Retirees, Take a Midyear Tax Checkup

What a difference a few months make. When 2017 began, it seemed all but certain that Republican control of the House, Senate and White House would quickly deliver wide-ranging tax reform, with much lower tax rates as a headline feature. After all, when George W. Bush was elected in 2000, he pushed through big cuts within six months (just before Democrats regained control of the Senate). The only question was: How much would taxpayers save?

Fast-forward to the dog days of summer. With Congress bogged down with health care, tax reform has been starved for oxygen. House Speaker Paul Ryan still promises a new law before year-end, but face it, even if Congress acts late in the year, any big changes are likely to be phased in rather than pay off immediately. That’s what happened the last time true tax reform won the day, in 1986. That legislation called for 15 tax brackets to be compressed into two, for example, but there were still five brackets in 1987 and the two-rate system only lasted for three years after that. Exemptions got a big boost, but in three steps starting the year after enactment.

We still expect Congress to approve both individual and business tax cuts, if not fundamental tax reform, sooner or later. But for the 2017 return you file next spring, you should expect the law to remain pretty much as is. That means any big changes in your tax bill are likely to be a result of changes in your financial life and do-it-yourself moves to trim the tab.

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How’s It Going?

Take a look at your income through the first half of 2017. Is it roughly half of what you reported on your 2016 tax return? Significantly more? Much less?

If this year is shaping up to be a much better, or much worse, year than last year, you may need to adjust your withholding or increase or reduce your quarterly estimated tax payments due in September and next January. You can change withholding on paychecks by filing a new W-4 form with your employer. For IRA and pension withholding, you’ll need to file a W-4P with the payer. For withholding on Social Security benefits, mail or drop off a W-4V form at a local Social Security office. Any changes—up or down—should go into effect with the next payment or two.

On the subject of withholding, are you one of the 75% of taxpayers who got tax refunds averaging $2,800 this past spring? If so, and your financial year is shaping up similarly to 2016, consider reducing withholding so you get more of your money now rather than waiting for a check next year. Most taxpayers have already banked half-a-year’s refund.

If any of the following changes are part of your life this year, the tax impact may be far more significant than anything Congress does.

Wedding bells. Marriage can bring a slew of changes to your tax situation. Consider how blending two incomes will affect your tax bill. Despite efforts to ease the “marriage penalty” in the law, two-earner couples often pay more after tying the knot than they did as two single people. If you married someone with a much lower income than your own, however, you could see your tax tab drop on a joint return. Did one of you sell a house when you set up housekeeping together? Most home-sale profit is tax-free, and if you paid off a mortgage on which you were deducting points year-by-year, you can deduct the remaining balance this year.

Home mortgage refinancing. If you took advantage of low rates to get a new mortgage, crank into your planning how paying less deductible interest could push up your tax bill.

Rebalancing or reallocating your portfolio. Soon-to-be and recent retirees often ratchet down risk in their portfolios, which generally means selling stocks and stock mutual funds to move assets to fixed-income investments. That often means realizing capital gains. The same goes if you locked in gains from the recent market run-up. Transactions inside a tax-favored account, such as an IRA or 401(k), are ignored by the IRS. But if you’re making moves in a taxable account, keep an eye on the potential tax bill. There’s no reason to wait until year-end to start considering whether to harvest losses to offset some of those gains.

Enjoying an inheritance. Although much of the wealth left to heirs is tax-free, be sure you know how any bequests affect your tax situation. Life insurance proceeds and cash come to you tax-free. For stocks, bonds and real estate, your tax basis is generally the assets’ value on the day your benefactor died. If you sell for more, you’ll have taxable, long-term capital gains; sell for less and you’ll have a tax-saving loss (even though you come out ahead).

If you inherit or are named the beneficiary of a company retirement plan, IRA or annuity, different rules apply. You will be taxed on distributions as the original owner was. For a traditional IRA, for example, that means you’ll probably owe tax in your top bracket on every dollar withdrawn. If you inherited a Roth IRA, payouts are tax free.

Death of a spouse. If your husband or wife died this year, you’ll still be able to file a joint return and claim an exemption for him or her. But if he or she died in 2016, you will file as a single taxpayer (unless you remarry).

The loss of a spouse almost certainly means a loss of income. If you were both receiving Social Security benefits, for example, the smaller of the two checks stopped. If you were receiving a joint-and-survivor pension, the monthly payment may have fallen to 75% or 50% of what you had been receiving. If your spouse was still working, you need to crank the loss of those earnings into your tax planning. If state income taxes on a spouse’s earnings were a major component of your itemized deductions, you might find yourself claiming the standard deduction.

Planning for an RMD. If you turned 70 during the first half of 2017, this will be the first year you’re required to take a distribution from a traditional IRA. (If your birthday was July 1 or later, required minimum distribution rules don’t kick in for you until 2018.) Your 2017 RMD is based on the total balance in all of your traditional IRAs on December 31, 2016.

Generally, RMDs must be withdrawn by December 31, but you can put off the first required payout until as late as April 1 of the following year. Keep a close eye on tax maneuverings in Washington. If tax rates will likely be lower in 2018, it could pay off handsomely to delay your first RMD.