The Form 1040 and associated schedules can be filled with red flags that may indicate opportunities to help your clients with a broad spectrum of financial services. Some of the warning signs can also prove to be false alarms -- but until you explore them, you won’t know.

“The trick is to know where to look and the right questions to ask,” according to Chad Smith, a wealth management strategist at HD Vest Financial Services. “For example, suppose you see a dramatic drop in earned income. It’s important to learn what’s behind it.” It could mean the client changed jobs and took a lower salary. Or that they are currently unemployed, or spent much of the year unemployed. Whatever the cause, it’s likely the client will need to revisit whatever long-term savings plan was in place.

Budget overhaul?

If the reduction in income is likely to be long-term, the client may need help in making the necessary budget adjustments to maintain a sustainable spending pattern that doesn’t sacrifice adequate retirement saving, and possibly other major financial goals. If the drop is only the result of a brief period of unemployment, the result still may have been a suspension of long-term savings that will need to be compensated for.


A related scenario arises if the client produces multiple W-2s. At a minimum, if the client has changed jobs, it’s important to determine what their intentions are with regard to any accumulated 401(k) balance at the previous employer. Investors have up to four options with separation from employment, depending on what’s applicable: They can leave their 401(k) in current plan, transfer to new plan, roll the funds over to an IRA, or cash out. Both qualified retirement plans and IRAs typically involve fees, expenses, and services that should be compared when considering a qualified plan rollover, and clients should consult with their tax advisors when considering the cash option for taxes and potential penalties. “While leaving it in the old plan might be a good idea, it might also be a bad idea, depending upon alternative opportunities with a rollover IRA,” said Smith.

It’s also important to determine whether your client has enrolled in the new employer’s plan, and is deferring appropriate amounts of income, taking full advantage of employer matching contributions, and that they understand the investment options.

Here are some additional red flags:

· Excessive short-term capital gains. Given that these gains are taxed at high ordinary income rates, it’s important to review the situation. Is the client simply trading stocks on his own without understanding the tax implications? Are the trades being encouraged by a broker who is simply churning the account? Or, if the gains are significant and consistently earned, perhaps your client is just a very shrewd (or lucky) investor.

· Excessive short-term capital losses. This could be a variation on excessive short-term gains -- too much trading is occurring, but it isn’t working out well, suggesting it’s time for a conversation about a sound long-term investment program.

· Excessive long-term capital gains. While long-term gains are generally a good thing, it’s important to determine whether any tax-planning opportunities were missed to harvest some losses that could have offset some of those gains.

· Lack of (or minimal) qualified dividend income. This could be a sign that the client’s only investments are in a retirement plan. That in turn could indicate the client isn’t saving and investing enough to meet long-term needs, to the extent that limits on retirement plan contributions are below the level the client needs to be saving. Also, it could suggest the client would sustain a 10 percent premature withdrawal penalty tax if they had to withdraw retirement funds before reaching 59-1/2 to meet an unexpected significant immediate financial need.

· Significant nonqualified (ordinary) dividend income. Clients might not realize that nonqualified dividend income is taxed at ordinary income rates instead of the maximum of 15 percent for qualified dividend income. Nonqualified dividends include those paid by real estate investment trusts and master limited partnerships. Dividends from some foreign corporations also are deemed as unqualified.

· Unusually high mortgage interest deductions. While deductions are generally welcome when tax liabilities are calculated, very high mortgage interest (relative to the client’s income) could indicate that the client would benefit from refinancing to a lower interest rate, or simply has taken on excessive debt.

· Alternative Minimum Tax liability. AMT is often unavoidable, but there are AMT triggers that could be avoided for some clients. For example, interest income from “private activity” muni bonds (for example, those used to fund stadiums, hospitals and housing projects and not backed by the public issuing authority) is factored into the AMT calculation, unlike that from standard general obligation muni bonds.

· Minimal charitable contributions. Although it’s not your job to cajole clients into being more charitable, a lack of reported charitable contributions could trigger a productive discussion about estate planning.

These are just a few examples of 1040 red flags; more could be lurking. Using HD Vest’s 1040 Analyst® tool is an efficient yet very effective method to identify the red flags and start conversations. Rather than peppering your client with a list of yes/no questions, remember, conversations are your objective. Ask open-ended questions, listen, and follow up with additional questions to keep your client talking.

“When you review clients’ tax returns with a red flag lens, you are bound to identify issues worthy of follow-up discussion,” Smith said. “Asking your clients the right questions that lead to conversations will put you on track to offering a broader array of financial solutions.”


For more information about HD Vest Financial Services and how they can help you transfer a client’s wealth, visit hdvest.com/join or contact a Business Development Consultant at (800) 742-7950. HD Vest Financial Services® and its affiliates (collectively, “H.D. Vest, Inc.”) do not provide tax or accounting services. You should consult your tax professional regarding the tax implications of any investments.

The views and opinions presented in this article are those of Chad Smith and not of HD Vest Financial Services® or its subsidiaries.

HD Vest Financial Services® is the holding company for the group of companies providing financial services under the HD Vest name. Securities offered through HD Vest Investment ServicesSM, Member SIPC, Advisory services offered through HD Vest Advisory ServicesSM, 6333 N. State Highway 161, Fourth Floor, Irving, TX 75038, 972-870-6000.