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OUR INCOME TAX SYSTEM is based on voluntary compliance. Taxpayers are responsible for reporting all their income and paying the required taxes.
In assessing tax returns, the IRS differentiates between tax avoidance and tax evasion. Tax avoidance is “an action taken to lessen tax liability and maximize after-tax income,” while tax evasion is “the failure to pay or a deliberate underpayment of taxes.”
What are the major sources of tax evasion? Under-reporting income seems to be No. 1. I’ve observed retirees who are supplementing their income by driving for local transportation companies. They only accept cash and don’t provide receipts. I’ve also heard stories about homeowners in our beach town who rent out their vacation properties for cash and don’t declare the income. And I often wonder about local businesses that only accept cash.
Claiming credits or deductions to which you aren’t entitled is another form of tax evasion. I’ve seen retirees try to claim an adult child or elderly parent as a deduction. There’s a process for determining if someone is a legal dependent, and—if so—what deductions or credits are then available. Ken Begley’s excellent article offered some amusing anecdotes about taxpayers’ questionable creativity when it comes to sidestepping taxes.
Meanwhile, tax avoidance is entirely legal. It involves taking advantage of the tax code to minimize your tax bill. The standard deduction is probably the most widely known and used deduction. Itemized deductions, including home mortgage interest, state and local taxes, and charitable contributions, have historically been popular. But the changes enacted by the 2017 Tax Cuts and Jobs Act made these itemized deductions significantly less valuable.
When you stop working, you miss out on some significant tax-avoidance methods available to the average taxpayer. Qualified retirement accounts, like a 401(k) or IRA, require earned income to contribute. Some good news: If one spouse is still working, he or she may be able to contribute to a non-working spouse’s IRA.
On the other hand, there are some advantages to being a senior. Taxpayers receive an enhanced standard deduction if they reach age 65 during the tax year. In 2024, this means an additional $1,550 each for joint filers and $1,950 for single individuals. Lower-income seniors who haven’t reached 65 by the end of the tax year are eligible for the earned income credit, assuming they meet the other criteria. Retirees who provide primary support for eligible dependents may be able to claim the “credit for other dependents,” with a maximum credit of up to $500.
Seniors who work and support children under age 13, or other qualifying dependents, may be eligible for the child and dependent care credit. For example, if you’re unable to care for yourself and need outside care while your spouse is working, you may qualify for this credit. The credit is based on a percentage of your qualified expenses, up to $3,000 for one person and $6,000 for more than one person. The maximum credit for the care of one qualified person is $1,050. The maximum for two or more qualifying people is $2,100. There’s no income cutoff for this credit, but the credit amount is reduced with increasing income.
How else can retirees legally minimize taxes? Here are six ideas.
Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. He enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. Follow Rick on Twitter @RConnor609 and check out his earlier articles.
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I think the tip about “bunching” deductions is under appreciated, from my discussions with friends and family.
my wife and I are charitably inclined and we make 2+ years of charitable gifts every other year. Last year in addition to “normal” giving we put appreciated stock and cash into our Fidelity donor advised fund.
we itemized last year and had about 160% of the standard deduction. Now this year our DAF will send checks to most of the charities that we support, and we’ll take the standard deduction this year.
next year (2025) we will make big donations to our daf again (thx Citigroup stock) and then rinse and repeat.
we are in our mid-60s so I think we have at least 3 more iterations of this process before we switch to qcds from our traditional IRA.
Thanks everyone for the interesting discussion. The tax code is a wondrous thing. In my 6 years of volunteer tax prep I’ve heard so much confusion, misinformation, and opinion. Many folks are sure the rich get all the tax breaks, some think the poor pay no taxes at all, and many think they pay taxes at a much higher rate than they actually do. The changes in 2017 to itemizing deductions and the increased standard deduction still confound many. They are convinced they are getting screwed because they can’t deduct a few $100 dollars of charitable gifts, but they actually are getting much more from the Std Deduction. Individual opinions on taxes are pretty fascinating.
Actually almost 50% of ‘taxpayers’ pay no federal income tax and probably no state income tax as well. However, even the poor pay sales tax which ironically is not a progressive tax.
Those who work also pay payroll taxes — probably the biggest “income” tax they pay.
Regarding ACA subsidies, it is possible to prepare our finances in such a way to maximize subsidies by leveraging ROTH and cash accounts to minimize income. I often run into folks who think it is unethical for people with decent net worth to obtain subsidies. I see it as knowing what is coming and being prepared… a simple matter of avoiding.
Rick, I’m not sure the voluntary reporting income part is all that valid anymore. By the time I do my taxes every penny of my income has been reported to the IRS by some organization or agency.
I read that cash businesses and restaurant servers are the largest sources of income evasion. I’m always leery when I see a “cash only” sign. Then there is the contractor who says he will save you the sales tax if you pay cash – guess how?
The number of restaurant servers may be high on the list of tax evaders but IRS data show that the wealthy easily top the list dollar-wise.
Tax returns containing schedules C, E, and F are statistically the worst “evaders” because they can easily lie about both expenses and income. Many but not all of those filers are wealthy. One could argue that the budget deficit would be much smaller if these people didn’t cheat. Sadly, one could also argue that if no one cheated politicians would figure out a way to spend all the extra money.
Maybe, but if that is true and the IRS knows that to be true what aren’t they penalized? I often wonder do we mix evasion and avoidance for the wealthy? I can see maximizing avoidance, but evasion seems quite stupid for highly visible people.
I don’t think the IRS has enough auditors to go after the cheaters. To your other point, we do mix the the two terms, and wealthy people who receive a W2 for their compensation do pay a ton of taxes.
The financial reality of the ultrawealthy is not so easily defined. For one, wages make up only a small part of their earnings. And they have broad latitude in how they account for their businesses and investments. Their incomes aren’t defined by a tax form. Instead, they represent the triumph of careful planning by skilled professionals who strive to deliver the most-advantageous-yet-still-plausible answers to their clients. For them, a tax return is an opening bid to the IRS. It’s a kind of theory.
In that tax world, nearly anything is possible. Stephen Ross is one of the world’s most successful real estate developers, a billionaire many times over, the owner of the Miami Dolphins. Ross, a former tax lawyer, once praised tax law as a particularly “creative” endeavor, and he is a master of the craft. His tax returns showed a total of $1.5 billion in earnings from 2008 to 2017, but he didn’t pay a dime in federal income taxes during that time. How? By mining a mountain of losses he claimed for tax purposes, as ProPublica reported. Look at Ross’s “income” for any of those years, and you’ll see numbers as low as negative $447 million. (He told ProPublica he abides by the tax laws.)
Texas billionaire Kelcy Warren owns a massively profitable natural gas pipeline company. But in an orgy of cake eating and having, he’s able to receive hundreds of millions of dollars from his company tax-free while reporting vast losses to the IRS thanks to energy-industry and other tax breaks, his records showed. (Warren did not respond to our questions.)
Based on those reported “incomes,” both Ross and Warren received COVID stimulus checks in 2020. We counted at least 16 other billionaires (along with hundreds of other ultrawealthy people, including hedge fund managers and former CEOs) among the stimulus check recipients. This is just how our system works. It’s why, in 2011, Jeff Bezos, then worth $18 billion, qualified for $4,000 in refundable child tax credits. (Bezos didn’t respond to our questions.)
In addition the the fact that the chances of being audited are very small even for the wealthy, offenders frequently just have to pay the additional taxes owed plus interest.
Adjusted Gross Income Audit Rate
$1- $25,000 = 0.4%
$25,000-$50,000 = 0.2%
$50,000-$75,000 = 0.1%
$75,000-$100,000 = 0.1%
$100,000-$200,000 = 0.1%
$200,000-$500,000 = 0.2%
$500,000-$1,000,000 = 0.4%
1,000,000-$5,000,000 = 0.4%
$5,000,000-$10,000,000 = 0.7%
Over $10,000,000 = 2.4%
https://www.nolo.com/legal-encyclopedia/irs-tax-audits-triggers.html
That is often true
If you were to look at our credit card accounts it would seem we are terrible tippers.
Not a penny over the cost of the food.
That’s because we ALWAYS tip in cash. And, usually, at least 20%.
Why?
Because a good friend of ours helped pay for her college education (in the 1970’s) by working as a waitress. Her stories, and knowing her, were not exaggerated. So we try to make up for all the miserable cheapskates as best we can.
And, yes, we always leave cash in the tip jars at coffee shops too.
I also tip cash. The government wastes entirely too much $$, and if waiters neglect to claim tips, great AFAIC.
I leave cash for two reasons: so the restaurant doesn’t net out the credit card processing fee from the server’s tip, or entirely “forget” to pass it through to him/her.
Me too. I do the same as you. And I try and hand tip to server and not leave cash on the table.
Yes, Greece has a truly voluntary system… We know how that turned out.