Tax Planning for Retirees

Miscellaneous Developments Affecting Retirees

Tighter Restrictions on Medical Expense Deductions. – The tax law imposes overall
limitations on the deduction of medical expenses. In the past, a retiree could deduct aggregate medical expenses for regular tax purposes only to the extent they exceeded 7.5% of adjusted gross income, and could deduct such expenses for alternative minimum tax (AMT) purposes only to the extent they exceeded 10% of adjusted gross income. After 2012, the deduction threshold permanently increased to 10 percent for regular tax purposes. However, it remained at 7.5 percent for taxpayers 65 and older for tax years through 2016. The AMT threshhold remained at 10 percent for all taxpayers.

(The Patient Protection and Affordable Care Act of 2010, Pub. L. No. 111-148, § 9013.) See Chapters 15 and 18 of the treatise for discussions of  a retiree’s medical expense deductions.

Relief from the New Tax on Net Investment Income. – To help fund Medicare and other government healthcare subsidies, Congress has imposed a 3.8 percent tax on net investment income for years after 2012. The investment tax applies to the lesser of (1) net investment income or (2) the excess of modified adjusted gross income over a threshold amount. The threshold amount is (a) $200,000 for an unmarried individual, (b) $250,000 on a joint return or for a surviving spouse, and (c) $125,000 for a married person filing a separate return.

Net investment income includes interest, dividends, annuities, royalties, rents, and net gains from disposition of nonbusiness property. However, net investment income does not include social security benefits or distributions from IRAs, qualified retirement plans, or eligible state/local government plans. Furthermore, the IRS has indicated that most distributions from nonqualified retirement plans are excluded. Unfortunately, other types of retirement income are not exempt (e.g., income from personally purchased retirement annuities). (I.R.C. § 1411; Treas. Reg. § 1.1411-1, 8.) See Chapter 19 of the treatise for a more complete explanation of the tax on net investment income.

No Income Exclusion for Former Spouse Receiving Workers’ Compensation Under a QDRO. – Workers’ compensation benefits are generally excludable from gross income. However, the exclusion is not available to a spouse or former spouse who receives workers’ compensation payments under a qualified domestic relations order (QDRO). (Fernandez v. Commissioner, 138 T.C. No. 20 (2012).) See Chapter 13 of the treatise for a discussion of workers’ compensation benefits.