Ask Liz Weston

Get smart with your money

Taxes

Q&A: Avoid deducting personal expenses

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Dear Liz: I am the sole owner of a condo. I am getting ready to realize a dream of mine by traveling around the world. I will be gone indefinitely. Thus, I am thinking about renting out my condo. I know I get a write-off for repairs on the unit, cleaning supplies, etc. What about the storage unit where I will need to store my things from my unit. Can I write off the storage unit?

Answer: Congratulations on your upcoming adventure! You’ll have excitement enough without defending yourself in an IRS audit, so avoid deducting personal expenses such as a storage unit.

The IRS says you can deduct the “ordinary and necessary” expenses for managing and maintaining a rental property. That includes mortgage interest, taxes, operating expenses, depreciation and repairs.

“If the storage unit was used in conjunction with the rental activity, such as storing maintenance supplies for doing work on the rental property, a deduction could perhaps be justified,” says Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting.

However, you won’t be around to do that work, so deducting the storage unit isn’t going to fly.

Q&A: Taxes and Social Security

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Dear Liz: You wrote in a column about retirement plan distributions and the effect that those have on taxation of one’s Social Security benefits. Your example was if someone made over $44,000 in combined earnings then their benefits would be taxed at 85%. Does this apply if one waits until full retirement age to start drawing Social Security? My husband also will be required to start making required minimum distributions in 2023. Are those distributions taxed differently from the rest of our income, since we are both still working? Or does it matter whether we are working or not?

Answer: The taxation of Social Security is complicated and often misunderstood, but rest reassured that you won’t lose 85% of your benefits. If you have income in addition to Social Security — whether it’s from work, retirement plan distributions or other sources — then up to 85% of your benefit might be subject to tax at your ordinary income tax rate.

The earlier column mentioned that taxes on Social Security are based on your “combined income,” which is your adjusted gross income — the figure you report on Line 11 of your 1040 tax returns — plus any nontaxable interest and half your Social Security benefits. Single filers who have combined income between $25,000 and $34,000 may have to pay income tax on up to 50% of their benefits while those with combined income over $34,000 may pay tax on up to 85% of their benefits. Married couples filing jointly may have to pay income tax on up to 50% of benefits if their combined income is between $32,000 and $44,000. If their combined income is more than $44,000, they could owe tax on up to 85% of their benefits. You can read more about how Social Security benefits are taxed on the agency’s website.

Your benefits can be taxable regardless of when you start. However, researchers have found that many middle-income people pay less taxes overall if they delay Social Security and tap their retirement funds instead. You can read more about the “tax torpedo” on the Financial Planning Assn. website.

Your husband’s required minimum distributions will be taxed as income unless he made nondeductible contributions to those retirement plans. If he did make after-tax contributions, then a portion of his withdrawals would not be taxed. Most people got a tax break for all their contributions, however, which means all their withdrawals are taxable.

A tax pro can look over the specifics of your situation, help you estimate your tax bill and make sure you have sufficient withholding to avoid penalties.

Will you face a tax bomb in retirement?

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Good savers, beware. The money you’re stuffing into your 401(k) and other retirement accounts has to be withdrawn someday. If you’re not strategic about how you save, you could face unnecessarily high tax bills and inflated Medicare premiums in retirement — plus, you could be saddling your heirs with higher taxes.

The earlier you start defusing this potential tax bomb, the better. But even people in their 60s or early 70s may have opportunities to lessen the potential damage — as long as they act swiftly.

In my latest for the Associated Press, learn how to lessen the potential tax bomb in retirement.

Q&A: Is the ‘tax torpedo’ coming for you? Here’s what you need to know

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Dear Liz: I am pondering the best time to begin drawing Social Security. I have no debt, am 61, retired and fortunate enough to have retirement funds that are projected to last until I’m 95 without Social Security. That said, when I begin drawing Social Security, I understand I am likely to get taxed at the full 85% rate based upon the monthly income I receive. Does it make sense to hold off on applying until 67 or later knowing that I’ll be taxed more on the higher income, or should I draw sooner, understanding the tax liability would be less? Or, when I begin receiving Social Security, would I cut back on the amount of retirement funds I receive monthly?

Answer: The way Social Security benefits are taxed is somewhat convoluted and easy to misunderstand. Just to be clear: You would never lose 85% of your Social Security benefit to taxes. But if you have income outside of Social Security, up to 85% of your benefit can be taxable at your regular income tax rates.

The taxes are based on what’s known as your “combined income,” which is your adjusted gross income plus any nontaxable interest plus half of your Social Security benefits. If you’re single and your combined income is between $25,000 and $34,000, up to 50% of your benefits may be taxable. If your combined income exceeds $34,000, you may owe tax on up to 85% of your benefits.

If you’re married filing jointly, combined income between $32,000 and $44,000 could trigger taxes on up to 50% of your benefit. If your combined income is more than $44,000, up to 85% of your benefit may be taxable.

Because of this unusual structure, people can face what’s known as a tax torpedo, which is a sharp rise and then fall in their marginal tax rates. If your income is high enough, you won’t be able to avoid the tax torpedo.

However, many middle-income people can mitigate its effects by delaying Social Security and drawing down their retirement funds instead. You can get some understanding of how this works by searching on the phrase “tax torpedo.”

For a more in-depth analysis, search for the research paper by William Reichenstein and William Meyer titled “Understanding the Tax Torpedo and Its Implications for Various Retirees.”

Consider discussing your situation with a fee-only financial planner who can model different scenarios and give you personalized advice.

Q&A: Inherited IRA taxes

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Dear Liz: I have about $16,000 in a Roth IRA that I plan to leave to my daughter. When she collects this on my death, does she pay tax on the withdrawals?

Answer: No. She would have to pay taxes on withdrawals if the money were in a regular inherited IRA, but not if the money is in a Roth. She will be required to withdraw the money within 10 years, though. Congress eliminated the so-called “stretch IRA” for most inheritors, so non-spouse beneficiaries can no longer stretch withdrawals over their own lifetimes.

Q&A: Consider taxes before retirement

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Dear Liz: I began converting two 401(k)s from previous employers to Roth IRAs. To lessen the huge tax hit, I decided to do the conversions over the course of seven years. Even with that, the tax hit is higher than I realized and too painful. Now that partial conversions have begun annually, am I required to complete the total conversion to 100%? Or can I stop midway and leave the remainder in the original accounts? Also, is there an age limit before which Roth conversions must be completed?

Answer: You don’t have to continue making conversions. (Before 2018, you could have even reversed conversions you already made, but that’s no longer possible.) There’s also no age limit for conversions, but the older you get, the less likely conversions are to make financial sense.

Conversions are a good bet if you expect to be in the same or a higher tax bracket in retirement. If you’re young and in a low tax bracket now, you can reasonably expect that to be the case.

As you approach retirement, though, the opposite may be true. Many people find their tax bracket drops once they retire. Why pay a big tax bill now if you can access the money at a lower tax rate later?

Then again, if you’re a good saver, you may discover you’ve accumulated so much that your tax bill will soar once you’re required to start taking minimum distributions at age 72. If that’s the case, then converting some of your retirement money might save you on taxes overall.

But you’ll want to discuss this with a tax pro or financial planner who can model how the conversions are likely to affect your overall finances, including any Medicare premiums, since those can increase with income.