Tax Surprises My Retirement Year

Upon retiring from clinical medicine and becoming a full time author/coach (I like to say I’m repurposed), I was uncertain as to the amount of taxes I needed to pay. I have a complicated tax return with several K-1s that don’t surface until March. My final return totals 32 pages for federal and 5 pages for state.  After making an estimate of my tax bill at year end, I figured I didn’t need to add any additional taxes to what had already been withdrawn. I worked my final two weeks of clinical medicine as an employee that year, and I thought the taxes withheld from my paycheck would cover my tax bill. Boy was I surprised!

Although I was concerned about whether or not I would owe additional taxes and penalties for not paying quarterly taxes, I took the risk and didn’t make any additional payments. I was pleasantly surprised to find that not only did I not owe additional taxes, but my actual tax bill for the year was zero! All the taxes withheld from those last two weeks I worked were refunded, in addition, I received some tax credits.

The bulk of my retirement savings occurred before the days of Roth IRA accounts, so any distributions I take from my retirement plans, with the exception of my HSA, will be taxable income. I did not take any distributions from my retirement accounts last year. I lived on investments that were outside of my retirement accounts and on my real estate income. Without much earned income, it’s hard for the government to charge me income taxes. Living off saving doesn’t generate taxes.

I did experience large capital gains from selling ownership in medical companies that required the owners to be practicing physicians, which created a forced buy out. I also had a large capital loss from one company I owned that closed.

No income taxes means no deductions

One of the down sides to owing no taxes, is the loss of tax deductions. All those nice Schedule A write offs that exceed the standard deduction can be written off against the tax bill. With a total tax of zero, there is nothing to write off. Now the true cost of giving to charity is the actual value of my gift, the discount for the write off is gone. I did have some income to work with so some of my deductions were used to bring my tax bill to zero, the rest of the deductions were not usable. Those unused deductions will be carried forward to use in the future.

This is an interesting issue. There were years that I made too much money to get all of my Schedule A write offs deducted. This year, I was not able to take all of my Schedule A deductions because I made too little money. I didn’t see that one coming.

Medical expenses are finally deductible

The deduction for medical and dental expenses are limited to only that which exceeds 7.5% of adjusted gross income (line 38 on form 1040). With my high income as a physician all these years, I was never able to deduct any of my medical or dental expenses. Not this year. With a low adjusted gross income, this 7.5% figure was very small. I was able to deduct most of my medical and dental expenses for the first time on Schedule A. Too bad I didn’t have a tax bill to use them against.

Charitable contributions limited

The deduction taken on Schedule A for charitable contributions is limited to 50% of adjusted gross income. I continued to make all my usual charitable contributions, even though I was no longer working and earning an income. Since my adjusted gross income was so low this year, almost half of my charitable contributions were not allowed. These deductions will be carried forward and used in future years, if I can come up with some taxable income to use then against. For those using this deduction as part of their reason for giving, limiting this deduction might dissuade them from making charitable contributions in their retirement years.

Tax credit for my son’s college expense

For the last eight years, I have had one or two children taking college classes. Every year my accountant informed me that I did not qualify for a deduction for my children’s higher education expense because I made too much money. When married and filing jointly, if your adjusted gross income exceeds $180,000, you may not take any education credits. This credit is also known as the American Opportunity and Lifetime Learning Credits.

This year was different. Since my gross income was less than $180,000, I was able to get a $1,000 tax credit for the final year my youngest son attended college. Just in time. Since this was a credit and not a deduction, the government sent me $1,000 even though I owed no taxes. So I got all the money I paid in taxes back as well as an additional $1,000 from this tax credit.

Roth conversions are not so easy

One interesting tax tip is to make Roth conversions in years of low income to fill up the lowest tax brackets. This is to avoid having to take required minimum distributions at a time that income might be higher and putting you in larger tax brackets. By transferring some money from my traditional IRA account and paying low taxes on the transferred amount, I can put that money in a Roth IRA account and never pay taxes on any future gain and not face required minimum distributions. Making the conversion now, while I’m in the zero percent bracket, would save me a lot on taxes.

Once I saw that my tax bill was zero, I realized that I could get some of the conversions done with zero tax, and then fill up the 15% tax bracket for an incredible savings.

Unfortunately, Roth conversions must be done before December 31^st. I didn’t know my taxes would be so low until the end of March. This is a real catch 22. You can’t fill up the lower tax bracket until you have your taxes done, which is unlikely to be accurate before December 31^st. But you must make the conversion before December 31^st. There is no accurate way to make the maximal contribution, unless your only income source is a W-2 wage. If a W-2 wage is the only income source, taxes can be predicted pretty accurately before Dec 31^st. Otherwise there is a lot of guessing.

My new tax plan is to have a meeting with my accountant the first week of December and make some estimates to see how much Roth converting I can do, then convert that amount hoping my final tax bill will be close to our estimate. My issue will be the K-1s that will come later with unknown income and/or losses. It was clever of congress to make the Roth conversion date earlier than the tax filing date so people will have a hard time maximizing this move.

The first year you are retired, meet with your accountant in December to calculate your estimated taxes. Determine what you can do to take advantage of the lowered tax bracket you will be in. This will let you take advantage of those Roth conversions if it works out right.

No quarterly tax payments

My second favorite outcome, the first being a tax due of zero, was not needing to make quarterly tax payments next year. If your tax burden is zero, you are not required to make quarterly tax payments the following year. This is nice because next year’s income is unknown. I don’t expect any big capital gains or losses, but my author business is growing and I don’t know how much income that will generate in 2018. Not worrying about making quarterly tax payments is very convenient.

If you do not have significant savings to pay the potential tax bill, make quarterly payments anyway. There is nothing worse than owing money to the government without the ability to pay. The government is very aggressive about getting their money, charging interest and penalties until all has been paid in full. So keep up with your tax payments.

There you have it, my incredible surprise of a zero tax bill. I do not expect I can do that next year, but a guy can dream can’t he? After all, I have all those write offs that will be carried over to next year, when the standard deduction goes up and I may not be able to use them. If you need more retirement information check out my book, The Doctors Guide to Smart Career Alternatives and Retirement. 

 

How about you? Share your story about your first year retired and how your taxes changed. Did anything that happened to me surprise you? Comment so we can all benefit from your tax experiences.