Most seniors will get no special breaks from the recently enacted tax package. Still, tax experts note that the extension of current tax rates will create a stable planning environment. They advise seniors to take advantage of the next two years to build a plan that will help them reduce taxes as they liquidate investments to meet retirement expenses. In particular, lower-income seniors will enjoy zero tax rates on qualifying capital gains and stock dividends.
Wealthy seniors, by contrast, will get very favorable treatment on estate taxes. Congress allowed the estate tax to lapse in 2010 but without this year's tax package, estate taxes would have returned in 2011. If that had happened, only the first $1 million of an estate would have escaped taxation and the rest of the estate would have been taxed at a 55-percent rate.
Under the new rules approved earlier this month, there will be a $5 million exclusion and the tax rate on the excess will be 35 percent. With each spouse entitled to that $5 million exclusion, the first $10 million of most estates will be shielded from taxes. During 2011, estates have the option of being taxed under the new rule or the 2010 rules, when there was no estate tax. As appealing as that zero tax rate was in 2010, some other provisions of the law were very unattractive, and many estate experts will prefer to use the new rules.
Very few people, however, are wealthy enough to be affected by the new estate tax rules. For most seniors, the benefit of the new law is in locking in low tax rates for the next two years. Many forecasters project that higher tax rates eventually will be needed to help reduce federal budget deficits. So, 2011 and 2012 are viewed as an ideal time to lock in favorable tax treatments.
Older taxpayers "are the ones who plan better than anyone else," says Bob Meighan, an accountant and vice president of TurboTax, the tax software company. He says seniors should focus on the continuation of the 15-percent tax rate on qualified dividends and capital gains. Generally, assets held more than a year qualify for capital gains taxation when they're sold. There also is a holding period that determines if a stock dividend is qualified for this low tax rate or if it is taxed as ordinary income.
Seniors who need to tap their investment funds to generate current income should make as much use of these low rates as possible, Meighan says. "You're going to want to look at your assets and look at which ones you can sell without incurring big gains," he says.
Here, there is an additional tax benefit that is only available to taxpayers in the 10-percent and 15-percent income tax brackets, the two lowest federal brackets. People in these brackets pay no taxes on qualifying capital gains and dividends. And most retirees fall into these brackets.
Couples with up to $69,000 in taxable incomes will be in the 15 percent bracket. Meighan calculates that this level of taxable income is equal to about $88,000 in gross income; personal exemptions and the standard tax deduction account for the $19,000 difference.
"If your joint income is $88,000 next year for a joint filer, your capital gains are tax-free," he says. "If you can make [qualified] distributions from your retirement accounts, that's a huge win." Meighan says the annual 1099 tax forms specify if dividends are qualified, so their tax status will be clear.
"While the extension of the maximum capital gains tax rate is receiving the most press attention," tax specialists at CCH, a tax information provider, said in a summary of the new law, "continuation of the zero percent rate will be equally as important to many taxpayers, from graduate students to retirees to those who live on their portfolio savings."
CCH notes that Congress also carried over a rule allowing people to make distributions to tax-exempt charities directly from their IRAs (individual retirement accounts). Such contributions can satisfy the annual minimum withdrawal rules of IRAs and avoid taxes on the distributions.