Navigating taxes in your golden years

Taxpayers 65+ may be eligible for certain benefits, including a higher income threshold, a higher standard deduction and some income exempt from tax.

Older taxpayers should note, however, that if income tax was withheld from their pay or if they qualified for a refundable credit (such as the earned income credit, the additional child tax credit, or the American opportunity credit), they should file a return to get a refund even if they aren’t otherwise required to file a return. The IRS also notes that older taxpayers shouldn’t file a federal income tax return if they don’t meet the filing requirements and aren’t due a refund. If an older taxpayer needs assistance to determine if they need to file a federal income tax return, they should go to IRS.gov/ITA and use the Interactive Tax Assistant.

 

Taxable and nontaxable income

Generally, income is taxable unless it is specifically exempt (not taxed) by law, according to the IRS. An older taxpayer’s taxable income may include compensation for services, interest, dividends, rents, royalties, income from partnerships, estate or trust income, gain from sales or exchanges of property, and business income of many kinds.

 

Under special provisions of the law, the IRS notes that certain items are partially or fully exempt from tax. For instance, an older taxpayer doesn’t have to include in their gross income amounts they receive for supportive services or reimbursements for out-of-pocket expenses under any of the following volunteer programs: Retired Senior Volunteer Program (RSVP), Foster Grandparent Program, Senior Companion Program, and Service Corps of Retired Executives (SCORE). All unemployment compensation received must be included in income.

See Publication 525, Taxable and Nontaxable Income, for more detailed information on specific types of income.

 

IRAs

In general, distributions from a traditional IRA are taxable in the year a taxpayer receives them, according to the IRS. Exceptions to the general rule are rollovers, tax-free withdrawals of contributions, and the return of nondeductible contributions. (Read Publication 590-B.)

 

Pensions and annuities

Generally, if a taxpayer didn’t pay any part of the cost of their employee pension or annuity, and their employer didn’t withhold part of the cost of the contract from their pay while they worked, the amounts they receive each year are fully taxable, according to the IRS. If the taxpayer paid part of the cost of their pension or annuity plan with after-tax money, they can typically exclude part of each annuity payment from income as a recovery of their cost (investment in the contract).

 

10% penalty on early distributions

Some taxpayers will have to pay federal and possibly state income taxes on their Social Security benefits. This usually happens only if they have other substantial income in addition to their benefits (such as wages, self-employment, interest, dividends, and other taxable and certain non-taxable income that must be reported on their tax return), according to the Social Security Administration. Taxpayers will pay tax on up to 85% of their Social Security benefits, based on IRS rules. If they:

• File a federal tax return as an “individual” and their combined income is
  – between $25,000 and $34,000, they may have to pay income tax on up to 50% of their benefits.
• – more than $34,000, up to 85% of their benefits may be taxable.

• File a joint return, and they and their spouse have a combined income that is
  – between $32,000 and $44,000, they may have to pay income tax on up to 50% of their benefits.
• – more than $44,000, up to 85% of their benefits may be taxable.
• Are married and file a separate tax return, they probably will pay taxes on their benefits.

Combined income is the sum of adjusted gross income, nontaxable interest, and half of the taxpayer’s Social Security benefits.

Scott Bishop, a partner with Presidio Wealth Partners, views the taxation of Social Security as a “stealth” tax. His advice: “Plan for your taxable income. If you will be just under those ‘cliffs,’ try to stay under as the next dollar over those levels can bring a lot of your Social Security subject to taxation.”

 

Railroad Retirement Benefits

Railroad Retirement Benefits fall into two categories: Social Security Equivalent Benefits (SSEB) and Non-Social Security Equivalent Benefits (NSSEB). Similar to Social Security benefits, this income can be taxable.

 

Military retirement pay

Military retirement pay based on age or length of service is taxable, according to the IRS. Disability pensions that are based on a percentage of disability from active service in the armed forces of any country are generally not taxable. For more information, see IRS Publication 525 (2022), Taxable and Nontaxable Income.

 

Sickness and injury benefits

Generally, a taxpayer must report as income any amount they receive for personal injury or sickness through an accident or health plan that is paid for by their employer.

 

Disability pensions

If a taxpayer retired on disability, they typically must include in income any disability pension they receive under a plan that is paid for by their employer.

 

Life insurance proceeds

Life insurance proceeds paid to a beneficiary because of the death of the insured person aren’t typically taxable unless the policy was turned over to the beneficiary for a price.

 

Sale of home

“A taxpayer may be able to exclude from income any gain up to $250,000 ($500,000 on a joint return in most cases) on the sale of their main home. If you meet all the requirements for the home sale exclusion, you can exclude the gain from your income on your tax return. However, you may still be required to disclose the sale on your tax return, according to Thomas Scanlon, CPA, CFP, a principal with Borgida & Company, P.C. in Manchester, CT.

 

A taxpayer can choose not to take the home sale exclusion, but this is rarely done. If the taxpayer chooses not to take the exclusion, they will have to pay taxes on the full amount of the gain.

 

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