking it all at once. So this will create a difference between lines 5-a and 5-b, not just in 2020, but in 2021 and 2022 as well.
This also means that in 2021 and 2022, there could be an amount in line 5-b, but no amount in line 5-a, because the taxpayer has to continue to claim that income in those subsequent years, but there’s no distribution to go along with it. So this is a perfect example of why I always recommend you get returns for every client every year. You should definitely be reviewing the entire return and not just the 1040, but the first two pages of the 1040 alone provides so many chances to uncover opportunities for your clients. The further we get from the tax deadline, the more stories I am hearing from advisors specifically about discovering the form 8915 E had been filed, and that they now need to adjust tax planning strategies for clients as a result. And this is coming up because, uh, similar to this advisor, I was talking to this last week there’s amounts in line 5-a that don’t match what’s in 5-b and the advisor has to dig into, okay, why is that? So just that quick review of even the first page or two of the 1040 can start to raise some of these red flags or yellow flags to say, Hey, that’s something I should look into further. That’s something I should ask questions about.
So this was a very quick discussion on just these two lines on the 1040. Uh, they are definitely worth exploring further. This is the kind of stuff that should make it into your personal and professional development time. So narrowing in on a specific line item like this will help not just improve your ability to review tax returns as a whole, but it’ll help you deliver even more value to your clients. Getting those repetitions in, of going through and looking for what you expect to come through on these different lines based on a client situation versus what’s actually there. Uh, I definitely plan to keep adding discussions in future episodes of specific line items and, and doing, giving more of these examples and talking about things that you can be looking for. But if you have a line item or a particular area of the tax return that is of interest to you, feel free to send me an email at: email@example.com, and we can get that moved up the priority list so that we’re addressing what’s most beneficial.
Alright, time for some action items. So first action item is, make sure you have a system in place for tracking tax planning strategies you recommend to clients so you can follow up on how they were reported to the IRS at the end of the year. If it doesn’t get reported, according to the IRS, it didn’t happen. And so that’s one way that you can really expedite or increase the effectiveness of that annual tax return review. If you have not just a checklist of here’s things that I should be looking for in every return, but specific to Bob and Sue or whichever client you happen to be looking at, here are the things we did with them during the year, we did a Roth conversion, we did a QCD, whatever it might be, uh, we recommended they changed their withholdings, these different kinds of things that should then flow through to the tax return. Uh, having having that in your CRM or having some system in place for tracking that will help that review be more impactful and will also allow you to better delegate some of those tasks to your team. So you, as the advisor, aren’t spending all of your time reviewing tax returns.
And of course the action item that goes right along this, along with this is making sure that you are getting every client’s tax return because keeping track of those strategies to verify does you no good, if you don’t then verify them.
All right, the next action item is that especially in years, where there are new or different amounts coming through the client’s tax return, make sure you review the return with them. So they understand what they’re looking at and how they benefited from the strategy you help them implement. It’s a great tool for showing the client how they are getting value from the services you provide. You can even as you’re recommending this strategy, show them pre-emptively, ‘okay here’s, here’s where we will see this come through.’ And then the next client meeting after the taxes have been filed, you can go back through and put the actual numbers to it. It’s a really effective way to help the client understand what it is that you’re doing for them in practice.
Last action items, since this is Tax Q&A Friday, please take the time to submit a question for an upcoming episode. Again, love to make sure that I’m addressing your questions as often as possible. So send an email to firstname.lastname@example.org, if you have a question that you would like to have answered on one of these episodes, that’s all for today, thank you everyone for listening. Good luck out there, and remember to tip your server and not the IRS!
The information on this site is for education only and should not be considered tax advice. Retirement Tax Services is not affiliated with Shilanski & Associates, Jarvis Financial Services or any other financial services firms.