How To Read Your Tax Return – The Schedules
Updated October 2022
To learn the basics of your Form 1040, please reference part one of this blog series: How to Read your Tax Return. This time we promised we’d do a bit deeper dive of the most used schedules that impact your tax liability.
Schedule A
After calculating your Adjusted Gross Income (AGI) the IRS allows you to deduct the higher of your total Itemized Deductions or the Standard Deduction. Itemized Deductions are calculated on Schedule A. If you can’t find a Schedule A, then the standard deduction was likely higher than your total itemized deductions. The most common expenses included on Schedule A are medical expenses, taxes, interest and gifts to charity.
As you look at the left-hand column of your Schedule A, you’ll see the seven categories the IRS allows you to deduct. Being familiar with these categories may make it easier to track deductions during the year and supply them to your tax preparer.
Schedule AMedical and Dental Expenses
Lines 1-4 on Schedule A calculates deductible medical expenses.
You are only allowed to deduct medical expenses that exceed 7.5% of your AGI. For example, if your AGI is $100,000, you can only deduct the medical expenses after you exceed $7,500. The higher your income, the smaller your deduction. Higher income individuals are unlikely to be able to deduct medical expenses due to this income restriction.
Tax Planning Tip: Premiums for health insurance (except for self-employed individuals, which are deducted on Schedule 1) and at least a portion of the premiums you pay for qualified long term care insurance policies are considered deductible medical expenses.
Taxes You Paid
Lines 5-7 on Schedule A are related to deductible taxes.
The deduction for state income taxes, property taxes and local taxes is limited to $10,000 in total. If you live in a state with an income tax and own a home (pay property taxes), you will likely hit the $10,000 cap.
Interest You Paid
Lines 8-10 are for deductible interest payments you made during the year.
Mortgage interest and points on your main home and second home are deductible up to $750,000 in mortgage debt. The limit is $1,000,000 on loans originated prior to December 15, 2017. This information is most commonly reported on Line 8a.
Tax Planning Tip: Interest on home equity loans and lines of credit are only deductible as mortgage interest if the borrowed funds are used to buy, build or improve the home that secures the loan.
Mortgage insurance premiums (PMI) are also deductible and reported on Line 8d. You’ll receive a 1098 from your mortgage holder detailing the deductible amount of interest.
Investment interest may be deductible and is reported on Line 9. The amount that you can deduct is capped at your net taxable investment income for the year. Investment interest is interest paid on money you borrowed to purchase property held for investment. It doesn’t include any interest used for passive activities or to purchase securities that generate tax-exempt income (muni bonds). Interest from margin loans and pledged asset lines is typically deductible when used to purchase securities.
Charitable Giving
Charitable gifts are reported on Lines 11-14.
Cash gifts are reported on Line 11. Donations of property, which include personal items and securities, are reported on Line 12. If you are making relatively large cash gifts, consider donating appreciated securities instead. Not only do you potentially receive a deduction for the value of the gift, but you do not have to pay tax on the gains (and neither does the charity because they are a tax-exempt entity).
For contributions of cash, check or other monetary gift (regardless of amount), you must maintain a record of the contribution: a bank record or a written communication from the qualified organization containing the name of the organization, the amount, and the date of the contribution.
For any contribution of $250 or more (including contributions of cash or property), you must obtain and keep in your records a contemporaneous written acknowledgment from the qualified organization indicating the amount of the cash and a description of any property contributed. The acknowledgment must say whether the organization provided any goods or services in exchange for the gift.
Tax Planning Tip: If you are close to itemizing your deductions, you may want to consider a bunching strategy for your charitable gifts. Combining several years of charitable donations to exceed the standard deduction in one year, while then taking the standard deduction in subsequent years may lead to larger deductions over a multi-year period.
Consider using a Donor Advised Fund if you want the full deduction in the year you make the contribution, but do not want to give all the money to a particular charity in that same year.
Casualty and Theft Losses
Fortunately, I rarely see this expense on a Schedule A. You can deduct losses caused by theft, vandalism, fire, storms, etc. only to the extent it is greater than 10% of your AGI and not covered by insurance.
Your total itemized deductions are listed on Line 17.
Whew! That was a lot of work. Now all we have to do is total these up and compare it to the standard deduction. If the total is higher, it should appear on line 40 of your 1040.
Schedule D
Skipping forward a few letters, let’s take a look at Schedule D. Schedule D tracks any sales of capital gain property during that year and reports a summary of your short-term and long-term transactions. Form 8949 is often used to report each individual transaction.
Schedule D
Sales are divided into two parts:
Part I – Short-Term Capital Gains
Assets held for less than one year. Short-term capital losses are first used to offset short-term capital gains. If you have excess short-term losses, they may be able to be used to offset long-term capital gains.
Part II – Long Term Capital Gains
Assets that were sold after one year. The distinction is important because under current tax law, long-term capital gains are taxed at a lower rate.
Capital gain distributions from mutual funds are reported on line 13. Long-term capital losses are first used to offset long term capital gains.
If you still have excess losses in one category and gains in the other category, they can offset each other and are combined on Line 16.
If you have losses that exceed gains, up to $3,000 can be used to offset other income. Additional amounts carry forward indefinitely.
Tax Planning Tip: If you are receiving large capital gain distributions from your investments, consider using more tax efficient options, like ETFs in your taxable accounts. Doing so can greatly reduce the tax drag on your portfolio over time. Place your most tax efficient investments in taxable accounts and the least tax-efficient investments in your retirement accounts (IRAs, 401(k)s, etc.).
Most of our clients hire an accountant to prepare their taxes and hire us to interpret that return and apply it to their financial plan. However, you are the one ultimately responsible for the information on your return. While reading this blog, take a few minutes to look through Schedules A and D. Give Shakespeare a call if you have any questions. We’d be happy to walk you through them in your next planning meeting.