Tales from Tax Season

Steven Jarvis:     Hello everyone, and welcome to the next episode of The Retirement Tax Podcast. I am your humble co-host, Steven Jarvis. And with me as always, is the wonderfully talented, Benjamin Brandt.

Benjamin Brandt:         Oh, Steven, I look forward to our recording times. I always have a blast and I suspect today will be no different.

Steven Jarvis:     Yeah, I’m really excited for today’s episode because I get to talk about real life situations where I get to help tax payers. And so, at the end of the day, that’s one of the things I really like about both what I do within my business and what we do together, is that it has an impact on people.

Benjamin Brandt:         Absolutely.

Steven Jarvis:     So, this is being aired on April 15th, which this year is not Tax Day. You have a couple days left, if you really want to use your weekend to try to force your tax return through. We get to file taxes on April 18th this year, lucky us.

But since we are most of the way through tax season, we filed all sorts of returns already, including some for some of your clients, Ben, that was a lot of fun to do this year.

Benjamin Brandt:         Absolutely.

Steven Jarvis:     And so, we wanted to just kind of share some things, the questions that came up, things that we were able to educate clients on, help clients on this year as we wrap up tax season.

Benjamin Brandt:         Excellent. So, Steven, you’ve got a story for us about some expert witnesses and some inside information that we can learn from that you’ve learned?

Steven Jarvis:     Yeah. So, I had the opportunity — one of the tax payers I worked with this year, he has retired but still, because of his expertise in his field, still gets pulled in as an expert witness on things, which I thought was fascinating. That’s one of those things that I would love to be able to add to my bucket list someday that I was an expert witness.

Benjamin Brandt:         Absolutely, absolutely.

Steven Jarvis:     But this came up because he had some income this year that was a little bit different, which is something I’m always on the lookout for, of what’s changed to make sure that we aren’t just paying our taxes and moving on, but we’re taking a step back and saying, “Is there something else I can do here to make sure that I’m not leaving the IRS that tip that we don’t want to?”

And so, what we were able to do in this situation is … he was an expert witness in a very specialized field, it was an area of interest for him. And so, he is a member of different professional associations and has different subscriptions so he can stay current on this field that’s most years is just of interest to him. He’s retired, quite often he has no income associated with this.

And so, every other year, this is almost more of a hobby for him, something he likes to do and so he spends money on it that doesn’t show up on his tax return anywhere. But this last year, since he had income that was directly associated with his expertise, that he is staying current on, we were able to go in and be able to offset some of that income with these different expenses that he incurs.

And so, even though his time as an expert witness was primarily just him committing time to this, there wouldn’t be any obvious expenses associated with that. We talked through and said, “Okay, what else do you do to be able to stay current, to be able to actually be this expert, to earn this income?”

Benjamin Brandt:         And where could we apply that in other areas? You know, I’m thinking about a conversation I had with a listener of my podcast a few months ago, and he plays in a band, and they get paid to play in a band.

So, then I started thinking, okay, well, how can we possibly turn this into something where we could maybe find some deductions? You know, we’re driving to gigs, maybe we’re buying instruments, maybe we’re taking lessons, maybe we’re sort of coordinating. Where do we want to travel in retirement, and maybe we could play some gigs there?

What would be some tips if someone is thinking about monetizing a hobby? Do they have to get an LLC? Like are there kind of some best practices like you experienced with this listener?

Steven Jarvis:     Yeah, really where we need to start is just having a way to keep track of the expenses we’re incurring. We don’t have to have an LLC, we don’t have to have a formal business license to be able to deduct expenses. If this is going to be more than a hobby, I mean, there’s some legal reasons and some state rules and things like that we probably need to look into.

But yeah, if we’re just talking about kind of a side hustle or a hobby that we’re monetizing, I like to start with anytime I’m seeing new income on a taxpayer’s tax return, as far as where it’s coming from, always want to step back and say, “What were the expenses associated with this?”

Not “Were their expenses …” because I’d be happy for someone to prove me wrong. I can’t think of situations where you’re incurring income that I can’t think of an expense that came along with it, to some degree. Not that we can offset all of it or necessarily even most of it.

But I always pause when I see someone giving me information that only has income and no expenses. So, having a way to track it is where we’re going to start.

Benjamin Brandt:         Okay. So, where we see pluses, we should be thinking, where are the minuses?

Steven Jarvis:     Yeah.

Benjamin Brandt:         Okay. So, what would be some tips? Are we keeping track? Is this something with a credit card or online bank statement, or we’re making an Excel sheet? Or we’re keeping track of expenses with the idea of somebody might have questions about this, years down the road after we’ve long forgotten the specific details?

So, maybe we’re taking pictures of receipts that there could be some real basic things that we’re doing, I think?

Steven Jarvis:     Yeah, those are all great recommendations, especially if this is a hobby you’re monetizing or like the taxpayer I worked with; this isn’t something he regularly does. So, we’re not setting up to separate bank accounts, you’re not necessarily getting a separate credit card.

But part of the reason we’re talking about this on April 15th, even though it’s going to be several months from now before you’re filing your taxes again, is that this is going to be a lot easier to track as you go along, as opposed to trying to go back and think, “Oh, well, what was I spending money on 12 months ago?”

And so, even if you only think there’s going to be a chance that your hobby gets monetized or there’s this additional income, take the extra few minutes as you’re reviewing your expenses for the month to flag them, either an Excel sheet, on your credit card statement (a lot of banks have the ability to add comments to your activity), and just kind of take some of those notes as you go along, to say, “Okay, when I get to the end of the year, this is going to make my life so much easier.”

Benjamin Brandt:         Excellent.

Steven Jarvis:     Yeah. So, that was one that was kind of fun for me of being able to work with someone who’s an expert witness. Hopefully, I’ll get my turn someday.

Another question that came up this year really specific to a taxpayer said, “My wife retired in February and then started taking social security, but wanted to see if we could still contribute to an IRA. Is that possible?”

And I love it when tax payers come to me with these questions, it shows us that they’re proactively thinking about these things. It also, to me, really reinforces why Google isn’t as helpful as we think it is sometimes because I always like to go on Google questions that I get just to see how much more helpful I am than Google (maybe that’s just a personal thing).

But as I went and tried to find the answer on Google, I had to sift through pages and pages, most of them paid advertisements, to get to what would’ve been a mildly helpful answer. As opposed to they come to me, and in just a matter of a couple of minutes, I can say, “Okay, here’s how we should think about this in your situation.”

Benjamin Brandt:         I do the same thing. I often Google things because I’m thinking about the podcast, I’m thinking about other things, and sometimes I’ll find the perfect answer to the question. And then I’ll look at the top of the article on it, it says June 1st, 2012, and I’m like, okay, great. Now, I have no idea if this is still valid. It’s the perfect answer to my question, but it’s 10-years-old, now what?

Steven Jarvis:     Yeah, so not to leave everyone hanging in suspense too much: the answer to the question is that claiming social security does not affect your eligibility to contribute to an IRA. In fact, if you go through a flow chart of not just can I contribute to an IRA, but will be deductible — social security is nowhere on there.

We have to start with if we had earned income. And so, since the wife hadn’t retired until February, they worked for the first part of the year, they did have some earned income, and so social security is not a limiting factor on being able to make those contributions.

And thankfully, they came to me early in the calendar year, so we were actually able to still go ahead and get those contributions made for 2021, even though the calendar year had turned over.

And so, again, I bring this story up to illustrate that we need to be thinking about taxes outside of that February, March, April timeframe so that we can plan ahead for these things and know what opportunities are available to us.

Benjamin Brandt:         Excellent. So, I understood you recently answered a question about medical expenses, the deductibility of medical expenses, and specifically some dental work. Tell us about that.

Steven Jarvis:     Yeah. So, Ben, I’d love your thoughts on this as well. You work with a lot of retired individual or a lot retired family households. I feel like this comes up more often. As we all age, we get these lovely opportunities to have different medical expenses. I wish they were less common.

But I feel like I get this question a lot more often with my pre-retirees, retired clients, of, “Hey, we had this batch of unexpected medical expenses, but I seem to remember that I can deduct them on my taxes, so here’s all the information, or like let me know how much money I saved on taxes by incurring these medical expenses.”

And so, this is a point of clarification I often get to make with taxpayers, of not only do we start by saying, do you itemize your deductions or take the standard deduction, keeping in mind that 90% of taxpayers take the standard deduction. But for medical expenses, we also have a floor we have to deal with.

And so, the IRS, even if you can itemize your deduction, the IRS is not so generous to say, every dollar you spend at the doctor gets to be tax deductible. And so, we have this floor that is 7.5% of our AGI. And so, for a lot of us, that becomes a threshold that is a little bit challenging to get over.

We certainly want to be able to have an idea of what we’re spending on medical expenses during the year, and so that if we have a year where they are higher, we can at least take a look.

And so, that’s what I always tell tax payers is great, yeah, let me know what your ballpark number is for the year. If we’re close to that number, we’ll probably dig into the details a little bit more and see what we can get in there. But quite often, it doesn’t end up being something we can deduct.

And what adds to that is that the IRS does not like double dipping. In fact, they prohibit it in most every case. And where that’s relevant here is that medical expenses you have paid through your HSA are not eligible to be included in that amount that we would potentially add to our schedule and into our itemized deductions.

Benjamin Brandt:         Right, it’s kind of a difficult thing to explain to clients. Yes, your medical expenses are deductible, but they’re unlikely to be deductible. So, in theory, we could deduct them, but it gets more difficult. The higher income is, it gets more difficult.

Many times/most of the time, a lot of these big costs are offset by insurance. So, the higher income is, 7.5%, 7,500 per a hundred thousand — if you have a high income, you need a similarly large sized deduction, similarly large size expense to kind of get you through that minimum table ante of 7.5%.

And I’m particularly disadvantaged because I swear back in 2011 when I passed the CFP exam, that it was 10% AGI floor, and so that 10% is just permanently lodged in my brain. I can’t get the 7.5% to dislodge it. But I guess that’s just my own personal issues.

But I have six kids: I’ve only ever had one year that I can think of, I think it was 2019 where I actually was able to deduct medical. And that was a braces year, that was many multiple trips to our children’s hospital out of state where we could deduct some plane tickets and things like that but we just barely made it over the 7.5%.

But especially when the kids move out, if you’re approaching retirement, it’s a tricky thing. So, in theory, it’s deductible; in practice, your standard deduction is very likely going to be better. So, that’s the route to take.

But if you have a year where maybe you made a large donor advised fund contribution, if we’re early on in the year to say, “Hey, I think we’re going to itemize this year,” maybe that’s the year that we start to do some of these things where we can try to jump over that 7.5%, we’re bunching some of these things together in an attempt.

Now, we don’t want you to get a hip replacement just because you’re trying to itemize, we want you to actually need the surgery. But it’s just like anything else with retirement planning and tax planning; the further ahead we plan, the better chances we have of saving some money and sanding off these rough edges of this big retirement tax bill.

So, if there’s something that you’ve been maybe putting off and you’re like, “Ah, I think I’m going to itemize this year anyway,” this might be the year to do it. So, I don’t know, we could throw out a wide net, but teeth often come up because it’s an easy thing to procrastinate. But if my spouse and I both do it in the same year, maybe we could start to scratch that 7.5%. So, something to think about.

Steven Jarvis:     Yeah. And the most recent example of this came up, it was a couple who they had both had to some dental work done, and I think really, they were just hoping that there was some silver lining to the pain, both financially and the pain of having the work done.

Benjamin Brandt:         There was silver lining, it was just … it was in their mouth.

Steven Jarvis:     Yeah, this is an area that always just kind of prompts me to throw out this reminder that I am just not a fan of the word “write-off” when it comes to taxes because I think it gives us the wrong idea or kind of the wrong emotion associated with it, that I’ll have people say, “Oh, well, I can write that off” and it kind of is treated almost like this great thing, this free thing.

Potentially, tax deductible is how I like to describe things, to your point before. Well, yes, medical expenses are potentially tax deductible, but we need to evaluate some other things first. It’s not just a dollar for dollar.

Benjamin Brandt:         Yeah, write-off is interesting because the term “write-off,” it almost reminds me of like credit card points, like airline miles. It’s like, well, I can spend impulsively because I’m getting airline miles. Or I can spend impulsively because it’s a write-off.

Well, your effective tax rate is like 15 … you’re getting a 15% discount based on where your taxes are. You’re still losing 85% of that. So, we still want to spend intentionally whether we’re getting airline miles or a write-off. But the word “write-off” in my mind triggers that, “Well, I can spend impulsively or I can spend flippantly.”

Don’t do that, don’t do that — you’re still losing the other half of what you shouldn’t have spent in the first place potentially. So yeah, don’t use write-off as a get-ot-of-jail-free for kind of violating your own personal budget or whatever that might be.

Steven Jarvis:     Yeah. Like so many things, we got to remember that taxes should be a consideration, they should not be the driving force. Passenger on the bus, not the driver.

Benjamin Brandt:         Right. So, you could save a lot of money by buying a brand-new pickup truck every year to offset income, but you’re investing and depreciating assets. So, you’re not doing well. But that comes up all the time is like, “Well, shouldn’t I just have a whole bunch of expenses this year so that I don’t have to pay taxes?” Well, that’s not going to work out long term for you.

Steven Jarvis:     Yeah, Ben, I’ll make you the same offer I make to lots of people; if you’d like to give me a dollar for me to give you 15 cents back, I will do that all day. We can do that for as long as you want. You give me as many dollars as you want and I’ll give you 15 cents back every time.

Benjamin Brandt:         Yeah, there’s the famous example there with mortgage too. I got to keep my mortgage because it’s a deduction. Well, in many cases, it’s not anymore. 90% claim standard, but yeah, send me a dollar and I’ll send you 10 cents back all day long.

Steven Jarvis:     Yeah, alright. Let’s switch to a listener question here. Listener asks “With investments issuing dividends, how can I ensure before the end of the year that I am not crossing IRMAA surcharge income levels? In other words, is there a way to ensure that my income is such that I don’t accidentally cross an income criterion?”

And so, of course, with IRMAA, we’re talking about Medicare premiums that get adjusted based on our income levels. So, Ben, I would imagine that this is something that comes up for you with your clients given their age. So, how do you answer this for clients?

Benjamin Brandt:         Well, I wouldn’t say that there is a for sure way — how can I ensure that I won’t? You can’t ensure. This kind of a game of horseshoes, we’re trying to get as close as we can.

Dividends aren’t usually the issue. Sometimes, it’s capital gain distributions that we weren’t fully anticipating and throws us a file. So, we’re probably not trying to get right up to the edge of that IRMAA amount just because there’s things that can’t be anticipated.

If you’re investing in a dividend-heavy portfolio, you should be able to go to Google or Morningstar and get an approximate dividend yield. And so, if it’s a 3% dividend yield and you’ve got $100,000, you can say, “Okay, I’m probably going to get 3%, $3,000 worth of income from this fund.”

And then you just build that into your tax projection just like with IRA withdrawals or your pension social security, plus 3,000 of dividend, whatever it would be. So, they could cut the dividend — if it’s a mutual fund, they could invest in a company that has more dividends, that could be special dividends.

There’s really no way that you could, on January 1st, say, “This is exactly what I’m going to get out of my dividend fund.” Maybe if it’s just that one individual stock of a utility that’s paid that for years, you could calculate out more accurately. But you’re probably in best guess territory, I think.

Steven Jarvis:     Yeah, I agree. I haven’t come across a way that we can ensure that, but it does just reinforce what we talk about as far as taking the time to at least estimate, okay, what do we expect for this next year? And if we’re going to be real close and we can see that based on the expected dividend yields, maybe we take time to do some other things.

We either say, do we accelerate some of our planned giving so that we make sure that we give ourselves a bigger cushion and stay under that threshold? Or do we say, you know what, we’re probably gonna be slightly over it, do we go ahead and an extra Roth conversion this year and just fill up that next IRMAA bracket?

There’s some things we can do, but anytime we’re looking to the future, this is doing the best we can with the information we have. If you’re working with a tax repair or financial planner who is guaranteeing that for you, that might be a red flag.

Benjamin Brandt:         You know, this is so simple, I almost hesitate to say it, but it’s so effective. When I see IRMAA and I’m getting close to IRMAA and things like that, I think emergency fund, emergency fund outside of your IRA. Because one of the simplest things we can do is just not take an IRA distribution in December.

You know, if you’re taking out 5 … $10,000 a month and we look at our November statement, it says, geez, we’ve taken out … we’ve got $8,000 in dividends that we didn’t think about — well, let’s just not take an IRA distribution, let’s tap outside of your IRA emergency savings at last month. And that can sort of be our mulligan that we can offset 112, potentially of our income by skipping that last month.

So, great reason to have three to six months of retirement income outside of all retirement accounts fully free and clear of taxes, not earning you much yield in a savings account, but it’s not the job of that. It’s more of an insurance policy than it is an investment vehicle. It’s so simple, again, I almost hesitate to say it, but skip December’s payment.

If you think you’re right up to the edge of that IRMAA, that IRMAA is going to follow you around for an entire year. Skip December’s payment and thank me later.

Steven Jarvis:     Well, perfect. Ben, that’s a great answer. Appreciate that. I think that’s everything we had for today. So, thanks everybody for listening. And until next time, remember to not let the tax man hit you where the good Lord split you.