Taxes During Your Working Years: What You Should Look For When Reviewing Your Tax Return As A Working Professional 

Tax season can be a daunting time for many working individuals, filled with complexities and uncertainties. Whether you’re a seasoned professional or a newcomer to the workforce, reviewing your tax return is an informative exercise to ensure you understand all your sources of income, the related tax liabilities for the prior year, and what you can do to reduce taxes going forward. In this comprehensive guide, we’ll explore the key considerations for working professionals when reviewing tax returns, empowering you to navigate tax season with confidence. The checklist below is a great starting point for what to look for and consider on your return. In this blog, we will look more in-depth at some of the items on the checklist as well as some of the other key considerations for reviewing your tax return. 

Review Your Sources of Income 

During your working years your primary source of income will likely be from salary or self-employment income, and many taxpayers have various additional sources each with their own unique tax implications. The most common income streams we see include: 

1. Salary and Wages and Self-Employment Income: Whether it is W-2 income or some form of self-employment, this is typically your primary source of income. These earnings are subject to federal income tax, as well as Social Security and Medicare taxes. 
2. Investment Income: Income generated from investments such as dividends, interest, and capital gains may be subject to different tax rates. qualified dividends and long-term capital gains are subject to preferential capital gains tax rates. Short-term capital gains and ordinary dividends are treated as ordinary income, so it is best to try to limit recognizing these as much as possible through [[tax-smart investing strategies.]] 
3. Other Income: Passive income from rental real estate, royalties, partnerships, s-corporations, or trusts. These other sources of income will typically be subject to ordinary income tax rates like salary and wages but are often not subject to Social Security and Medicare taxes.  

Review Your Deductions and Credits 

1. “Above The Line” deductions: These are adjustments you can make to your income regardless of whether you Itemize or take the Standard Deduction. These have the added benefit of reducing Adjusted Gross Income (AGI) which is used as the starting point for many tax benefit phaseouts. Some of the most common and beneficial are: student loan interest, IRA contributions (SEP, SIMPLE, or a Traditional IRA), self-employed health insurance, and Health Savings Account (HSA) contributions. 
2. Qualified Business Income Deduction: Many owners of sole proprietorships, partnerships, S corporations, and some trusts and estates may be eligible for a qualified business income (QBI) deduction. This deduction is sometimes called “between the line” because it can be taken regardless of whether you Itemize or take the Standard Deduction, but it does not reduce AGI. The deduction is subject to a number of phaseouts and caveats, but essentially allows you to take a deduction for 20% of Qualified Business Income which is net income from a qualified trade or business excluding investment items, interest income, and wage income. 
3. Standard vs. Itemized Deductions: Working professionals should assess whether they are claiming the standard deduction or itemized deductions. The Tax Cuts and Jobs Act of 2017 nearly doubled the standard deduction amount greatly reducing the number of taxpayers who benefit from itemizing their deductions.  
4. Consider “Bunching” And Other Strategies To Maximize Benefits From Itemized Deductions: Some taxpayers are able to benefit by alternating years that they itemize and “bunching deductions” into those years in order to get a greater benefit from them. Common itemized deductions for those who are working include mortgage interest, state and local taxes, medical expenses, and charitable contributions. Donor Advised Funds can be great tools to assist with bunching many years of charitable giving into one year. If you are a high earner with income from a pass-through entity, the pass-through entity tax election could provide an effective method of circumventing the $10,000 cap on state and local tax deductions. Eligibility for this election and the mechanics of implementing it are state-dependent.  
5. Child Tax Credits and Dependent Care Credits: Two additional credits available to taxpayers with dependents are the Child Tax Credit (currently up to $2,000 per qualifying child in 2024), and the Child and Dependent Care Credit (up to $2,100 per tax return depending on income, and qualifying expenses).  
6. Education Tax Credits: For taxpayers pursuing higher education or paying for their children’s education, you may qualify for education tax credits, such as the American Opportunity Tax Credit (max $2,500 per student) or the Lifetime Learning Credit (max $2,000 per tax return), which can help offset education expenses. 
7. Foreign Tax Credit: We often see this overlooked in self-prepared returns, but for investors with a large amount of taxable investments in an internationally diversified portfolio this can create meaningful tax savings and prevent you from paying tax twice on income (usually dividends) from other countries.  
8. 529 College Savings Plan Contributions: This is a state-specific deduction for funding a Qualified Tuition Program. 529 College Saving Plans are usually one of the more tax-efficient ways to help fund a loved one’s education. Many states allow for a state tax deduction if you contribute to that state’s plan. In Alabama, that deduction can be up to $5,000 per taxpayer, or $10,000 for a married couple. At the federal and state level the growth of the investments in the plan are tax-free if used for qualifying education expenses. 

Retirement Account Contributions 

1. 401(k) 403(b) and Similar Plans: Contributions to employer-sponsored retirement plans, such as 401(k) or 403(b) plans, are typically made on a pre-tax basis, reducing your taxable income for the year. The reduction doesn’t show up as adjustments on your tax return but instead reduces the amount of taxable income reported to you on your W-2.  
2. Traditional IRA, Roth IRA, and Backdoor Roth IRA: We mentioned the “above the line” benefit of traditional IRA contributions previously, you will want to confirm you are eligible before making these contributions. Eligibility depends on your income level and whether you or your spouse are covered by a retirement plan at work. Eligibility for making Roth IRA contributions also depends on your income level. If you happen to phase out of making Roth IRA contributions, there is still the option of “backdoor” Roth contributions which allow taxpayers at any income level to make a Roth IRA contribution. If you are utilizing the “backdoor” contribution method, you will want to ensure this is being reported correctly on your tax return on Form 8606. Roth contributions do not have current-year tax benefits but can give you a huge tax benefit in retirement since the growth is tax-free.  

Tax Planning and Tax-Efficient Investment Strategies 

Once you have reviewed your tax return using the checklist and recommendations above you may want to consider ways to optimize your current and future year’s tax situation. In addition to the strategies mentioned above, I encourage you to check out our full presentation on [[tax-smart investing]] which goes into detail on those strategies and more. Some of the additional strategies in that presentation are highlighted below: 

1. Tax-Smart Asset Location: Optimize your investment portfolio to minimize taxable income. Allocate tax-efficient investments like municipal bonds to taxable accounts and high-growth investments, such as equities to both Roth accounts and taxable accounts where they are either tax-free or can get preferential capital gains rates and prioritize tax-deferred accounts for investments generating ordinary income and dividends. 
2. Tax-Loss Harvesting: Utilize tax-loss harvesting to offset capital gains with capital losses, reducing your overall tax liability. 
3. Roth Conversions: Consider converting some pre-tax accounts to Roth accounts in years when your income is temporarily lower than it will be in the future. Many investors find that they are on track to leave substantial inheritances to their heirs, and they may want to consider whether their beneficiaries will be forced to pay large tax bills during their prime working years if they inherit a Traditional IRA. Doing a Roth conversion in retirement can ensure you are not leaving behind large tax bills for your children or other beneficiaries. 
4. Reduce Self-Employment Tax and Maximize QBI: Self-employed taxpayers who run their business through an entity taxed as an S-corporation are tempted to keep their salary low and take a majority of their profits as distributions to minimize the amount of payroll tax they must pay on their income. However, when taking into consideration some of the limitations on the 20% deduction for Qualified Business Income, this can have unintended consequences. It is important to understand the optimal amount of salary to pay yourself to maximize QBI and ensure it is reasonable for the amount of work you are doing in the business. 
5. Penalty reduction: Proper planning to ensure you are not over-withholding and making an interest-free loan to the government, or under-withholding and having to pay penalties and interest on top of your tax bill. For the self-employed, this would include making accurate quarterly estimated tax payments. 

Seek Professional Guidance 

Given the complexity of tax laws and the diverse range of financial circumstances for working professionals, consulting with a financial planner and tax professional specializing in tax planning is invaluable. A knowledgeable advisor can provide personalized insights, identify tax-saving opportunities, and ensure compliance with ever-evolving tax regulations. 

The process of reviewing your tax return requires a comprehensive understanding of various income sources, deductions, credits, and tax strategies tailored to your financial situation. By carefully assessing these considerations and seeking professional guidance when needed, taxpayers can maximize their after-tax investment returns, minimize tax liabilities, and achieve greater financial security.