What You Can Learn From Your 2018 Tax Return

I know several CPAs who are closing in on retirement and they’re all saying the same thing: Thanks to the new tax laws that went into effect last year, the just-ended tax season was a doozy. Although many fewer taxpayers are expected to itemize their deductions under the new tax regime, tax preparers still had to run the numbers to compare deductions eligible for itemization with the new, higher standard deduction.

There’s also the form itself: While the 1040 form itself has fewer lines, many of the line items on the old 1040 have been scattered across six new schedules. Having spent some time with the new form, I'm unconvinced this is an improvement.

All these changes call for looking at your just-completed tax return with a fresh set of eyes. Can you make any adjustments to your financial plan to help reduce the taxes you’ll owe for 2019? There’s also an evergreen reason to take a closer look at your tax return: It offers valuable intelligence about your investment and financial life. Rather than focusing just on the bottom line of your tax return--what you owe or what you're getting back--it pays to take a closer look at what's actually on those forms.

Here are some of the key items to focus on.

1040, Page 1, Identity Protection PIN While the first page of the 1040 form is mostly all basic personal information, the Identity Protection PIN boxes may have caught your eye because they're making their debut on the 2018 1040 form. The IRS' Identity Protection PIN program enables taxpayers to apply for a six-digit PIN to help protect against fraudulent use of their Social Security numbers on federal income tax returns. The program is strictly voluntary and not designed to protect against other forms of identity theft. The PIN program is now available in nine states and Washington, D.C.

1040, Line 1: Wages, Salaries, Tips, etc. Compare this figure for 2018 to your 2017 number. Is the trend a positive one? In a strong economy, it should be, barring mitigating factors such as a job change or loss. If your wages have barely budged or have gone down, consider whether a change is in order. Is it time to ask for a raise, change jobs, and/or improve your skills through an investment in additional education? Also consider the opposite scenario: If your wages are trending up but you're in a job that's making you miserable or leaving you no time for activities that enhance your quality of life, give some thought to enacting change.

Remember that phantom income has the potential to inflate the number you see here--if you've received restricted stock units from your employer that have vested, for example, the amount that vested in 2018 will show up in your wages, even if you haven't sold the stock and pocketed the money.

Alternatively, you may notice that the amount on this line is lower than what you know to be your gross income. That's because it shows your gross income less any of your pretax deductions, such as health insurance premiums, your contributions to a health savings account or flexible spending arrangement, or contributions to a traditional 401(k) or other defined-contribution plan.

1040, Line 2: Interest Income You can see the raw dollar amounts of your interest income on this line: Tax-exempt interest, usually from municipal bonds, is in Box 2a and taxable interest is in Box 2b. If you have a high level of taxable interest income, make sure that you're paying attention to asset location and have assessed whether taxable bonds and money markets, rather than municipals, are truly the better bet for your taxable savings, once the tax effects are factored in. Now that cash and bond yields are finally decent, the negative tax effects of improper asset location will be more meaningful.

In a related vein, pay attention to which of your financial institutions issued 1099s for 2018. If you didn't receive a 1099 from financial institutions where you know you hold cash, such as your bank, don't be alarmed; it's possible that your interest was less than $10, so the institution doesn't need to send you a 1099. You're technically still required to report that interest, however; you should be able to find the amount online.

1040, Line 3: Dividends This line shows the dividends you received last year; those that count as qualified--meaning that they're subject to the more-favorable qualified dividend tax treatment--are in Box 3a and ordinary dividends are in 3b. As with taxable interest above, take a hard look at any investments, such as REITs, that are paying nonqualified dividends that you're being taxed on; those investments are better housed in a tax-sheltered account such as an IRA, if possible. In a similar vein, some of your dividend-focused mutual funds may hold investment types like convertibles and preferred stocks to boost their income; income from those securities doesn't typically qualify for the favorable qualified-dividend treatment.

1040, Line 4: IRAs, Pensions and Annuities If you're retired, this line and line 5 (Social Security benefits) are where most of your income action is apt to be. You'll also have an entry on Line 4 if you converted traditional IRA assets to Roth. If you're making backdoor Roth IRA contributions because you earn too much to make a direct Roth IRA contribution, make sure you're documenting those nondeductible contributions via Form 8606.

Schedule 1, Line 13: Capital Gain (Or Loss) In order to fill out lines 6 (total income) and 7 (adjusted gross income) of the 1040, you'll need to complete Schedule 1. Here you'll list income from various other sources, including capital gains and losses. (Schedule D goes into detail on those gains and losses, including whether they're short- or long-term.)

As the market has trended up for the past decade, many investors will be recording gains, either because they've sold appreciated winners from a taxable account, or one or more of their mutual funds realized gains and made a distribution. If one of your fund holdings made a big capital gains distribution last year, have you considered giving your taxable account a tax-efficient makeover? If you've had a serial capital gains distributor in your portfolio, you've effectively prepaid at least some of the tax bill due on your holdings. In other words, swapping into a more tax-efficient portfolio mix may cost less than you think, as discussed here.

Note that going forward, just like in years past, the tax on long-term capital gains for certain taxpayers is 0%. For 2019, single filers with taxable incomes of up to $39,375 and married couples filing jointly with taxable incomes of up to $78,750 can sell securities they've held for at least a year without triggering capital gains. If your household’s taxable income is likely to come in under those thresholds, it’s smart to consider whether tax-gain harvesting--pre-emptively selling appreciated winners--can help you wash out the gain without any tax costs. Even if you would like to maintain exposure to that same stock or fund, you can sell at no tax cost, re-buy immediately thereafter, and increase your cost basis in the security. If the security appreciates and you’re no longer in the 0% capital gains bracket in the future, the taxes due upon sale will be lower than would otherwise be the case.

Schedule 1, Line 25: Health Savings Account Deduction If you're covered by a high-deductible healthcare plan, are you also contributing to a health savings account? These accounts can be used either to cover out-of-pocket expenses as you incur them or as a long-term investment vehicle. If you have the wherewithal to cover any out-of-pocket healthcare expenses with non-HSA assets, you can take maximum advantage of the tax three-fer that HSAs afford: pretax contributions, tax-free compounding, and tax-free withdrawals for qualified healthcare expenses. Health savings accounts can also be useful in the context of paying for long-term care, either to pay premiums or the care itself, as discussed here.

Schedule 1, Line 32: IRA Deduction If you made a Roth IRA contribution for 2018, you won't see anything on this line, as you can't deduct a Roth contribution. But have you given much thought to the Roth versus traditional IRA decision? Many investors reflexively assume a Roth IRA is always the way to go. But if you are closing in on retirement, haven't saved much, and can deduct your contribution, funding a traditional IRA may be a better bet than putting money into a Roth. If you're not contributing to a company retirement plan, you can deduct your traditional IRA contribution regardless of income level. For the 2019 tax year, single filers earning less than $74,000 who are covered by a company retirement plan can make at least a partially deductible contribution to a traditional IRA for the 2019 tax year. Married couples filing jointly who are eligible to contribute to a company retirement plan can make at least a partially deductible IRA contribution if they earn less than $123,000.

1040, Line 8: Standard Deduction or Itemized Deductions Among the most significant implications of the new tax laws for individuals are the changes on the deduction front. Thanks to the new higher standard deduction amount ($12,000 for single filers, $18,000 for heads of household, and $24,000 for marrieds filing jointly) and a $10,000 cap on state and local tax deductions, as few as 10% of taxpayers were expected to itemize their deductions for 2018, down from 30% in 2017.

The idea of not having to itemize deductions might seem incredibly freeing. It was no fun, after all, to track down all of those healthcare and charitable contribution receipts during tax season. But even if you got a bigger bang from your standard deduction than you did from itemizing in 2018, don't write off itemizing forever. Some taxpayers may find that it's worthwhile to itemize in certain years and claim the standard deduction in most others. For example, if a taxpayer incurs heavy medical expenses and makes high charitable contributions in a given year, those itemized amounts may be greater than the standard deduction. So save your receipts--or at least make sure you have a good system for retrieving them if you need to--before giving up on itemization altogether.

Schedule A, Lines 1-4: Medical and Dental Expenses Schedule A is where you document your itemized expenses to determine whether you're better off itemizing or claiming the standard deduction. As noted above, in the future fewer taxpayers are apt to itemize, as the standard deduction will be higher in many cases. For the 2017 and 2018 tax years, medical and dental expenses were deductible to the extent that they exceeded 7.5% of adjusted gross income. That's going back up to 10% for the 2019 tax year, however.

Schedule A, Lines 5-7: Taxes You Paid One of the biggest changes to itemized deductions, taking effect in 2018, is that the deductibility of state and local income and property taxes will be capped at $10,000 in total. That cap is one of the major reasons that many fewer taxpayers will benefit from itemizing their deductions versus claiming the standard deduction. Unfortunately, there's not much you can do about it, save for contemplating a move from a high-tax state to a lower-tax one (along with all of the lifestyle trade-offs that that entails).

Schedule A, Lines 8-10: Interest You Paid In another blow to homeowners in expensive parts of the country, the new tax laws put in place more stringent guidelines around the deductibility of home mortgage interest and home equity loan interest. As noted above, the tax laws limit interest deductibility to mortgages of $750,000 or less. (For properties purchased prior to Dec. 15, 2017, interest on mortgages of up to $1 million is tax-deductible.) In addition, home equity loan interest will only be deductible if the loan is used to finance home improvements (like home additions), not new car purchases or home maintenance.

The fact that many fewer taxpayers will benefit from itemization--along with the more stringent rules related to deductibility of home-related debt--makes it hard to consider mortgage debt "good debt" and embellishes the case for mortgage-debt paydown. That's especially true for older homeowners who plan to stay in their homes, are late in the life of their mortgages (and hence most of their payments go toward principal), and would like to reduce their amount of debt coming into retirement.

Schedule A, Lines 11-14: Gifts to Charity As with medical expenses, here's another area where taxpayers would be wise to think strategically, making large contributions in single years when they itemize. (And it's obviously easier to exert control over the timing of charitable contributions than it is over the timing of healthcare expenses.) Donor-advised funds can make a lot of sense in this context, allowing a taxpayer to obtain a deduction for the year in which the funds are contributed to the donor-advised fund but then distributing the money deliberately over a period of years.

In addition, the fact that many taxpayers will be claiming a standard deduction rather than itemizing underscores the case for the qualified charitable distribution, the merits of which are unaffected by the new tax laws. With a QCD, an RMD-subject investor over 70 1/2 would steer a portion of his or her RMD from an IRA, up to $100,000, to the charit(ies) of choice, thereby reducing taxable income. Retirees who have been writing checks to charity and deducting their charitable contributions might consider, to the extent that it's practical, the QCD instead.

1040, Lines 19 or 22: Refund or Amount You Owe As has been widely reported, many taxpayers who have historically received refunds actually owe taxes for 2018. That's because the tax cuts enacted for the 2018 tax year and beyond resulted in higher take-home pay throughout the year but reduced or eliminated refunds for many taxpayers who were used to getting them. Of course, it's not rational to give the government an interest-free loan for a year in exchange for a big windfall in April. But if you'd rather avoid a big painful bill next year at tax time, you can adjust your withholding or pay estimated taxes, which are required for taxpayers who expect to pay more than $1,000 when their tax returns are filed. The IRS Withholding Calculator can help you assess your current withholding elections, but it's also wise to check with your tax advisor to plot the best course of action.