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Avoiding or Evading?

Richard Connor

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.

  • Tax-efficient withdrawals. Taking your spending money from Roth IRAs, health savings accounts and taxable accounts—rather than from traditional retirement accounts—can reduce your taxable income for the year and hence your taxes. Once you’re on Medicare, you can’t contribute to a health savings account. But you can still use the balance to pay for qualified medical expenses.
  • Tax-efficient investing. In your taxable account, if you favor funds that make modest annual taxable distributions, such as broad stock market index funds, you can limit your annual tax bill.
  • Maximize your itemized deductions. Bunch charitable deductions for several years into a single year, so your itemized deductions comfortably exceed your standard deduction. Similarly, consider bunching non-emergency medical procedures into a single year. Some cosmetic dental procedures could fall into this category.
  • Qualified charitable distributions. If you’re charitably inclined and in your 70s or older, qualified charitable distributions can significantly reduce your taxable income if you make these distributions and count them toward that year’s required minimum retirement-account distribution.
  • Understand how your state taxes income. There are 50 different state taxation systems. For example, in 2024, nine states will tax Social Security benefits. My old state, Pennsylvania, doesn’t tax retirement income, while my adopted state of New Jersey has a phased retirement-income exclusion.
  • Investigate property-tax reduction programs. States have a myriad of programs to help seniors and lower-income taxpayers reduce their property taxes. In addition to its Tax-Aide program, which offers free tax preparation services, AARP provides Property Tax-Aide to help seniors understand state programs.

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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