4 Tax Mistakes to Avoid

4 Tax Mistakes to Avoid
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(This article originally appeared in the February 2024 issue of Military Officer, a magazine available to all MOAA Premium and Life members. Learn more about the magazine here; learn more about joining MOAA here.)


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The federal tax code is complicated, and you might be making mistakes without even knowing it. Here are some common ones.


1. Over-Contributing to a Roth IRA

If you retired from the military and are working in a second career, you might trip over this obstacle. There is an income limit for contributing to a Roth individual retirement account (IRA). In 2023, that limit was $228,000 if you file your federal tax return as married filing jointly and $153,000 for those who file single.


If your modified adjusted gross income (MAGI) exceeds these amounts, you can’t contribute directly to a Roth IRA. For joint filers, there is a phaseout of the amount you can contribute, starting at $218,000 MAGI. For single filers, the phaseout begins at $138,000.


The limits are higher in 2024. For married taxpayers filing jointly, the 2024 limit is $240,000, with the phaseout range starting at $230,000. For single filers, the limit increases to $161,000, with the phaseout range starting at $146,000.


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What happens if your income is above the limit and you contributed to your Roth IRA? If you don’t withdraw the contributions and the income on them prior to filing your tax return, you will be subject to a 6% excise tax for each year the excess funds remain in the Roth IRA.


Normally, you could be audited for up to three years after you file your return. For this particular item, the statute of limitations is six years from the date of filing, which could lead to a hefty penalty.


2. Missing Donation Tax Breaks 

Sending cash to a charity is the least tax-efficient way to support it. There are better ways to support a charity and reduce your tax bill. One option is to gift appreciated assets. If you held the asset for more than one year, you can deduct its fair market value on the day it is donated.


Even if you don’t itemize deductions, there is still a tax advantage. The  capital gain goes to the charity, and because the charity is tax exempt, no tax is due from the charity or you.


If you’re 70½ or older, you can make qualified charitable distributions (QCDs) from your IRA to your charity of choice. The QCD is not included in your adjusted gross income (AGI), so it reduces your overall tax bill even if you don’t itemize.


[MOAA CHARITIES: Ways to Give (Includes QCD Information)]


The reduced AGI might make you eligible for credits you wouldn’t normally be eligible for or increase your deductions that are limited based on AGI, such as the medical expense deduction.


Either way, this could reduce your total tax even more.


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3. Not Depreciating Rental Real Estate

When you buy a rental property or convert your residence to a rental, you own a capital asset. Capital assets normally can’t be expensed in the year purchased, and instead, the capital asset must be depreciated over its useful life.


In the case of residential real estate, the IRS has determined that the useful life is 27½ years. That means each year you’ll deduct about 3.6% of the basis of the structure (land is not depreciated). Some tax software might allow you to decline to depreciate the rental property. Or perhaps you hear that you’ll need to pay depreciation recapture when the property is sold and you don’t want to pay those taxes, so you don’t depreciate the property.


That’s the problem. When you sell the property, you will owe taxes on the depreciation allowed or allowable (depreciation you took or should have taken).


What should you do if you failed to depreciate your property? If you haven’t skipped the depreciation for two years or more, you can file an amended return for the first year and properly depreciate the property going forward. If it has been two years or more, then you’re operating an impermissible accounting system, and you must request a change in accounting method from the IRS.


The change is automatic, but you have to file for it via Form 3115.


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4. Not Withholding Sufficient Income Tax 

In many ways, U.S. tax code is still designed for Ozzie and Harriet (households that have one income source). In America today, that isn’t often the case, especially for a military retiree. That can cause problems with your withholding.


The withholding tables that your employer (and, if you’re retired, the Defense Finance and Accounting Service) uses are based on that single-income assumption. So, each entity that withholds taxes from your income starts at $0 of income. They withhold some at the lowest rate and work their way up.


But if you have multiple income sources, your income should be stacked, and one or more of those entities should start withholding at the rate the other entity ended at.


How do you avoid this? The IRS has a W-4 calculator that can help to figure out how much your withholding should be. You can also complete Form 1040-ES using your estimated income and estimated withholding.


If you find you will owe, ask for a specific additional dollar amount to be withheld from your pay or retirement pension.


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About the Author

Col. Curt Sheldon, USAF (Ret), CFP®
Col. Curt Sheldon, USAF (Ret),  CFP®

Sheldon is the author of Well and Faithfully Discharged: Financial TTP for Military Retirement and has written several articles for Military Officer magazine. He holds the Certified Financial Planner™ designation and is an Enrolled Agent.