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 back to the Retirement Tax Services Podcast! In episode 32, How To Articulate Your Tax Planning, Steven began going over the 2020 US individual tax return. This episode continues his focus on explaining each line to clients. Today, we continue reviewing the 1040 on Page 2.
In the first episode of this Form-1040-centered series, Steven ended at Line 15. As a result, we are resuming at Line 16 at the top of Page 2.
It gets easier to understand some peoples’ confusion here. Line 15 is the taxpayer’s total taxable income. However, Line 16 is their total tax liability.
Note that different types of income are taxed according to different brackets. Additionally, the level of income changes the tax rate applied to those different income types.
Forget finding an explanation of how those brackets line up with the amount on line 15. In fact, there isn’t one on the 2020 Form 1040. Therefore, it’s easy to see why taxes frustrate and confuse many people.
Don’t worry, though! Retirement Tax Services listeners aren’t left in the dark. Steven’s written an article for the Tax Library that breaks the details down for advisors here.
Many taxpayers turn to Page 2 and then immediately skip down to the bottom. In other words, they want to know if they are getting a refund or making a payment.
As Steven often says, “taxes are very emotional:” That end-of-year tax result ends up being the focus of their anticipation or dread. Gently buck this trend.
If all you review is whether their refund or payment is changing annually, you aren’t conveying 100% of the picture. These things can be affected by the timing of payments or withholdings. In other words, they don’t truly represent how much money the IRS has kept. Remember that.
So, when you reach Page 2 of the tax return, begin at the top. To be honest, few people may understand the impact of your planning strategies, if you don’t.
Start with Line 16 and highlight their total tax liability for the year. This is where changes from year to year will be much more meaningful. In fact, the process of explaining these should quantify the value you are providing throughout the year.
In sum, Line 16 is the total tax as calculated based on the taxpayer’s ordinary income bracket. This is for their filing status and any qualified dividends or long-term capital gains. Determine it using the applicable preferential rates.
Line 17 typically only applies to a small number of taxpayers. This amount is pulled from IRS Schedule 2. Further, it represents any alternative minimum tax (AMT). Any excess premium tax credits the taxpayer has received during the year.
Consequently, Line 18 is a subtotal of the 2 amounts from Lines 16 and 17.
Steven covers the rest of Page 2 of the 2020 Form 1040 in this episode of the Retirement Tax Services Podcast. Feedback, ideas for future episodes, and unusual tax planning stories can be sent to email@example.com.
Thank you for listening.
Hello and welcome to the next episode of the Retirement Tax Services podcast, Financial Professionals Edition. I am your host, Stephen Jarvis, CPA, and in this show, I teach financial advisors how to deliver massive value to their clients through tax planning. A couple of weeks ago, I did an episode going through the first page of the 2020 form 1040, giving examples of how to explain the return in a way that is relatable to your clients. Today, we’re going to continue that discussion and move on to the second page of the 1040. So again, this might be an episode that is worth listening to, while you can look at an actual 1040, make sure it’s for 2020, that’s what’s going to line up with the line items that I’m talking about, the general terms are there year to year, but the lions can shift a little bit and the 2021 1040 hasn’t been released yet, so we’re going to use the 2020. As a reminder, this conversation, and more importantly, you having a similar conversation with your clients is really valuable to them, because taxes for most people is this magical black box of confusion and anxiety. Taxes impact everyone; however, very few people really understand what that impact looks like for them personally. Pulling back the curtain for your clients, even just a little bit on how their tax return works is a great way to lessen, even if you can’t completely remove the annual anxiety related to taxes for them. So in our last discussion, we finished page 1 on line 15, which is a taxpayer’s total taxable income. As we go from line 15 on page 1 to line 16 on page 2, which is a taxpayer’s tax liability – it’s really easy to see why there’s so much confusion on taxes. Although line 15 is total taxable income, we know that different types of income are taxed according to different brackets and that within those brackets, the level of income changes the tax rate applied to the different types of income. Nowhere on the 1040, does it clearly show how the tax brackets line up with the amount on line 15 of the 1040.
So when a taxpayer turns the page and sees their total tax liability on line 16, you can understand why taxes feel like this black box. Now, if you want some more detail on how, kind of, that order of operations of how those different buckets get filled up and those tax rates applied – we actually have an article on retirementtaxservices.com that illustrates this, so it’s a great reference if you want some more detail on which buckets get filled up first and how things like the standard deduction get applied when there are multiple buckets involved. So for lot of taxpayers, when they flip to the second page, they skip right to the end of the page and look to see if they are getting a refund or if they’re making a payment. Because as we’ve discussed previously on this podcast, taxes are very emotional and that end of year tax result, a refund or a payment, ends up being the focus for many taxpayers. To really illustrate, however, to clients, the impact of the strategies you help them implant – you need them, make sure you start at the top of this page so that you can highlight what their total tax liability is for the year, because that’s where changes from year to year are going to be much more meaningful, and can help really quantify the impacts of these different tax planning strategies. If all we look at, is whether their refund or payment is changing year to year, that’s something that really can just be affected by the timing of payments and timing of withholdings…things like that – it doesn’t truly represent how much of your money the IRS kept. All right, so 16 is total tax as calculated based on the taxpayer’s ordinary income bracket for their filing status and any qualified dividends or long-term capital gains using the preferential rates applicable to those income strains.
From there, we go to line 17, which is typically only applicable to a small number of taxpayers, but it’s an amount pulled from IRS schedule two, which we’ll talk about more in a minute, but line 17 is going to represent any alternative minimum tax also known as AMT and any excess premium tax credits the taxpayer received during the year. So again, this will only be applicable to a handful of taxpayers. Line 18 is simply a subtotal of those two amounts. Then we get to line 19, which is where the child tax credit gets reported. In Monday’s episode, we talked about the advanced payments of the child tax credit for 2021 that had started hitting taxpayers’ bank accounts, presumably the 2021 1040 we’ll have a way to distinguish the total credit a taxpayer is eligible for and the amount that was received in advance. However, the 2021 1040 has not yet been released yet, so we’re going to keep going through the 2020 version. Line 20 comes from IRS schedule three and represents any non-refundable credits the taxpayer was eligible for in the current year, things like the foreign tax credit, education credits and residential energy credits. Again, these are areas that are only applicable to certain taxpayers. Line 21 and 22 are once again subtotals – amounts that are just calculated from other balances on the form.
So line 23 is additional taxes outside the traditional brackets that we typically think of. For many of your clients, this line could be blank, but there are a variety of taxes that could be applicable, which are detailed on IRS schedule two, separate from the AMT and premium tax credit payments that I mentioned previously. When you are going through this with the client, make sure you only highlight the areas that are currently or at some point may become applicable to them. The goal here is to demystify the portions of the tax return that are relevant, not add more confusing terminology. There are quite a few taxes, including the net investment income tax, additional Medicare tax, and self-employment tax that all come through on schedule two, and then end up on this line of the 1040. So make sure that you’re prepared to put these taxes in relatable terms for the situations you most commonly see. To again reinforce this, having a niche can be nice – it really limits what you have to spend your time, really learning.
So this takes us to line 24, which is the total tax bill for the year. This takes both the taxes calculated based on the income brackets we typically think of as well as any additional taxes that might have come through on these other lines we’ve talked about. So this really is the number you should be highlighting for clients as you work with them year over year to reduce their lifetime tax liability, so they can see what those impacts might be. It can be easy to get lost in whether a person received a refund or made a payment, but this line represents how much of a client’s hard-earned money and IRS kept for the year. So again, make sure this is something that your clients understand. Line 25 is any tax withholding from wages or distributions during the year, and line 26 is estimated payments. It’s important to understand, to be able to articulate that the IRS does not treat withholdings and estimated payments equally, not from a dollar standpoint, but from a standpoint of whether the IRS is going to ultimately charge you penalties and determine if you’ve paid enough tax at the right time. No matter when withholdings occur, the IRS treats them as if they had happened throughout the year, which is important for avoiding those penalties and potentially interest. In contrast, the IRS treats estimated payments as received when they are actually received. This could mean that if a taxpayer waits until the end of the year to pay all their taxes through estimated payments, the IRS will charge penalties and interest on earnings that happened early in the year — not the earnings, but the taxes on those earnings. For clients who are taking distributions, this gives us a great opportunity through doing tax projections during the year to see if there could be any shortfall and then make up any difference through a withholding instead of an estimated payment, so there isn’t a potential for penalties. All right, so lines 27 through 30 are all refundable credits. The only one I’m going to highlight for 2020 is line 30, which represents COVID stimulus payments that were made in 2020. For many clients, this line will show as zero, it won’t be blank, there’s an important difference, anywhere in a tax form, that was prepared through a software – if it shows the zero, there was some sort of input in the background or as a blank line, there just wasn’t anything applicable, and so the reason I highlight this is that for most taxpayers, they received those stimulus checks during the year and there’s a form that goes through and says: how much did you receive and how much were you eligible for, and is there any difference? And so that zero’s going to come through because they already received the full amount they were eligible for. However, for some taxpayers that may have been eligible but did not receive that payment ahead of time – this is the chance to reconcile that and make sure they got anything they’re eligible. So this probably is a good time to clarify for your clients that the stimulus checks were in fact treated as tax credits, which is why there’s a line on their return for them and why they have to reconcile us. At the end of the year, line 31 32 and 33 are all subtotals getting us to total payments made during the year. So then from here, your client will either have a refund or be required to make a payment just based on the difference between their total tax liability and total payments. If they’re receiving a refund, it will show on line 34 and if they need to make a payment, it will show online 37. Whether they receive a refund or make a payment, take a look at line 38, which is, tax penalties. Even if a taxpayer receives a refund, it is still possible to have a penalty, if a portion of their tax bill was covered by estimated payments, and they did not meet the Safe Harbor rules around tax payments. Like I said, even if they received a refund, double-check this line. Penalties can almost always be avoided through proactive planning, and the only thing worse than paying taxes is paying tax penalties that were completely avoidable. Even if the penalty is small, have a conversation with the client and make sure this doesn’t happen in the future. So that takes us through all the numbers on the 1040, but there’s still valuable information at the bottom of page two. If the client is working with a tax preparer, it will be listed at the bottom of this page, and you should be recording that in your CRM – so you can proactively work with our tax preparers on any situation specific to that client, and so you’re building a list of professionals to develop relationships with. This really is the best way to identify tax preparers who serve clients like yours, because they’re literally serving your clients.
All right, time for action items. First action item of course is to get tax returns for your clients, so you can review this information and help them better understand it. The second action item is to make sure in your conversations with your clients on taxes, you are highlighting their total tax bill and how it changes from year to year and not just whether they received a refund or made a payment. The last action item is to make sure you’re recording the tax preparers your clients are working with, in your CRM, and then implementing a strategy to build relationships with them. If you aren’t sure on how to go about doing that, go back to episode one of the show – it was the first topic we covered, and one that comes up pretty regularly. Thanks for listening, everyone! Please feel free to send us an firstname.lastname@example.org. If you have any questions or feedback, we’d love to hear from our audience. Good luck out there and until next time, remember to tip your server, 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.
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