Income Taxes – some opportunities for reducing what seniors and/or caregivers pay

In this episode, John Ross and Lisa Shoalmire are discussing income tax implications on our senior loved-ones and their caregivers.

Episode Transcript
Lisa
Welcome to Aging Insight. I'm Lisa Shoalmire and I'm here with John Ross. And we are here to give you and our community information about issues that affect seniors and the families that are caring for seniors. John, welcome.
John
Thank you.
Lisa
Well, it's this time of year, all of us are starting to think about things with the new year, coming into things like income taxes. And it's almost time to start thinking about gathering up those documents and getting ready to file income taxes for 2013. And our seniors have particular concerns about filing income taxes and if there are any special provisions, how social security is impacted and taxed in the income tax world. So I thought we would discuss a little bit of that today. And of course, all of our discussion today is always preffaced about... Make sure you talk to your tax advisor, who may be someone that you've depended on and been with you. Or if you don't have one, certainly, you need to discuss your individual situation with a tax advisor. But we hope today that you will get some information that you can ask some good questions and gather up your information to take in.
John
Well, that's right. Especially when it comes to... If you're out there and you want to protect and preserve those very needed resources that you've accumulated during your lifetime, there's... We've talked about lots of different things about ways to protect your assets from the cost of say nursing home care, or government benefits like Medicaid, or Medicare, or VA benefits that can help keep you from reducing your estate down and maybe stretching those dollars out through your lifetime. But tax is one of those things, a lot of times people forget along the way. And they forget that if you are unnecessarily paying extra taxes or not taking advantage of tax situations that are out there, you might be losing opportunities. And therefore, you're reducing those assets that frankly you need. And so you've gotta protect them. So yeah, that's what we're gonna be talking about today.
Lisa
Well, and just so that we're clear, now remember John, we have talked about things like gift taxes and estate or death taxes on our program before, but today we are talking about income taxes. And that, of course, is the typical tax when we talk about paying taxes that most people think about. So today, now our discussion is gonna be focused on income tax.
John
Right, and one of the, probably the first things that a lot of people don't realize that's out there... So often, when we have a family member, maybe it's your parent or maybe even a grandparent, maybe it's an aunt or an uncle, but somebody that because of their age, because of their health, they now require a tremendous amount of care. And maybe you're providing a lot of the support for that person. Maybe they're living with you. Maybe they're not living with you, but you're providing that care financially or you're paying for some of that care. So one question a lot of times we'll get at this time of the year is, can I claim a parent as a dependent on my tax return?
Lisa
Well, that's right. That's not something that immediately comes to mind. Most of us certainly think about claiming a child, a minor child, or even a college-aged child that's a full-time student as a dependent. But the tax rules allow you to claim as a dependent, any person who lives in your household for whom you have provided the majority of support. And that can include a person of the older generation; a parent, a grandparent, a mother-in-law, a father-in-law. So those persons can be claimed as dependents if you meet the requirements.
John
Yeah, now one of the things that a lot of times comes up with this sort of thing is people will say, "Well, I thought that... " If you look at the rules, the rules say that the person that you're claiming as a dependent has to have very little income. And so if you were to just look up the rules, it would say that the person has to have income of less than their personal exemption amount. And the personal exemption amount varies from year to year, but it's not very much. It's only a few thousand dollars. And you might be thinking, "Well, my mom or my dad, they get social security income which is a lot more than that. They get $1,000 a month. Or maybe they get $2000 a month." Well, one thing to keep in mind, social security income, standing alone, is not taxable. So when you're looking at the person's income being below certain limits, we're talking about their taxable income. So taxable income is not going to include social security, unless of course, you have some other income like a pension, for example, or maybe interest and dividends. And if you have enough of those, your social security can become taxable. But for many people, their only income is that social security.
Lisa
Right, so it does make it really possible to claim that parent that you're caring for as a dependent. But John, even if the income level is too high of that parent or grandparent that you're caring for, and so you can't claim them as a dependent. If you are paying medical bills for that parent, grandparent, loved one that you're caring for, you may still be able to deduct the cost of those medical expenses.
John
Yeah, and that can actually come in many forms; direct payments to providers. Certainly, that's a medical expense. Maybe you're paying a portion of that nursing home care. But a lot times, family members are caring for that person in their home, and so some of the, what would otherwise be unreimbursed medical expenses, might include, for example, a share of the utilities or even the fair market value of the rent for that room that they're staying in. So there's lots of different things that could fall under expenses that you're paying for that person. And so whether or not it's claiming them as a dependent, getting a dependent's tax credit, which is different than the deduction, or whether you're just being able to take some deductions associated with things that you pay, lots of different things out there on that. So we're gonna take a quick break, and when we come back, we'll keep talking about taxes.
John
Welcome back to Aging Insight. I'm your host, John Ross, here with my co-host, Lisa Shoalmire. We're elder law attorneys and we're talking about issues that relate to seniors and people with disabilities. And specifically today, we're talking about taxes and maybe some opportunities out there for reducing the amount of taxes that either that senior pays, 'cause maybe this is you that we're talking about, or maybe you're the caregiver for this person. And so yeah, we talked about claiming a parent or other person, other adult, as a dependent if you're providing care. And so that's a big one. Now, I'll tell you, with a lot of seniors, Lisa, one of the biggest assets that I see many people have is an IRA. IRAs, where they've invested some money and that money has grown tax-free, but at some point in time, money's gotta come back out.
Lisa
That's right. You can't avoid the tax man forever. An IRA, an individual retirement account, is a... It's a pretty well-known retirement savings vehicle where you put in dollars that you're able to deduct during your working years, and you put dollars into this IRA account. And once you get to retirement age, you can then start withdrawing those funds, but the catch is, you pay income tax on those funds at the time you withdraw them in retirement. And of course, the idea is that your tax rates are lower in retirement than they were during your working productive years, so that hopefully, you are paying actually less income tax on an IRA withdraw. However, a lot of seniors, they wanna keep those IRAs intact for as long as they can, but the tax man wants you to withdraw it at some point.
John
That's right. There are some rules related to the fact that, if at the point where you turn age 70-and-a-half, if you have money in an IRA, you're required to take out a certain portion. This is what's called the "Required Minimum Distribution," the RMD. And so whether you want to or not, some money is gonna end up coming out of this IRA and that income, when it comes out of that IRA, is going to be taxable. Now, one interesting thing about IRAs is that from our standpoint, many times they can be very difficult to deal with as far as planning because we cannot use trust to shield IRAs. You can't just give them away because that creates taxes, and so a lot of times, this money has sat there waiting to be taxed.
John
And people are very nervous about pulling that money out because they know about the tax, but they're forgetting that there may be other deductions that are available to them. For example, lots of times, people have long-term care insurance. Well, long-term care insurance can be expensive, but one thing people don't realize is that that long-term care insurance, the premiums are a tax deduction. And so sometimes, maybe you don't need that RMD, so if you take that RMD, that required minimum distribution, and then use that money to pay for some long-term care insurance, you may have just offset. Yes, it's income, but you're using that income to pay for something that is a tax deduction.
Lisa
Well, and John, a lot of times when you know you're gonna have to already, when you're forced to take out those required minimum distributions, sometimes that makes a long-term care insurance policy appear a lot more affordable when you know that, "Hey, you could use IRA dollars and get a deduction for a portion of your long-term care insurance premium." Or sometimes, it makes it to where that policy... You can continue that policy in force when if it weren't for the tax deduction and the issues with the IRA. Long-term care insurance, the premiums go up and as we get older, those premiums can sometimes get out of reach. So this is a great place to get some tax savings as well as provide for your own future security.
John
Now, the other thing that a lot of times when we're talking about IRAs, many people, as they get older and the costs of their care start getting high. Maybe you're paying that in-home care provider at $15 an hour. Maybe you're living in an assisted living at $2,000 or $3,000 a month. Or maybe you're even needing skilled nursing care, what most people refer to as a nursing home, which can easily run $4,500 or more a month. One thing a lot of people also don't realize is that that too is a tax deduction. And so just to give you an example, I had a client here recently who had been... Their mother had been in a nursing home the entire year and she had paid about $5,000 a month, and so over the course of the year, we're talking about $60,000 worth of deductions.
John
And one of her assets was an IRA. And they didn't wanna touch the IRA, they wanted to leave the IRA alone because they knew that if they pulled the money out of that IRA, it would be taxable. But when I explained to them and I said, "Look, now is actually the time to pull that money out of the IRA because here we have $60,000 worth of deductions to offset against that cost." And so that IRA is gonna get taxed to somebody. Either that account holder, that parent or husband or wife while they're alive or when they pass away, then it's gonna get taxed to their beneficiaries. And so if you've got a situation where there's deductions that can be taken to offset that taxable income, now may be the time to do it. As bad of a situation is where you are looking at these long-term care costs, at least this may be an opportunity to reduce the tax burden that's hidden inside that IRA.
Lisa
Well, and John, it just goes to show you that everyone's tax situation on an annual basis is different. And a lot of seniors, one year, they don't have much in medical expense at all because of Medicare and their supplemental plans. The following year, those expenses may be quite high. So once again, you should always sit down with the tax advisor and lay out your situation and look to see what would be the best option for you in a given year.
John
That's right. And don't be afraid to try to think outside the box. I mentioned that these IRAs, you might take a portion out now, you might take a portion out later. And yes, there might be some tax consequences, but there may also be some savings opportunities because there's things you can do with those dollars once they're out of that IRA that you couldn't do otherwise. So we're gonna take another quick break and when we come back, we're gonna keep talking about taxes.
Lisa
Welcome back to Aging Insight, I'm Lisa Shoalmire, and I'm here today with John Ross. And today, we're talking about, I believe everybody's least favorite subject, which has to be taxes. And John, taxes are just inevitable and we all are under an obligation to fill out that paperwork, and get it in. So we wanted to talk to you about it today and maybe give you some information as you come into 2014, getting ready to look at your 2013 taxes. Now John, one of the biggest areas of concern, and I think confusion when it comes to income taxes, has to do with income that you earn and the taxability and how that affects your social security situation. So in our last segment, John, you pointed out that social security by itself is not a taxable income.
John
Right. But it's one of these situations where, you mentioned a second ago, and you said, "Filling out those forms," and I'll have maybe the children of somebody that is older, and the kids will come in and they'll say, "Well, Dad hasn't filled out a tax return in years. Is this gonna be a problem?" Well, it's not a problem if the only income that person receives is social security. Social security, if that's all you're receiving, is not taxable. But if you're receiving some other form of income... So for example, let's say you retired from a company and that company has a pension, or maybe you have interest and dividends, or maybe you're...
Lisa
My favorite is the oil wells and the natural gas that we've seen.
John
The oil wells, that's right. If some portion of your income is taxable, so if you've got social security and something else, well, then if that something else gets up over some limits, and it depends on if whether you're a single person, or whether you're a married couple and you're filing jointly, or if you're a married couple filing separately, and all of these other things. But it's always possible that some portion of your social security will become taxable. Now, notice I've said that they don't take away your social security. If you've reached full retirement age, even if you're working, that doesn't reduce your social security. What it means though, is that some portion up to 85% of your social security, can become taxable if you have other taxable income.
Lisa
And John, for the most part, I haven't seen a lot of situations where we've had folks who've gotten caught up in that having to pay a lot of tax back in because their earnings, in addition to their social security, were so high, a tough problem to have. But I have seen some folks who maybe they took social security early at age 62 or age 63, and they were not at full retirement age, but they still continued to work. And that's very common these days because retirement dollars just don't go as far as they used to. So you see a lot of seniors who retire early, go ahead and start collecting that social security, but yet continue to work part-time or even full-time, and that, we really can get into an issue with taxes.
John
That's right. And also, that family member who's only receiving social security, other things that we see sometimes are where they have single type income. So for example, maybe dad is a farmer and he's receiving social security, and he's got a whole bunch of cows, but as a general rule, he sells a cow, he buys a cow, he sells a cow, he buys a cow. And so the net result at the end of the year is that he has very little actual farming income. But as that care needs increase, as dad is less and less able to manage that farm, there may come a day where they say, "You know what? We're just gonna sell off all of the cows." And all of a sudden, you've got a whole bunch of income in that one year. Or maybe there's an oil well and you get that first-year bonus check in, or something else. So one thing you wanna realize is, I've had people say, "Oh, well, we're gonna sell the cows. We know we're gonna have to pay taxes on that, but we've already calculated. We know how much that's gonna be," not realizing that that income is gonna push them up high enough that it's also gonna cause some of that social security to also become taxable. And maybe that tax gets a little higher than what they were expecting.
Lisa
And this is one of those situations where sitting down with someone knowledgeable about the current tax situation, and that you can share your information with, is so helpful, because even if we're not talking about preparing your taxes for this year, we... Sitting down with someone can help you plan for the coming year. Is it time to sell these cows? How much time can you work and not affect your taxes and your social security? It's time to get those answers early in the year, so you can plan out the rest of your year.
John
Absolutely. And probably the last thing when it relates to taxes that we see pretty common, as people have aged, and maybe they've decided, "You know what? I'm gonna move into the retirement community," or, "I need to go to assisted living," and a lot of times they're looking at selling the home. But used to, for a long time ago, there was an old rule that one time during your life, you could sell a house and not have to pay any taxes on it. Some people still think that's the rule. It's not the rule any longer. Under section 121 of the Internal Revenue Code, anybody can sell a home tax-free. Now, there's a couple of rules on this, as with anything. You had to have lived and occupied that home as your primary residence for at least two of the last five years.
John
If you've lived in it for at least two of the last five years, then when you sell that home, if you're a single person, the first $250,000 of the sale of that home is tax-free. If it's a married couple, you're looking at $500,000 before you ever pay any taxes on the sale of that residence. And so I know that's a lot of times people are saying, "Well John, we're thinking about selling the house, but we don't want to have to pay a bunch of taxes on it." For most people, that's not a big concern because of these exemptions related to the sale of the house. But here is one little caution out there. Hopefully, you've watched the show before and you know not to give your house away. Don't put it in your kids' names. But sometimes people have done that, not realizing that when you put that house in your kid's name and then later they sell it, it's not their personal residence. And they might end up having to pay capital gains tax on it and lose 20% right off the top.
Lisa
Well, 20%, that's quite a bit.
John
Yes.
Lisa
Well, and so as you think about as we age, and you think about downsizing, don't let the tax on the sale of that house be the deciding factor. There are plenty of other benefits to look at in downsizing, tax-wise, maintenance and upkeep. But don't let those taxes scare you off.
John
That's right. And the old saying goes, there's only two things certain in life and that's taxes and death. Well, I'd add one other one in there, and that's aging, taxes, and death. And as you're planning for your future, plan for how you're gonna take care of yourself as you get older, and don't forget that one of the components in there is taxes.
Lisa
Well, great. It's been another great episode, and we look forward to being back with you next week.
John
Bye bye.

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