After finishing their taxes, most folks want to file and forget them. But if you do that, you're missing a great chance to reassess your finances.
"I can sit down with somebody's tax return for two minutes and learn more about their finances than I can from an hour of talking to them," says Art Canter, an investment adviser and accountant in Boca Raton, Fla.Here are just some of the things you can learn from your federal tax return:
Form 1040: Start with your total income. Deduct the amount you paid in taxes and contributed to Social Security and Medicare. Also subtract the amount you saved in 1999.
Result? You now know how much you spent last year. "That's the starting place for financial planning," Canter says. "If you're going to retire someday, you need to know what you spend."
Next, figure out your marginal income-tax rate. To get that number, pull out the Form 1040 instructions and look at the tax-rate schedules. In the formula that applies to your income and filing status, there will be a percentage, which represents your marginal rate.
Schedule A: Maybe you take the standard deduction and don't itemize your deductions on Schedule A. That can happen if your itemized deductions are too small or if the value of these deductions is curtailed because your income is too high.
In either case, paying mortgage interest or making charitable contributions isn't garnering you any tax advantages. You should still give to charity. But you may want to bunch those contributions in years when you will itemize.
And when you make those bigger contributions, don't necessarily reach for the checkbook. "If somebody is making significant charitable contributions, you should be doing that with appreciated stock," says Cincinnati financial planner David Foster.
Meanwhile, if you regularly take the standard deduction and you have cash sitting around in low-yielding certificates of deposit or savings accounts, consider paying down your mortgage. That way, you should save more in mortgage interest than you are currently earning on your cash investments.
Schedule B: Remember figuring out your marginal tax rate? If you are in the 28 percent or higher income-tax bracket, and you are reporting a lot of taxable interest on Schedule B, you may want to rethink your bond portfolio.
"People in high tax brackets have too much in taxable bonds," says Hope Egan, an accountant and financial planner in Chicago. "They aren't doing the comparison and seeing if they'd be better off in municipal bonds," which pay tax-exempt interest.
Your mix of interest and dividends can also tell you whether you are being excessively cautious or overly aggressive. "If all you've got is interest from certificates of deposit, maybe you're too conservative," Canter says. "If all you've got is dividends from your employer's stock, maybe you're not diversified enough."
Schedule C: Anxious to save more for retirement? Even if you fully fund your employer's 401(k) plan and even if you stick the full $2,000 in an individual retirement account each year, you can sock away additional money in a retirement account if you report self-employment income on Schedule C.
These contributions typically go into Keogh plans or the Simplified Employee Pensions known as SEP-IRAs. "Hands down, I'd do the SEP-IRA," Foster says. "There's just much more paperwork with a Keogh."
Schedule D: For many, this is the real eye-opener. "The biggest thing I've seen is an enormous amount of trading," Egan says. "The good news is, they're getting losses to offset against their income. The bad news is, they're losing money."
And when people are realizing stock-market gains, often they are selling winners within a year, which means those gains are taxed as income rather than at the lower long-term capital-gains rate. "For the people in the highest tax bracket, it can mean the difference between paying at 39.6 percent and paying at 20 percent," says Matthew Mullaney, a tax partner at BDO Seidman in New York.
You can get a handle on your level of trading by looking at your total proceeds from selling securities. If all these sales are stocks and stock funds, you can estimate your portfolio turnover by dividing this number by the amount you have invested in stocks in your taxable account.
If you are selling more than 25 percent of your stock portfolio each year, consider curtailing your trading or at least doing your buying and selling in your retirement account, where you won't have to pay taxes on each year's gains.
Similarly, if you own high-trading stock funds that make big capital-gains distributions each year, you may want to shift these funds into your retirement account, where they won't hurt you at tax time. Meanwhile, for your taxable account, consider buying and holding individual stocks and purchasing market-tracking index funds, which tend to be fairly tax efficient.