Retirees, Cut Your Taxes With These Moves

For now, trimming your tax tab is up to you, not the men and women in Washington who write the tax law.

(Image credit: Troels Graugaard)

During a presidential debate last fall, Hillary Clinton accused Donald Trump of paying $0 in federal taxes for at least a couple of years in the past. The soon-to-be president retorted: “That makes me smart.”

So, just how smart do you feel as you sit down to complete your 2016 tax return? President Trump has promised tax cuts for all. But any changes will be for future years. For now, trimming your tax tab is up to you, not the men and women in Washington who write the tax law. And you’re stuck with the rules as they stand now. We hope some of these ideas will help you burnish your reputation as a taxpayer but limit how much you owe.

Use the right form for 0% gains. Investors with taxable income up to $37,650 on a single return and $75,300 on a joint return get the smartest tax rate ever for their long-term capital gains: 0%. But that’s not exactly the same as saying the gains are tax-free. They still have to be reported on your tax return, and if you simply report your profits on your Form 1040, they will be taxed in your top tax bracket. Instead, report your gains first on Form 8949 and then carry them over to Schedule D. Figuring your tax bill on the Schedule D tax worksheet, which you’ll find in the instructions for that form, will apply the 0% rate to qualifying profits. Whew! It’s a lot easier to use tax-preparation software.

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Take advantage of a supercharged standard deduction. One of the proposals in President Trump’s tax plan is to more than double the standard deduction, pushing it to $15,000 for single folks and $30,000 for married couples. That would put a big dent in the number of taxpayers who itemize deductions, since you only go to that trouble if the total of your qualifying expenses exceeds your standard deduction.

But taxpayers age 65 and older need to remember that they already get a supercharged standard deduction. For younger folks, the 2016 standard deduction is $6,300; for married couples, it’s $12,600. At 65, though, the no-questions-asked write-off grows to $7,850 for singles and $13,850 for a couple if one spouse is 65 or older or $15,100 if both spouses are. If the bonus figure beats the total of your itemized deductions, as it might if you’ve paid off your mortgage, you’ll not only avoid the hassle of itemizing but you’ll also save money.

Embrace the “angel of death” tax break. Proposed tax reform might restrict this, but for now the tax basis of inherited assets is their value on the date of death of the previous owner. Assume that last year you sold stock that Uncle John bought for $1,000 but was worth $10,000 when he died and left it to you. Your tax basis is $10,000, and you owe capital-gains tax only on any sales proceeds above that level. (The tax on the $9,000 appreciation while Uncle John was alive evaporated when he died.) If you sold for less than $10,000 in this example, in fact, you can claim a tax-saving capital loss (see 10 States With the Scariest Death Taxes).

Congress figures that stepping up basis to date-of-death value will save heirs more than $32 billion this year. If you sold inherited assets in 2016, don’t leave your share of the savings on the table.

Can you deduct Medicare premiums? Like other health insurance premiums, what you pay for Medicare counts as a deductible medical expense. But such expenses are generally deductible for 2016 only to the extent they exceed 7.5% of your adjusted gross income (it’s 10% for taxpayers under age 65). But if you’re self-employed—say, you retired from your job as an employee and set up shop as a consultant or contract worker—you’re not inhibited by the 7.5% threshold.

You can deduct medical insurance premiums for Medicare or private insurance on Form 1040. One caveat: You can’t claim this deduction if you are eligible to be covered under an employer-subsidized health plan offered by either your employer (if you have retiree medical coverage, for example) or your spouse’s employer (if he or she has a job that offers family medical coverage).

Compute the tax bill on a widow’s sale of home. We often hear from readers confused over the tax treatment of the sale of a home following the death of one of the spouse co-owners (see Most-Overlooked Tax Breaks for the Newly Widowed). Does a widow, for example, get to take up to $500,000 of home sale profit tax-free, or is she limited to the $250,000 exclusion available to single taxpayers? It depends. Assuming at least one spouse met the two-out-of-five-year ownership test and both spouses met the two-out-of-five-year use test at the time the spouse died, the survivor gets the $500,000 exclusion. If more time has passed, the $250,000 limit kicks in. Remember, though, that the stepped-up basis rule mentioned earlier would wipe out the tax on at least half of the profit that accrued up to the time of the first spouse’s death.

Meet an April 1 RMD deadline. If you turned 70½ last year and decided to put off your first required minimum distribution from your IRA until 2017, the April 1 deadline is fast approaching. Your 2016 RMD is based on the 2015 year-end balance in your accounts, not the 2016 balance. No matter how many traditional IRAs you have, total the balance and divide by 27.4 if you turned 70 or by 26.5 if you turned 71 on your birthday in 2016. You can take the payout from any account or combination of accounts.

Although April 1 is a Saturday, the RMD deadline does not slip to the following Monday. Don’t wait until the last minute. Request the payout with plenty of lead time to meet the April Fool’s Day deadline.

Make a spousal IRA contribution for a retired spouse. Retiring doesn’t necessarily mean an end to the chance to shovel money into an IRA. If you are married and your spouse is still working, he or she can contribute up to $6,500 a year to an IRA that you own. (That assumes you were at least 50 last year; otherwise, the limit is $5,500.)

Kevin McCormally
Chief Content Officer, Kiplinger Washington Editors
McCormally retired in 2018 after more than 40 years at Kiplinger. He joined Kiplinger in 1977 as a reporter specializing in taxes, retirement, credit and other personal finance issues. He is the author and editor of many books, helped develop and improve popular tax-preparation software programs, and has written and appeared in several educational videos. In 2005, he was named Editorial Director of The Kiplinger Washington Editors, responsible for overseeing all of our publications and Web site. At the time, Editor in Chief Knight Kiplinger called McCormally "the watchdog of editorial quality, integrity and fairness in all that we do." In 2015, Kevin was named Chief Content Officer and Senior Vice President.