One of the most common issues the financial planning group deals with on a regular basis is explaining eMoney’s 1040 tax calculation. Typically the question gets asked by advisors in one of 2 ways:
Why do the taxes seem high? or Why do the taxes seem low?
So let’s handle each question separately and go over a few of the “usual suspects.”
Why do the taxes seem high?
- You may not have entered all of the available deductions your client is eligible to receive. Some of these include:
- Mortgage Interest – If you have added a mortgage, make sure that you have set the interest to be deductible on the basic tab.
- Charitable Gifts – If you model these as expenses (or as part of the living expense worksheet), make sure to select the correct deductible type.
- State/Local Income Taxes – Make sure to enter these in the assumptions area so that the taxes paid will show up as an itemized deduction.
- Retirement Plan Savings – Make sure to enter these as contributions so that you will be given an above line deduction in the tax report.
- Property Taxes – Make sure you select the correct deductible type when you enter these as “other expenses.”
- Your realization on your taxable investments is off.
- Watch out for “by asset mix” as your realization model. When you have this setting and the underlying asset mix for an investment is unclassified, this results on ALL growth from this asset being taxed as ordinary income. To avoid this, you can either manually classify your asset mix (only available for manually entered accounts) or change your realization to a model from the realization drop down.
- Make sure the turnover rate accurately reflects how the account is being managed. The turnover ratio simply refers to what percentage of the account is being re-positioned on an annual basis. Long term capital gains are realized based on the total amount of unrealized gain (FMV – basis) times the turnover rate.
Why do my taxes seem low?
- You may not have entered the basis for a taxable investment. If you leave the basis field blank, then the system will assume that the basis is equal to the current fair market value. This could significantly reduce the amount of taxable gain being realized in future years.
- You may not be taking into account the impact of inflation. Some specific things to keep in mind are:
- The marginal limits increase every year at inflation. For example, the upper limit on the 25% tax bracket for individuals in 2017 is $153,300. In 2030, assuming the default inflation rate of 2.64%, the upper limit in this bracket rises to $215,100.
- Exemptions and standard deductions are indexed at inflation. For example, in 2017 an individual exemption is worth $4,050. In 2030, this increases to $5,680.
If you are still struggling to understand why your taxes look a certain way, there are 2 reports that will help you find a solution.
Income Tax Report – This is great for a high-level look at the tax calculation for all years. It shows the characterization of all income as well as the actual 1040 calculation which you can follow along by drilling down into the column headers.
Tax Events Ledger – This is great if you have detailed questions about how a specific income or growth from a specific asset is being taxed. You can find every single taxable event for any year in this report and see how the simulation is treating it for tax purposes.
With these 2 reports, you should be able to answer any tax question that comes up!
For more information on troubleshooting taxes, check out this Planning Guide available in The Knowledge Base.
– Chris Hershey -Sr. Financial Planning Analyst