Last-Minute Tax Advice for Boomers

With the tax deadline right around the corner, once again we baby boomers are sitting down to review our 2010 tax returns to Uncle Sam.

Whether you use an accountant, tax professional or e-file on your own, it’s in your best interest to be aware of the tax changes for 2010 that might impact your return.

After all these years of saving, boomers are getting ready to enter retirement and many of us will start drawing income from our retirement nest eggs. But there are tax implications of drawing on certain funds and ways to minimize potential penalties.

We can all use some tips on how to minimize our tax bill. Gil Charney, principal tax research analyst at The Tax Institute at H&R Block offered these tax tips for baby boomers.

Boomer: What are the specific requirements for filing business, travel and entertainment expenses?

Charney: IRS Publication 463, appropriately named Travel, Entertainment Gift and Car Expenses, addresses this topic specifically. To be deductible as a business expense, a transaction must have incurred in a trade or business that includes employee expenses and the expenses have to be "ordinary and necessary" and related to the business. For example, a self-employed carpenter could deduct the expenses for supplies, but a teacher who has a woodworking shop in his basement as a hobby could not deduct his expenses as part of a business. For travel and entertainment expenses receipts are necessary to show who you met with, what business was conducted, and anything that could legitimize the deductions as a business expense.

Boomer: If I own more than two homes what interest expenses am I entitled to deduct?

Charney: You can deduct the mortgage interest of up to two homes that includes your principle residence and a second residence. The interest has to be what is called “qualified mortgage interest,” which means the mortgage has to be secured by the home. If you are fortunate enough to own three homes, you can not deduct the interest on the third. If the third home is a rental property, you could deduct the interest as rental expense. There is a $1 million limit on what is called “acquisition debt,’ which is the mortgage that you used to buy the home.

Boomer: How are capital gains taxed?

Charney: Capital gains can be very complex. A capital gain is the difference between what you sell a capital asset for and what you paid for it--if there is a gain. If you have a home and sell it for more than what you paid for it, (otherwise known as basis) than you have a capital gain. The rate that capital gain is taxed at depends on how long you owned the home; if you owned the home for more than a year and a day it becomes a long-term capital gain or it could be capital loss. If you owned the home for less than a year, it is considered short term. The reason there is a distinction is because of what they call “netting rules” on how you calculate net short term, net long term, capital assets and gains and losses. You mix them together and you have a net gain and a net loss. This can get pretty confusing and that is why we have tax professionals. The importance of long term versus short term is if you sell something at a long term capital gain you get a better rate. There is a maximum of 15% on a long-term capital gain through 2012. A short-term capital gain is taxed at ordinary rates. If you have capital losses that exceed capital gains you can deduct it against ordinary income up to $3,000. Any capital loss that you could not deduct as ordinary income can be carried forward. It is important to keep track of your investments and your assets. If you don't know your basis the whole thing gets taxed and you want to minimize that as much as possible.

Boomer: If I withdraw from my IRA or 401(k) account can there be penalties involved?

Charney: If you are under age 59 1/2 and you take a distribution from an IRA or a 401(k)K, not only do you get taxed on that distribution at ordinary rates, but you could be hit with a 10% penalty on top of that. There are exceptions to that 10% penalty that include if you are permanently and totally disabled, you use the withdrawal for medical expenses or if you are taking distributions in what is known as substantially equal payments. It would be helpful to determine if you fall into one of these categories before you take a distribution. If you take a loan from a 401(k) while you are still working you have to pay it back based on the terms of the loan, but you won’t be subject to a penalty.

Boomer: Is long-term care insurance income taxable?

Charney: It is generally not. If it is a qualified long-term care insurance plan there are certain tax rules that would apply to it and a qualified long-term care plan is treated as an accident and health insurance contract and any benefits or payments made on that contract are excluded from income. There is a limit beyond which any excess would be taxed. For 2010 you can get up to $290 per day in benefits and have it be excluded from tax; for 2011 it’s up to $300 per day. If you have benefits that pay more than that, the excess is generally taxable unless you have actual expenses that you can offset that excess with.

Boomer: Are there any limits imposed on itemized deductions?

Charney: Beginning in the early 90s a limit was imposed on the deductibility of itemized deductions for higher-income taxpayers. If your income was above a certain amount, the amount of total overall itemized deductions would be reduced based on the excess of your income over those thresholds. When the Bush tax cuts came online in 2001 those reductions were phased out and by 2010 there was no limitation on overall itemized deductions. It will stay that way through 2012. Every type of itemized deduction for the most part has its own kind of limitations. For example, medical expenses are deductible only to the extent that they exceed 7.5% of your adjusted gross income (AGI); the higher your income, the higher your medical expenses have to be for you to deduct them. A lot of baby boomers who have retired may have higher medical expenses than their income and they might be able to benefit from that. Generally speaking, taxpayers cannot deduct more than 50% of their AGI.

This column is written for a Baby Boomer, by a Baby Boomer. It uses nostalgia to bring readers back to where it all began and then gets answers from personal finance experts to help navigate best routes for a healthy and prosperous future. E-mail your questions or topic ideas to