The taxman still cometh
Just because you're retired doesn't mean the IRS has gone away
Taxpayers may retire, but the tax collector never rests. Nevertheless, the tax code by and large favors the elderly. "Lower income may qualify you for new or bigger tax breaks, and there may be deductible expenses, such as for medical care, that you didn't have before," notes Bernard Kent, a personal financial services partner at PricewaterhouseCoopers, the giant tax and auditing firm.
Some seniors may even find they owe no income tax at all, thanks to various special exemptions and deductions. Others may find they can now use the simpler 1040A form if, for example, they had been claiming itemized deductions but now opt for the standard deduction, which is higher for those 65 or older. For 2004 returns, the fixed standard deduction is $6,050 for a single senior, $11,600 for a married couple in which both spouses are 65 or older, and $10,650 for a couple in which only one spouse is 65 or older. But few things in the tax laws are straightforward. Here are some twists to keep in mind.
What happened to withholding? Your employer may have handled most of your tax payments. Retirees must adjust to not having tax withheld on income from investments, bank accounts, pensions, and Social Security. The danger is both a big bill when you file your return and a possible underpayment penalty.
You can ask that tax be withheld from Social Security if you expect your benefits to be taxed. In other cases, such as pensions and annuities, tax is usually withheld unless you elect otherwise. Quarterly estimated tax payments, using Form 1040ES, can take the place of withholding. If you are 62 or older and a new retiree, the IRS may waive a penalty if you claim extenuating circumstances. That's done on Form 2210.
Social Security's bite. It may seem like the unkindest cut to retirees who have put after-tax cash into Social Security all their working lives, but Uncle Sam may also take a bite out of the benefits they now receive. Depending on income, as much as 85 percent of Social Security benefits may be subject to possible income tax. In general, you'll be among the 1 in 3 beneficiaries hit if your adjusted gross income (AGI), plus tax-exempt interest from, say, municipal bonds, plus half your Social Security benefits add up to more than $25,000 for a single person and $32,000 for a couple. Working part time? Sorry, you'll also have to pay normal Social Security tax on those earnings. And, if you retired before 65, you'll lose $1 in benefits for each $2 earned above a limit of $11,640 in 2004.
Paying the doctor. It may be cold comfort, but seniors with newly modest incomes and sizable unreimbursed bills may find it easier to get over the tax code hurdle that limits medical expense deductions to the amount by which they exceed 7.5 percent of AGI. Items such as tooth implants and bridges, hearing aids, glasses, nursing expenses, and premiums for Medicare and other health insurance can add up. Modifying a home could possibly qualify as a deductible expense--a stairway chairlift for someone with a heart condition, perhaps. Even a pool might partially qualify as physical therapy, but you may have to argue with the IRS if you get audited. Note: Depending on your income, only some or none of Social Security benefits have to be included in AGI when calculating the 7.5 percent threshold.
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