Taxes in retirement

As you go through life, you will encounter several "life-changing" moments.  Some are good, such as graduating college or having a child, while others are bad, such as losing a parent or going through a divorce.  These moments can also bring changes to your financial life, including how much tax you owe and how it is paid.  

This article addresses taxes in retirement.  I realize this is not chronologically accurate, but it is an issue that several people are not prepared for when they enter retirement.  

Income and deductions

A retired taxpayer will likely have very different income and deductions than they had earlier in life, maybe even than the year before.  Their wage income will be replaced by distributions from retirement plans, investment income and Social Security.  Personal exemptions for children and mortgage interest will be replaced by charitable contributions and medical expenses.  Changes in income and deductions must be considered when determining how much tax will be owed each year.

Social Security

There's no easy way to say it: if you have other sources of income, up to 85% of the gross Social Security benefits you receive are taxable.   This often comes as a surprise to retired taxpayers, because there is often no tax withholding against this income.  However, you can elect to have Federal withholding taken from your SS benefits if you don't want to change the withholding on your retirement distributions.  Fortunately, SS benefits are not taxed in several states.

Paying taxes

The most challenging part of determining taxes in retirement is determining your income from all sources and electing tax withholding to cover all of it (or pay estimated taxes).  If you are taking distributions from a retirement plan, they will give you the option to withhold taxes on that distribution.  But, this withholding will be based on that distribution alone, and most likely will not cover investment income or Social Security benefits.  The key is to set your withholding high enough to cover taxes on all of your income, not just one source.  

In all, it is important for individuals that are nearing or entering retirement to meet with their tax advisor to determine tax implications of retirement.  Your tax advisor will consider changes in your income and deductions and advise on how much to withhold from retirement distributions or quarterly estimated tax payments that need to be made.  

The 5-year 529 gift

Most taxpayers know that they can give gifts of up to $14,000/year to any individual without reporting the gift on a gift tax return.  If married couples elect to split gifts, then the couple can give up to twice that amount ($28,000) to an individual without reporting.  But, there is a little known loophole for making larger gifts without affecting the lifetime gift exclusion.  

As a part of the Internal Revenue Code section 529(c)(2)(B), taxpayers can elect to treat a gift to an individual as given over a 5 year period as long as it goes into a qualified Section 529 plan.  Here's an example:

Granddaughter is nearing college age, and Gramma has some excess funds she would like to use to help pay for college.  Gramma can deposit up to $70,000 ($14,000 x 5) into a qualified 529 plan with Granddaughter as the beneficiary, or Gramma and Gampa can deposit up to $140,000 ($28,000 x 5) into a 529 plan if they elect to split gifts.  In that year, Gramma (and Grampa if splitting gifts) will file a Form 709 gift tax return and check the box on page 2, Schedule A section B to elect to recognize the gift over 5 years.  Gramma (and Grampa if splitting gifts) will pay no gift tax in the year of the transfer, and they are not required to file a gift tax return in subsequent years unless they make other gifts over the annual limit.  

The only catch is that if Gramma or Grampa make an additional gift to Granddaughter during the 5 year period, that gift must be reported and will be a taxable gift subject to the lifetime exclusion.  Also, if Gramma and Grampa live in a state where they can receive a tax credit for a contribution to a 529 plan, the credit is typically only good in the first year, since that is when the contribution was made.  

As I mentioned, this is not a well known tax benefit for gifting, and can be very beneficial for parents or grandparents with sizeable estates looking for ways to transfer assets without incurring gift taxes.

2015 filing season in review

Now that I have had a day to recharge after the April 15 deadline, it's always fun to look back at the last few months and analyze what went well and what didn't.  Although a lot of this will be more relatable for other tax practitioners, it does give an insight into the variety of issues CPAs deal with during the course of tax season.  

Health insurance

"I know I've never asked you this before, but you do have health insurance, right?"  I got so tired of that question.  But, it had to be asked to be in compliance with the new Affordable Care Act minimum required coverage rules.  This was a challenge because you not only had to make sure the coverage met minimum requirements, but if they received a 1095 then there were additional forms to complete.  Then, you had to hope the 1095 they received wasn't incorrect the first time.  

Late 1099's

I gained some respect for the big brokerage houses this year because they started printing "THIS IS NOT A FINAL 1099" on the 1099 they sent out at the end of February.  They also tried to identify the transactions that were not final, making it easier to get the return completed when the final 1099 was received.  Now, I'm not saying that made it less stressful to get an amended 1099 on April 14, but at least you could anticipate a change.  

The IRS

I'm not going to be too critical of the IRS because it is a busy time of year for them and they are, reportedly, heavily understaffed and underfunded.  But, it is very difficult to discuss anything with the IRS on the telephone.  Wait times are long and agents spend a lot of time encouraging the taxpayer to go to IRS.gov.  And, I think the IRS has a real problem on their hand with the identity theft issue.  The increase in electronic filing has created an opportunity for computer savvy criminals to get a hold of taxpayer money.  I hope the 6 digit pin numbers become mandatory in the near future.  

Financial aid

Thank you, financial aid forms, for asking of an estimate of the applicant's taxable income due by January 31.  This is a double-edged sword because it is difficult to meet those early deadlines, however the financial aid forms encourage clients to get their organized tax information in quickly, expediting the completion of the return.  

Unreimbursed expenses as an employee

If you work for an employer that you have a moderate level of respect for, then most likely you have gone out-of-pocket to buy something to benefit your company without getting reimbursed.  This can be a range of expenses, from mileage to birthday cakes, but there are certain rules regarding how these unreimbursed expenses can be treated on an employee's individual tax return.  

Before diving into this, there is one big catch.  For an expense to be considered unreimbursed, they must not be eligible for reimbursement or actually reimbursed by the employer.  For example, if your employer has a policy to reimburse an employee for mileage, but you choose not to seek reimbursement, the mileage is not technically an unreimbursed business expense.  Only expenses incurred above and beyond a set reimbursement policy should be considered.

Common expenses that an employee pays out of pocket that could be considered deductible include:

• Professional dues and licenses
• Depreciation on a computer you pay for yourself and required for your job
• Mileage
• Medical exams required by your employer
• Necessary tools and supplies used for work
• Work-related education
• Specific uniforms or clothing not suitable for everyday use

Of course, there is always a catch.  Here are some expenses that are, by rule, nondeductible:

• Social club dues
• Home repairs or rent
• Lobbying expenses and political contributions
• Expenses related to attendance of board meetings
• Lost vacation time

Unreimbursed business expenses are included as a miscellaneous deduction on Schedule A, and they are subject to a 2% of income limitation.  This means that only miscellaneous deductions exceeding 2% of your income will be deductible.  

Forms schedule

I commonly hear clients tell me this time of year "I'm going to get my stuff to you early this year, as soon as possible."  For most people that don't work in the accounting/tax profession (but maybe even for some that do!), taxes are a pain.  People want to get their forms, get their return done, and move on to get ready for spring.  In an effort to anticipate when you will receive certain tax forms, here is a brief synopsis of the filing deadlines for various information returns:

You should receive the following common forms by February 2, 2015:

• W-2
• 1099-INT (interest)
• 1099-DIV (dividends)
• 1099-MISC (rent, royalties, nonemployee compensation, other misc income)
• 1099-R (retirement plan distributions)
• 1099-C (cancellation of debt)
• 1098 (interest expense)

You should receive the following forms by February 17, 2015:

• 1099-B (proceeds from broker transactions i.e. investment accounts)
• 1099-S (proceeds from real estate transactions)

A quick note about amended forms - with the increased regulation of investment companies to report wash sales on Form 1099-B, you will not receive your 1099-B until the middle of February.  This gives the investment company time to see if any sales that occurred in 2014 were subject to a wash sale as a result of a transaction in the first 30 days of 2015.  As a result, it is not uncommon for the investment company to send a 1099-B in the middle of February, and then send an "amended" form later on.  If you have several transactions in your investment account, it might be a good idea to wait until March to file in case you receive an amended form.  

Almost all of the big investment companies will publish a schedule of when their customers can expect to receive forms, like this notice I got from Fidelity a few days ago.  Check with your investment company to see if they have a similar publication.  

One final note, if you are expecting a 1099 from your bank or investment company and do not receive one, don't panic.  Companies are only required to issue a 1099 if your income exceeds certain thresholds.  For example, if your savings account did not earn more than $10 for the year, the bank is not required to send you a 1099.  You can check this quickly by looking at your December statement.