If you read Part 3 of this series last week, you should be familiar with my football analogy. Specifically, when it comes to winning the Social Security retirement benefit game once you start receiving benefits, you need to win two halves of the game: (1) reduce taxable benefits, and (2) reduce the tax attributable to your benefits. Parts 2 and 3 of this series discussed how to win the first half. Now that the halftime entertainment is over, we’re ready to start the second half.
In order to reduce the tax attributable to your Social Security retirement benefits, once you’ve employed appropriate strategies for reducing your taxable benefits, the focus should be on maximizing your itemized deductions – without increasing your exposure to alternative minimum tax (“AMT”). If the total amount of your itemized deductions is less than the standard deduction – game over. If you’re able to itemize your deductions, read on.
There are basically five categories of itemized deductions to pay attention to:
- Medical and dental expenses
- Taxes paid
- Interest paid
- Gifts to charity
- Job expenses and certain miscellaneous deductions
Here’s a brief overview of each category, two of which are only deductible if the total amount exceeds a specified percentage of adjusted gross income (“AGI”):
Medical and Dental Expenses
A deduction is allowed only for expenses paid primarily for the prevention or alleviation of a physical or mental defect or illness. You may only take a deduction for the amount of your total medical and dental expenses that exceeds 7.5% of your AGI.
Deductible taxes primarily include (1) the greater of state income taxes or general sales taxes, (2) real estate taxes, and (3) motor vehicle registration fees. You need to be careful about prepaying state income and real estate taxes at the end of the year to maximize these deductions since they can also increase your alternative minimum taxable income and your AMT liability.
The most notable deduction in this area is home mortgage interest on first and second homes up to specified limits. Investment interest is also deductible to the extent of investment income.
Gifts to Charity
Charitable contributions made to qualified charitable organizations are deductible and include gifts made by cash or check as well as noncash contributions.
Job Expenses and Certain Miscellaneous Deductions
The most notable deduction in this area is unreimbursed employee expenses, including job travel, union dues, and job education. Other potential deductions include tax preparation and planning fees, investment management fees, and safe deposit box fees. You may only deduct the amount of your total job expenses and specified miscellaneous deductions that exceeds 2% of your AGI.
Based on my 25+ years of experience as a tax professional, including defending deductibility of itemized deductions on behalf of clients in IRS examinations, I can tell you unequivocally that consultation with a tax professional is crucial to maximizing, and defending, your itemized deductions – without increasing your exposure to AMT.
Assuming you’ve implemented strategies to reduce your taxable benefits and maximize your itemized deductions without increasing your exposure to AMT, you’ve won both halves of the game since you will have (1) reduced your marginal income tax rate, (2) reduced the income tax attributable to your taxable Social Security benefits, and (3) increased your after-tax Social Security benefits. Congratulations – let the celebration begin!
Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. Bob is also the sole proprietor of Robert Klein, CPA. Bob applies his unique background, experience, expertise, and specialization in tax-sensitive retirement income planning strategies to optimize the longevity of his clients’ after-tax retirement income and assets. He does this as an independent financial advisor using customized holistic planning solutions based on each client’s needs and personality.