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Numbers Game

Richard Connor

IT’S TAX SEASON—not something many of us look forward to. Although HumbleDollar’s readers may be ready and willing to tackle their own taxes, many others approach Form 1040 with dread. I’ve seen that firsthand.

This has been my second year as a certified volunteer tax counselor for the AARP Foundation’s Tax-Aide program, which offers free tax preparation for low-to-moderate income taxpayers, especially those age 50 and older. Earlier this year, Tax-Aide was providing this service at nearly 5,000 locations nationwide, but the program has been shut down because of the coronavirus. With the extension of the filing deadline from April 15 to July 15, AARP will  attempt to restart the service as soon as it’s allowed.

Last year, as a new volunteer, I had three or four days of training and had to pass three tests. This certified me as an advanced counselor, qualified both to complete tax returns and to check returns generated by other counselors. In 2019, I worked three days a week at two different centers.

My first year was an eye-opening experience. Although I was comfortable doing my family’s tax returns, and familiar with TurboTax software, doing a complete stranger’s return was stressful. Most of the clients were senior citizens with modest incomes. Many were widowed. Some were even my neighbors.

I quickly realized there were areas of the tax code I’d never encountered, but which were important to my clients. Many of these provisions apply as we head into retirement and get into our 60s. Others are more important to lower income taxpayers, as well as those with elderly parents.

For example, Pennsylvania has a tax forgiveness provision for lower income taxpayers. Depending on your income and family size, you may qualify for a refund or reduction of your Pennsylvania income tax liability. But the software we used didn’t automatically check to see if a taxpayer was eligible. Instead, you had to manually initiate the calculation.

On one of the first returns I completed, a senior counselor gently informed me that I should have checked for state tax forgiveness. It turns out the client was eligible, and it wiped out a state tax bill of several hundred dollars. I learned to check for this every time, even if I thought a client probably wouldn’t qualify. This is the kind of tax provision that a new retiree may be eligible for, but not know about.

I quickly realized how much people count on the various credits, refunds and rebates available. Folks get used to being eligible for these things and, if something changes, it can be a big shock. One of my worst days involved explaining to a single mother that her oldest son had “aged-out” of eligibility for the earned income tax credit, and that her refund would be significantly less than the previous year’s. The issue: Her 19-year-old had taken a semester off and wasn’t considered a fulltime student. Children older than 18 and under 24 must be a fulltime student for at least five months during the year to qualify. Like many interconnected parts of the tax code, his decision to take time off had a major impact on his mother’s tax situation.

I discovered that one of the biggest sources of confusion were the many definitions of income. The federal and state tax codes have multiple definitions. Take Social Security. If you claim benefits before your full Social Security retirement age of 66 or so, you’re restricted in how much income you can earn before your benefit is reduced. For this purpose, the tax code uses earned income from a job or self-employment. Your spouse’s income doesn’t come into play.

The tax code, however, uses a completely different definition of income when determining if a portion of Social Security is subject to income taxes. To see if your benefits are partially taxable, you calculate your “combined income.” What’s that? It’s your family’s adjusted gross income, plus municipal bond interest and half of your Social Security benefit.

Timing is also an important concept in taxes. Many provisions are tied to the taxpayer’s age. For example, at 65, a taxpayer’s standard deduction goes up.

You can also take certain actions up to the tax-filing deadline—July 15 this year—that’ll impact the previous year’s tax return. Perhaps the best known of these provisions is the ability to fund an IRA for the prior year right up until July 15. You can use this flexibility to trim your taxes, potentially turning a tax bill into a refund. If you time it right, you could even file your taxes, claim a deduction for an IRA contribution, get your refund and then use that refund to help make the previous year’s IRA contribution.

I even saw how a late IRA contribution could help a family with the premium tax credits available for health insurance under the Affordable Care Act. Those tax credits can reduce monthly premium payments for health insurance bought through one of the health care exchanges. The amount of the premium tax credit is based on that year’s expected adjusted gross income and how it compares to the official federal poverty level.

When preparing one family’s tax return, it became apparent that their income was significantly more than they’d estimated at the beginning of the prior year, when they claimed the credit. In fact, they had passed the upper income limit of 400% of the federal poverty level. That meant that all the premium credits they’d received the previous year had to be reimbursed. By running some calculations, the counselor showed that—if the couple made the maximum IRA contribution—it changed their multi-thousand-dollar tax bill into a modest refund.

Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. Rick enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. His previous articles include Should You Sell, This Too Shall Pass and Think Like a Retiree. Follow Rick on Twitter @RConnor609.

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