Divider
Divider

Alan Haft
Alan Haft

What Do Horror Movies Have to Do With Tax Returns?

A simple tax saving often missed.

April 18, 2011
by Alan Haft

Fade in:

EXTERIOR HOUSE — LATE NIGHT

A dreary moon casts a dark shadow across a small isolated hillside house.

INTERIOR HOUSE

A scantily clad woman sleeps on a couch, a fireplace crackles nearby, TV plays in the background. A sleeping cat awakens sensing something. Moments later, the cat hisses, hair needles up and it inches back to a corner, cowering.

Then, all power goes out and somewhere in the house, something shatters a window. The woman instantly awakens, unsure as to whether or not she just heard something.  A moment later, she hears distant footsteps walking on broken glass. Something is most definitely in the house.

She sweeps the cat into her arms and takes very careful steps towards the dark hallway, terrified, wondering who or what can be at the end of it. Frightened, the cat scratches off her, running away.

The woman turns to the front door ... run out? Or, walk the dark hallway to see what's at the end of it ... which way? ... She takes a deep breath, musters up some courage and as she steps and disappears into the darkness of the hall, screeching music fades up and in bone-chilling letters, the title of the movie fades in, "The Hallway of Doom."

Fade out.

Have you ever seen a bad movie like this? I have. And every time I do, I ask myself the question, "why doesn't she just run out the house?"

Needless to say, if she did make a run for it, the movie would be over and I'd feel cheated because there was no confrontation between good and evil.

Similarly, when tax season comes rolling around — it may not be something as obvious as the woman who can escape pure evil by running out her door — but glancing at a specific part of a tax return, I often wonder, "Why aren't more people paying attention to lines 8a and 9a of their tax returns?"

Often, but certainly not always, these line items represent one of the best opportunities in which clients can reduce tax. If it sounds like an obvious area to look at, it certainly might be. But like many things in life, sometimes the most obvious things in life get lost in the busy lives many of us lead, especially when many of us hurry to get our returns completed on time.

8a, 9a and Schedule B: Matches Not Made in Heaven

Let's start with the basics as to how lines 8a and 9a appearing on page one of the 1040 return relate to Schedule B.

As a reminder, the amounts noted on 8a and 9a tie directly to Schedule B in which clients are going to find a listing of the places where your clients have money invested, such as banks and brokerage firms. On Schedule B, the line items list and tally interest and dividends earned on investments such as CDs, brokerage and savings accounts.

Most clients obviously need things such as banking accounts. After all, having a savings account is an important thing and I'm certainly not implying one should consider getting rid of something as needful as this just to save some taxes. But when Schedule B Part I (Interest) tallies amounts your clients aren't using to supplement their income or pay for day-to-day living, this is the first leak in their tax tub that can be potentially patched up.

For example, in Part I of Schedule B, interest being earned from something such as bond mutual funds are often kept in brokerage accounts. If it was my money, I'd ask myself whether or not these funds can be replaced with an investment that doesn't throw taxable earnings over to line 8a, causing me to pay unnecessary taxes. Questions your clients should be asked include:

  • Can they replace their bond funds with something such as bond exchange traded funds (ETFs) that seldom trade the positions in its portfolio (or throw off interest)? If it makes sense to do this, your clients are doing themselves a big favor by not paying the Internal Revenue Service (IRS) more than they have to.
  • Can your clients replace a bank certificate of deposit (CD) with a highly conservative municipal short-term bond fund that generates tax-free instead of taxable earnings?
  • Would it make sense to consider something such as a fixed annuity to defer taxes to a later time?

These are important considerations and several possible solutions are available that may reduce unnecessary taxes. According to Lipper Inc., a provider of mutual and hedge fund data analytics, the average mutual fund in the country loses between one-and-a-half percent to two percent of its value to taxes paid each year.

While these percentages may not sound like much, think about this:

  • Over a 30-year period, an investment that earns a pure seven-percent return and causes no taxes would turn $10,000 into $76,000.
  • On the flip side, an investment that loses two percent of its earnings to taxes each year turns that same $10,000 into $43,000.
  • At first, a two-percent loss to taxes might not sound like much, but when your client translates these percentages into dollars and adds time to it, this often makes all the mental difference, especially since in this case it represents over $30,000 in an account — an amount that's certainly nothing to sneeze at and something that can easily pay for many horror flicks (with popcorn) further on down the road.

Do your clients have line items on Schedule B Part I that are throwing income over to line 8a? If they aren't actually using these earnings, you would likely do them a great service by evaluating their holdings. Doing so can often save them plenty of taxes and make you feel like the valiant hero that helps the gorgeous feline defeat that nasty evil awaiting at the end of her dark hall.

Part II: Dividends

I love dividends.

Think about it. Your clients are investing in stock(s) that not only can go up in value, but while it's hopefully doing that, it's paying them cash, which is certainly a nice thing.

But when those dividends show up on Schedule B, Part II, unless your clients are a part of the Internal Revenue Service (IRS), it may not be such a nice thing. Consider the possibilities to replace a stock or stock fund with:

  • Stocks that pay no dividends,
  • A stock index fund that typically generates no dividends or
  • "Move" the position into an individual retirement account (IRA) that shelters the dividends from immediate taxes.

If your clients see a brokerage account listed in this section and earnings showing up on these line items, recommend your clients evaluate holdings. When doing so, you will see funds that either pay many dividends or "turn over" your client's portfolio of stocks many times, thereby causing all sorts of taxable income and capital gains.

In these cases, it's once again an opportunity for clients to take their investments in for a tune up. Exploring the possibility of moving investments into a more tax favorable environment can not only put them into a better position, but also give you a way to help your clients proactively save some unnecessary taxes.

Humanoids From the Deep?

The Blood Sucking Thing From Outer Space? Or

Line 8a and 9a of your tax return?

At first glance, they may appear completely different but underneath it all, there are usually obvious solutions that can typically help save the day.

 Rate this article 5 (excellent) to 1 (poor). Send your responses here.

Alan Haft is an investment advisor representative with an insurance license, author of three books including the national bestseller, You Can Never Be Too Rich, and makes frequent appearances in national print, television and radio media such as The Wall Street Journal, Money Magazine, CNBC, BusinessWeek and many others.

For full disclosure, Haft is a part of a firm that utilizes all industries which typically includes us receiving percentage based fees for brokerage services as well as commissions when implementing insurance based plans. Haft does not work for any particular financial company or industry nor should this column be construed as an endorsement or condemnation for any particular product. Readers should note that all views and vendor recommendations as expressed in this article are solely the author's and do not necessarily reflect the views of the AICPA CPA Insider(TM) or the AICPA.

* This article is not intended to provide tax or legal advice and should not be relied upon as such. Any specific tax or legal questions concerning the matters described in this article should be discussed with your tax or legal advisor.