By Preeti Shah, CPA, CFP, Guest Writer
The tax extension deadline is approaching and I just spent 2 hours today with yet another physician explaining to them their own tax return. Yes, it actually took that long, and no, neither he nor I prepared it – it was filed by a tax professional who has been doing his return for years. And yet again there were deductions that were forgotten, carryovers that were dropped, and numbers that could be audit flags. A few of these were the fault of the preparer, and a few the fault of my client.
So I thought I’d take the time to explain to those of you on WCI how to understand your own tax return, even if you have a professional who prepares it for you. It might be a dry few hours of learning, granted, but once you’re done, you’ll know how to read and understand your own tax returns for life. Again, let me emphasize that I am not saying you must PREPARE your own tax return. It’s great if you can, but many physicians are too busy and have too many complications on their returns to do it themselves. However if you don’t do it yourself, it is imperative that you UNDERSTAND what is being filed on your behalf.
While I can’t fit everything I’d like to teach you into one article, I will do my best to highlight the major points – here goes:
Understanding the Basics of Your Tax Return
The 1040 Form
The 1040, your personal tax return, is the ocean into which all rivers flow (Forms, Schedules, K-1s, 1099s, W-2s).
Did you know that the 1040 is, in fact, only 2 pages long? It starts on page 1 with your name and ends on page 2 with your total refund or tax due, along with your signature.
This might be obvious to many of you, but surprisingly, I was a CPA and Auditor for 20 years and even I didn’t realize this until I started reviewing tax returns as part of my practice. Once you grasp this, following the logic of your return becomes much easier.
Major Sections of the 1040:
- Identification Info: Name, Address, Filing Status, and Dependents
- Income: W-2, 1099, Passive, Business, IRA, Dividend, Interest, Unemployment, Pensions, etc.
- Taxes and Credits: Student Loan Interest, Moving Expenses, Childcare, Itemized Deductions, and more
- Payments and Refunds: How much tax you’ve had withheld already, and a final calculation of what you owe or will receive back
The Rest of the Return Is to Support the 1040
The rest of the 50-75 page tax returns simply consists of supporting forms, schedules, and documentation for those first 2 pages.
A Few Examples:
1. Line 7, “Wages, Salary, Tips, etc.” (on page 1 of your 1040): This number comes from your W-2.
2. Line 8a, “Taxable Interest”: This comes from your 1099-INT or Schedule B if you have multiple 1099-INTs.
3. Line 12, “Business Income (or Loss)” or Line 17, “Rental Real Estate, Royalties, Partnerships…”: These are supported by the rivers named Schedule C or Schedule E. These schedules are further supported by smaller rivers, or streams (like your K-1s). Hopefully all your business information is further supported by your Quickbooks or accounting system, which are supported by your credit card and bank statements, and further supported by actual receipts. Here's how that looks:
Receipts, Invoices –>Credit Cards –>Bank Statements –> LLC –> K-1 –> Schedule E –> 1040 line 17
4. Line 40, “Itemized Deductions”: This line of your 1040 “ocean” is fed from the river named Schedule A. This is where you list familiar deductions like Charitable, Medical, and Mortgage Interest.
How to Review and Understand Each Line on Your Tax Return
What I would recommend is separating the main two pages of your 1040 from the rest of your return, and then start line by line and understand where each number comes from. If the supporting document is coming from somewhere OUTSIDE the tax return like a 1099, it might not reference it.
But if the supporting document is WITHIN the tax return, such as an attached schedule or form, it should reference it (i.e. Schedule D or Form 8917). If it references a form or schedule, simply go to that part of your return, and then logically trace everything that was done there. The final number on that form or schedule should tie back up to the main 1040. Once you check that form or schedule, put it to the side or mark it as “reviewed” and then go back to the 1040 and continue your journey on down the page. When you reach the end of those 2 pages for your 1040, you should have also reached the end of reviewing all the other pages behind it.
Then I would recommend a second session, where you go back and review the 2 pages of the 1040 in general, not just for the line items where you have numbers filled in, but for the blank lines as well. My client had only 20 of the 79 line items filled in. But we discovered another few that might apply to him, such as moving expenses and the foreign tax credit for a property he has abroad. These were not explained to him as a possible deduction by his tax preparer.
Stay Vigilant, It's Your Money
Unfortunately, most tax preparers are crazy busy during tax season, and they don’t take the time to walk you through all the possible deductions for which you might be eligible. CE classes, tax preparation fees, childcare, mortgage insurance premiums, uninsured flooded basements – these are common omissions I’ve seen. Many of you won’t be eligible for these because your income levels are too high, but that doesn’t excuse the tax preparer from not asking you about possible deductions anyway.
So take it upon yourself to read all 79 lines on the 2 pages of the 1040, and to generally understand the deductions and credits you are allowed. That will help you trigger your memory for anything you might have forgotten to take. I would also advise going through Schedule A as well – it’s only one page but it lists common deductions to which you may be entitled. If you can understand those 3 pages, you’re halfway there.
One other parting suggestion is to also track your own carryovers, such as any capital losses, real estate losses, business losses, accumulated depreciation, AMT credits, or other types of deductions that may not have been allowed in previous years, but can possibly be used in your current or future years. I have seen careless preparers who are working with a new client forget to transfer a carryover from an older tax return to the new one. It doesn’t happen as often when you’re with the same preparer for many years, but it can occur, so stay vigilant.
It’s your hard-earned money, and you have the right to take every legal deduction available to you. But I advise you not to depend on someone else to be your watchdog – you are your own best advocate and should always perform the final quality control check.
[Editor's Note: Preeti Shah is the owner of Enlight Financial MD where she does financial planning for physicians and is an advertiser here at The White Coat Investor, however, this is not a sponsored post. This article was submitted and approved according to our Guest Post Policy.]
What do you think? Do you prepare your own taxes? How did you learn to understand the 1099 and it's forms, schedules, and documentation?
My eyes glaze over whenever I look at my return but I know I should take more interest in this subject…. can you recommend a resource for explaining taxes for business owners?
Hi Triad –
It’s funny you say that, about 15 years ago my eyes used to glaze over with tax returns too, even though I was a CPA. But I was working in audit, and even though I technically had the CPA, that didn’t mean I knew anything about taxes. I hated them and never did them myself.
Then I forced myself to learn at some point, and over the years it’s gotten easier, especially now when I’ve seen hundreds of them. Once you realize that the main return is only 1-2 pages, it’s not that hard to review in a systematic manner. All the tax returns – 1040, 1120 and 1120S (C Corp and S Corp), 1065 (Partnership) – are quite short. The 1120 and 1065 are only 1 page.
The rest is just supporting schedules and forms. They all flow into each other. Unfortunately I don’t have a resource to recommend in terms of who can “teach” you your return, although I always thought tax preparers should do it as part of their process. Many of them don’t explain how to keep your books either, so clients will estimate rough numbers for their expenses and then get in trouble come audit time. You’re supposed to match beginning and end balances of business credit cards, bank accounts, etc. to your QuickBooks or accounting system and be able to show receipts or proof of expenses in case of an audit.
Sorry, I don’t mean to confuse you further, but this is something that “clicks” and can be easy if it’s just explained to you in the right way. I’ll keep it in mind and if I run into some kind of resource that might help, will come back and post.
Do you offer tax preparation services?
Hi Triad –
Unfortunately I don’t officially file returns myself, though I help alot of my planning clients to file their own tax returns via Turbo Tax, and I review all tax returns done by official tax preparers. I also teach accounting setup, ie how to keep your books so that you can defend your deductions in case of an audit.
I have filed numerous returns in the past, but I feel that preparing tax returns is a full time job and I don’t like to spread myself too thin. I have someone I refer clients to, and I don’t receive any commissions or referral fees from her, you would go to her directly. Contact me at [email protected] and I can give you the name.
But before I send you to someone, you’re welcome to send me your tax return and I can take a look. If it’s an easy one, I’m happy to volunteer some time and teach it to you myself, it may not take long depending on how quick you pick things up.
Lots of decent books out there, but none that are awesome so I plan to write my own. Was going to do it this year until the GOP swept into power and I put it off until after the changes that I knew would come. So it’s next year’s project.
Maybe Deduct This! is what you’re looking for.
I’m super excited you’re writing a tax book. If you can save me my CPA fees for taxes as an IC, that’d be awesome! Count me in as a buyer.
I agree that you should prepare your own taxes if not, you should always review your tax preparer’s work.
Make sure you educate yourself and know what kinda deductions you’re allowed.
After a couple of years of doing this, you might finally become comfortable enough to do your own taxes.
I used a prepared for 2 years but then.realized my taxes are just not that complicated. Since then i have used turbo tax and been doing okay since. I do agree, understanding how each item comes into play is crucial to making sure you pay the right amount of taxes. This becomes even more important with the upcoming tax over haul for 2018 where deductions will be changing.
For sure. My understanding of the tax code is what allowed me to act this morning to reduce my overall tax burden by over $10K simply by prepaying my property taxes and lumping my charitable deductions into 2017 and taking the standard deduction in 2018. Didn’t change a thing but the timing of the payments.
Wow, you don’t get hit by the AMT? I do, so pulling forward property taxes or state income taxes doesn’t help because the AMT removes those deductions. I am very interested in getting the new Tax Act for 2018 to see how the new tax law changes the AMTI.
The reason I don’t get “hit by the AMT” is because I pay more tax under the regular system than I do under the AMT system. I’d LOVE to pay under the AMT system. That would be great. But at my income level, it’s pretty rare to pay under the AMT system. That’s mostly people in the $200-400K range.
Funny guy! Regardless, for those of us stuck with the AMT accelerating property tax payments won’t help with deductions. And pulling forward state income taxes is not allowed by the new law. Bunching charitable deductions might help, but it is hard to say with the Pease limitations.
Pease shouldn’t have much effect. It’s really just a stealth 1% bracket.
I think this is a great post. Definitely useful. Understanding taxes better each year is a big goal of mine and I like the systematic approach this takes towards attacking taxes.
My great fear is forgetting to look at a schedule or form that I should fill out and simply do not know it. The more I learn about this topic the more I feel I can tackle it myself.
Thanks for the encouraging and informative post!
Sure, I understand that fear – what you can do is maybe fill out your tax return next year, then see if you can get a discounted rate to have a professional just review it (make sure they are a CPA who takes time to talk to you and seems detailed in their communication and data gathering efforts – too many of them rush you through and don’t explain things). Some of them may say they need to charge you full price because they have to type it into their own software from scratch, but there may be someone who will do a review for you via Turbo Tax. Doesn’t hurt to ask.
Then if the two returns match, from the next year onwards you’ll be more confident that you’re not missing anything. I’m suggesting this, but the one time I tried this myself (many years ago when I didn’t know how to do taxes very well), the CPA charged me $350 for just the review. So it didn’t really work in my case. But just thought I’d toss the idea out there anyway.
All rivers flowing to the ocean of the 1040. Awesome analogy. Thanks!
Great timing with this particular guest post, as I had my 1040 out on my desk, open to page 1. I’ve been perusing it as I attempt to understand how the many changes in the GOP tax reform bill will change my taxes in the coming years.
I’m comparing apples and oranges in a way, since I now work less and earn less. I don’t imagine I’ll have $141,396 in itemized deductions like I did on my2016 return. In fact, I doubt I’ll be itemizing deductions at all anytime soon, assuming the $24,000 standard deduction is signed into law.
It is helpful to understand what is meant by terminology that affects your taxes. “Above the line” versus “below the line deductions, marginal versus effective tax rate, credit versus deduction, etc… When you’re better informed, you can make better choices.
Cheers!
-PoF
Do you foresee the new tax bill making tax loss harvesting a thing of the past?
Nope, not at all. The “FIFO” method as mandatory for selling lots in a taxable brokerage account did not make the final bill.
I’ve found books from Mike Piper, at obliviousinvestor.com, were just my speed in explaining taxes. Taxes made Simple: income taxes explained in 100 pages or less. Several other related topics.
His blog post Monday says he is planning to revise them over the next few months
I think he is speaking at the WCI conference
I started doing my taxes with TurboTax as a first year resident. As they have become more complicated with each year, I’ve learned each of the different parts that apply to me, since TurboTax basically spoonfeeds it to you. I’ve been able to do good planning with the help of WCI, like maxing out HSA and SEP-IRA. Though it is nice to see how it all ties together on the forms at the end with this post – that translation of input to completed return isn’t very transparent on the software.
Basis of stocks is an issue for me. Maybe they just let you step up value of stocks on an inheritance since you probably couldn’t find the original purchase bill anyway. Vanguard now reports a basis I trust (not for all our stuff there though). Having sold some stocks and not needed to prove my purchase price I now, in addition to keeping those 30 year old records, record in my money spreadsheet the basis I calculated one January with time on my hands for all the older stuff. (DRPs make it a real nightmare.)
I once loved doing taxes, but realized the love was over when the kid said she was sad I had to do them- not because it cut our time together (it did) but because I was cussing and moaning the whole weekend doing them. Now I have more time it’s just a chore but not so painful. It’s 9 dimensional boring chess to follow each line to the usual (for us) conclusion that it doesn’t apply to me. However I prefer that to paying an accountant or using a program: early on the program missed a few things, and with the hubris of a doctor I am certain that I am more intelligent than any CPA I might hire (at least about our family’s finances, and maybe about taxes with some CPAs). If I worked full time again especially if it were an office I might hire one- have only done ‘easy’ locums business on Sched C.
While doing taxes can be quite annoying, it’s not rocket science. Following the instructions for the 1040, the associated schedule instructions and publications are all you really need. Helpful to cross check things with tax software as well. See publications:
https://taxmap.irs.gov/taxmap/pubs/pubtoc.htm
When I was a grad student I taught a personal finance class to undergraduates. I actually had a homework exercise with a hypothetical tax situation and the students were asked to fill out the paper form and calculate the tax manually. Related: a shocking number of people don’t understand how marginal tax brackets work.
Great post. Ironically in filling out my wci conference survey yesterday, this exact subject is something I was requesting to have reviewed. Am hoping to get something with a little more detail (which is something I can do with a little of my own personal elbow grease) but this is a great start.
Thanks for the article, definitely going to attempt it this year after finding out past 2 years having it professionally prepared (and paying $600 each time) that my itemized deductions did not eclipse the standard deductions.
I do have a question if anyone is knowledgeable on the answers:
If I do plan to take the standard deduction given (and it looks like more the case in future years courtesy of the tax reform bill) do these things go away and can only be utilized if doing itemzation
1) Does carryover from prior tax lost harvesting still count as well as any future tax loss harvest
2) This is the first year I have invested with a real estate syndicator (37th Parallel) and expect several K-1s coming in from them. They preach that these investments are favorable to say REITS b/c the depreciation etc gets passed on to the individual investor. Will I lose this if I don’t itemize?
3) I have one house I am renting out and periodically have expenses (plumbing to include purchasing some pricey items (bidet) etc that happened this year. Will I lose deduction for the cost of replacement and the labor I paid to have it done if I don’t itemize?
Appreciate any insight.
Xrayvsn –
None of these will appear on Schedule A (Itemized Deductions).
Your loss carryforwards will appear on Schedule D.
Your rental deductions for plumbing and other expenses will appear on Schedule E. You will either expense them right away or capitalize and depreciate them over time.
K-1s don’t appear on itemized deductions either, though I can’t speak to the depreciation question at the moment, I don’t recall having worked with a real estate syndicator investment. But if depreciation comes through, it won’t appear on your Itemized Deductions, they get claimed elsewhere.
Itemized Deductions are mostly Medical, Charitable, Property and Income Taxes, Job Expenses, and other Miscellaneous (like a flooded basement that wasn’t completely covered by insurance). New tax laws might take away some of these deductions for high-end earners, that’s why it may make more sense to do the Standard Deduction in the future. (And AMT – Alternative Minimum Tax – also takes away many of the Itemized Deductions as well.)
I know it’s frustrating to lose so many of the deductions you think you have coming, the IRS is constantly getting tougher on high income earners and eliminating all the ways to save on taxes. And unfortunately what they think is a “high earner” is not fair in my books, they need to set that bar higher.
Exactly. A lot of people just don’t realize that many deductions aren’t on Schedule A, so you can take the standard deduction and still get them.
Thank you so much for the very informative reply. Well that definitely is a huge relief that the main deductions I have won’t be lost if I take a standard deduction. My CPA said that for past 2 yrs they calculated both ways and I came put ahead with standard deduction after I paid off my home and became essentially debt free. I live in Tennessee so no state income tax either so this tax reform is seeming to be a good benefit for me. Thanks again for the article and response
Yes, that makes sense, if you don’t have a mortgage and your property and income tax deductions are being lost due to AMT, the Standard Deduction is probably better. You’re welcome!
“One other parting suggestion is to also track your own carryovers, such as any capital losses, real estate losses, business losses, accumulated depreciation, AMT credits, or other types of deductions that may not have been allowed in previous years, but can possibly be used in your current or future years.”
This is the part I’d really like to learn more about. I’m sure it’s simple once I learn, but now I don’t understand. On last year’s return, wife cashed Roth IRA early, and since the bank went out of business, could not figure out cost basis. So off to the tax preparer to do the return. What do you do when you get stuck on something but can’t find the answer on Google?
Hi Mike –
I had this happen with a client once. We simply had to estimate the day he bought the securities and look up the market price as of that date. Then we used that to file his taxes. In case of an audit, you have to be able to defend how you got your cost basis. I’m not completely sure if that would have held up during an audit, but it’s the best we could do.
As of 2011, brokerages and financial institutions are required to track cost basis, including whether they are long or short term. But I can tell you that despite the ruling, the cost basis sometimes does not come over. I use TD Ameritrade as my client’s custodian, and I make it a point to check for cost basis having come over – 95% of the time it does but occasionally it does not. When I ask TD why they are not tracking it as required by law, they pass it off to the prior custodian, saying they didn’t send it over.
So even with laws in place, things sometimes fall through. The best thing to do in that case is try to come up with a reasonable way of estimating it and hope you can defend it in case of an audit. With the IRS, safer is better, so when in doubt, be conservative, don’t try to overestimate to save a little on taxes, the penalties are not worth it!
I was in the exact same situation several years ago. The brokerage I invested in was bought out by another company and then that brokerage got bought out as well. In the process all of my cost basis were lost. This is before 2011 BTW. Basically I knew the dates I bought those stocks and estimated the average price for that day as my cost basis. I did not get audited but highly doubt the IRS would have an issue with this strategy. I find the IRS to be extremely responsive and fair.
There is no such thing as “rocket science”. The science of rocket(s) is invented by humans.
Fabulous!
I would love, love, love to see a post on pass through entities and physicians. What business structure would be best for an IC/self-employed physician? Can you explain the phase-out for contractors earning more than 157k? And any other issues surrounding the changes to pass-through entities that I don’t even know to ask…
It’s coming. A broad overview on the 29th of the whole tax code and then a specific piece on pass through entities later. It’s probably not going to change much with regards to self-employed physicians though to be honest. Whatever business structure is right for you in 2017 is probably going to be right in 2018.
In the meantime, I recommend this one from Stephen Nelson: https://evergreensmallbusiness.com/pass-thru-income-deduction-dozen-things-every-business-owner-must-know/
I have learned 2 things from this post. One, my accountant charges about $2000 for fairly basic (although AMT) income taxes and the going rate on these comments is about $600. Two, now that I will no longer be subject to AMT starting in 2018, I can really do this myself. I always figured CPA would buffer me from an audit but I have nothing to hide. I was part of the Medicare identity tax theft a few years back but my accountant couldn’t protect me from that either. The IRS just ended up giving the “bad guy” my first tax refund in January and I had to wait until August to prove I was me and get the second tax refund. Last year was the first time I actually analyzed the 1040 in detail and saw some charitable giving had been left off. Similar to hiring a financial planner, only I care about my financial life as much as I do.
This is a very basic post… and almost all of it was new to me. You’ve hit on one of my knowledge black boxes.
A CPA is to understanding taxes what a calculator is to doing long division on paper.
One of these days I’ll do my own just to learn and make sure I’m paying the least. But I’ll wait until my tax situation simplifies.
I’m glad to know I hit someone’s black box on WCI, when writing this I was wondering if everyone already knew what I was talking about, everyone is so savvy on here!
Certainly, use a CPA, many of my clients do. But we still review the tax return prepared by the CPA, because sometimes they forget to ask about certain deductions that you are eligible to take or they forget to carryover something. They don’t explain how to keep your expenses documented either, in case of an audit.
So just spend a few minutes understanding your return and how they prepared it, that’s all I would recommend. At least understand the 2 pages of your 1040, if nothing else.
Hi. This was a very informative post. Kudos ! I came to the US in 2012, 3 years of residency and now i am an attending. to be honest, since i didnt know ABC of how US tax works, I used a preparer for 3 years. Then i thought about doing it myself, but my situation changes every year, so if i think i should do it myself this year, I get scared that i will miss something and i hire a preparer. for example , i had to file 2 states and i thought i will mess up, the next year, my wife became a full time student and i thought i will mess up, i did do one year myself and it turned out to be ok, but i still was afraid that i will miss out on a deduction or underpay the IRS and get penalized. this year , i wanted to do it myself , but turns out my wife was working as an independent contractor and got form 1099 without any taxes withheld and turns out we owed taxes to the fed. so i again hired a tax guy. thankfully my returns are not that complicated – no business income, no mortgage , no child, no investments, so they charge me anywhere from $125 to $300.
I always use turbotax to calculate my taxes , but don’t submit them and then i compare with the preparer. over the past years, i have learnt that those guys use the same software and the returns are pretty comparable, so i think i am doing it right 🙂
But being on a visa here, i am probably just too scared to get caught in a IRS scandal !
This year 2018, I started investing and had a kid and wife got a permanent job and the tax laws changed, so may be i’ll hire someone again or may be not ( after reading your articles ! )
But this website has definitely educated me a lot. I have made it my mission that 2018 will be the year i gain my CFE’s
Thanks again !
Thanks Rahul, and sounds like you’re making every effort to educate yourself and do your taxes correctly!
Hello,
You mentioned “I also teach accounting setup, ie how to keep your books so that you can defend your deductions in case of an audit.” Where do you teach this? Online, classes? Do you still do this?
Thanks in advance.
Not sure what you’re referring to.
Hi Dee –
I think that’s something I might have written privately, I don’t see that in the article. I teach audit defense to my clients on a one-on-one basis, it’s part of what I do. I don’t have online classes or anything like that.
Hope that answer was helpful?