If you are a senior or retired, be sure to understand and take advantage of the deductions available to reduce your income taxes each year. Here are some of the most important tax deductions.
1. Standard deduction. Every taxpayer can either take the standard deduction or itemize his or her personal deductions on IRS Schedule A. You should take the standard deduction if your personal deductions (primarily home mortgage interest, real estate taxes, charitable contributions, and medical expenses) are less than the applicable standard deduction. The Tax Cuts and Jobs Act, the massive tax reform law that took effect in 2018, roughly doubled the standard deduction. As a result, about 90% of all taxpayers, including the elderly, will take the standard deduction.
Anyone 65 and older by December 31 of the tax year is entitled to a higher standard deduction than younger folks. You can claim the higher deduction only if your spouse is older than 65 and you file a joint return.
2. Medical and dental expenses. Medical and dental expenses are often one of the largest expenses for retired people. Fortunately, some of these expenses are deductible if you itemize your personal deductions. These include health insurance premiums (including Medicare premiums), long-term care insurance premiums, prescription drugs, nursing home care, and most other out-of-pocket heath care expenses.
If you itemize your deductions, medical and dental expenses are deductible from your income taxes on Schedule A of your tax return. However, they are subject to a limit. For 2018, the limit is 7.5% of a taxpayer's adjusted gross income (AGI), meaning that only those expenses in excess of 7.5% of a taxpayer's AGI are deductible. For example, if someone's 2018 AGI is $100,000, only those medical and dental expenses above $7,500 (7.5% x $100,000 = $7,500) would be deductible.
The rules for deducting medical and dental expenses change starting in 2019. For that year and later, only medical and dental expenses in excess of 10% of a taxpayer's AGI are deductible.
To learn more, see Nolo's article Deducting Medical Expenses and IRS Publication 554, Tax Guide for Seniors (available on the IRS website).
3.Charitable contributions. Retirement is a time many people think about giving back to their community by making charitable contributions. Such contributions are deductible as itemized deductions; however, they are subject to special limitations. Cash contributions of up to 60% of your adjusted gross income are deductible each year as an itemized deduction.
If you donate property other than cash to a qualified organization, you may generally deduct the fair market value of the property. If the property has appreciated in value, however, you may have to make some adjustments. However, if you donate a car, boat, or airplane, your deduction generally is limited to the gross proceeds from its sale by the charitable organization. This rule applies if the claimed value of the donated vehicle is more than $500.
Because charitable contributions are only deductible if you itemize, you may wish to bunch your contributions into a single year so that you have enough personal deductions to itemize. For example, you could make substantial charitable contributions in one year, and make none at all for one or more following years.
4. Selling your house. Retired people often sell their homes to move into smaller places or retirement communities. If you've lived in your home for a long time, you probably have substantial equity and will earn a large profit on the sale. Fortunately, you may not have to pay any tax on your profit. As long as you live in your home for at least two out of the five years before you sell your house, the profit you make on the sale -- up to $250,000 for single taxpayers and $500,000 for married taxpayers filing jointly -- is not taxable.
(For more on this, see Avoiding Capital Gains Tax When Selling Your Home: Read the Fine Print.)
5. Retirement plan contributions. Just because you are retired or semi-retired doesn't mean that you can't make tax-deductible contributions to retirement plans such as IRAs. Those over 50 have higher contribution limits for traditional IRAs, Roth IRAs, and 401(k)s.
Or, you may prefer to contribute to a Roth IRA. You'll pay taxes on the income you contribute now, but the withdrawals upon retirement are tax-free. This means no tax need be paid on all the interest or other income earned by your Roth IRA investments.
Retirees with their own businesses may also establish SEP-IRAs, Simple IRAs, Keogh plans, and solo 401(k) plans that have higher contribution limits for those over 55.
6. Business expenses. Many retirees continue to run their own businesses or start new ones. For example, some retired employees work part-time as a consultant for their former employers and other clients. Having a business (whether full- or part-time) is a great way to get tax deductions. You may deduct from your business income all the necessary expenses you incur to do business, so long as they are reasonable in amount. This includes business travel, the cost of business equipment such as computers, and outside or home offices. If you incur a loss from your business, you may be able to deduct it from other income you earn, such as retirement income. Find out more in Nolo's section on Business Tax & Deductions.
To learn more about tax deductions for seniors, see Nolo's Essential Retirement Tax Guide, by John Suttle, CPA and Twila Slesnick, PhD.