What Your Tax Return Is Trying to Tell You
Most people see their tax return as a finished task—filed, signed, forgotten. I completed my business tax returns and personal returns last week. I fought the urge to move on to other tasks and sat down to slowly review the personal return. It was enlightening. Your personal tax return is one of the clearest financial snapshots you will get all year.
If you are willing to take a few minutes to review your 1040, here are some points of interest:
You may be more dependent on one income source than you think.
W-2, business income, or investments—concentration shows up clearly.
Your portfolio’s tax efficiency is either helping…or hurting.
Too much ordinary income via short term capital gains and qualified dividends can create unnecessary tax drag. Some ordinary income is inevitable, but realized stock sale gains are only taxed as ordinary income (short term) if the stock is sold within a year of purchase.
Your real tax rate is often lower (or higher) than expected.
The effective rate—not the bracket—is what matters for planning decisions. Your income is taxed in part under all brackets up to your highest bracket. So, your effective tax rate is much lower than your marginal tax rate. It’s helpful to know your effective tax rate because that is your “real” tax rate.
Retirement savings habits don’t hide here.
Retirement contributions—or the lack of them—are easy to spot if they are made to IRAs. If they are employer based—like a 401K or SIMPLE IRA, then they only show up on your W2.
How Michigan’s flat 4.25% income tax fits into the picture
Retirement income may be partially or fully exempt depending on your birth year.
Don’t forget about local tax.
No local income tax (outside a few cities if you are here in Michigan) keeps things simpler. My wife works at UD Mercy, so we must keep track of the City of Detroit income tax (1.2% for non-residents working in Detroit).
Surprises in April usually aren’t surprises.
Large tax balances due often point to missed withholding or planning gaps during the year. Likewise, a big refund might sound nice, but it means you withheld too much over the year and gave Uncle Sam an interest-free loan.
Your giving strategy may not be as efficient as it could be.
Many people give generously—but not always tax-smart. Check into the Qualified Charitable Distribution (QCD) that I touched upon a few weeks ago.
Opportunities are easier to see in hindsight.
Roth conversions, tax-loss harvesting, and timing decisions tend to stand out after the fact.
You may be closer to key thresholds than you realize.
IRMAA brackets (Medicare Part B and D premiums), NIIT(3.8% when applicable), and marginal tax rate jumps can be triggered by relatively small changes in income. Know how much wiggle room you have left.
Your tax return isn’t just a record of last year—it’s a guide for what to do next. Take some time to review it before you file it away.
Fun Fact: The NCAA Basketball Tournament is in full swing. The term “March Madness” was actually first used for high school basketball in Illinois—not the NCAA tournament. It wasn’t until the 1980s that broadcaster Brent Musburger popularized it during NCAA coverage, and it stuck. Good luck with your bracket!
