(This article by Col. Curt Sheldon, USAF (Ret), CFP®, EA, originally appeared in the February 2023 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.)
It’s that time of the year again. Time to sharpen your pencil, get out the calculator, or go online to settle your account with Uncle Sam. As you work on your tax return, here’s what to keep in mind.
1. Don’t Ignore Tax-Free Income When Itemizing
When you start your tax return, you’ll want to know how much you received
in tax-free income, whether that is allowances, VA disability compensation, or combat pay. As you complete your tax return, if you itemize deductions, you can choose to deduct your state income tax or sales taxes paid. Since a lot of active-duty members are residents of states without an income tax and plenty of retirees migrate to those states, too, there is a pretty good chance the sales tax deduction will be the better option for you.
The sales tax deduction is calculated using your total income, and you can include any tax-free income you received when running the calculation.
2. Deduct the Correct Amount of Mortgage Interest
The Tax Cuts and Jobs Act (TCJA) limited the amount of mortgage interest you can deduct. First, it limited the size of qualifying new mortgages. You can only deduct mortgage interest on up to $750,000 of principal.
Under the TCJA, you can also only deduct interest on home acquisition debt to acquire or improve real estate — and that applies to home equity loans, too. If you use a home equity loan for other purposes, you can’t deduct the interest.
Over the past few years, many people refinanced their mortgages, and in many cases, rolled closing costs into the mortgage amount. But the amount that your new loan exceeds the payoff of your old loan is not home acquisition debt, and the interest on it is not deductible.
So, you’ll need to reduce the amount of interest reported on your Form 1098 to account for the amount that’s not deductible. As you pay down the loan, the non-home acquisition debt is paid off first, so eventually you won’t have to do this.
3. Check the Date of an Electric Vehicle Purchase
To encourage the purchase of electric vehicles, the government will give you a tax credit if you buy one. But note that the Inflation Reduction Act (IRA), which passed in 2022, changed the rules for the tax credit. In a strange move, Congress made one provision of the law effective on the date of enactment.
Under the new law, the final assembly of the electric vehicle must occur in North America to qualify for the credit. The IRA became law on Aug. 19, 2022. If you purchased or had a binding contract for the purchase of an electric vehicle prior to that date, the vehicle doesn’t have to be assembled in North America to qualify for the credit.
4. Get a Do-Over
As you may recall, the CARES Act allowed taxpayers to take a distribution in 2020 of up to $100,000 from a retirement account and, if the funds were redeposited by the end of 2022, the distribution is treated as a rollover and is not taxable. Even if the funds are not redeposited, the 10% early-withdrawal penalty is waived. If you took a distribution and redeposited none, some, or all of the distribution, you have some options.
Let’s say that because of COVID-19, your income in 2020 and 2021 was very low and you couldn’t redeposit any funds. You included one-third of the distribution in your taxable income each year as that was the default election. In 2022, your income was a lot higher and you decided to redeposit the full amount into a retirement account. You can amend your tax returns for 2020 and 2021 to remove the taxable distributions and get a refund for those years.
Or let’s say you didn’t make any repayments over the last three years. Like the above scenario, you included one-third of the amount in your taxable income each year. But your tax bracket in 2022 is much higher than in 2020. In fact, even if the full distribution is included in your 2020 income, your 2020 tax rate is lower than 2022.
It may make sense to amend your 2020 and 2021 tax returns. You can include the full distribution on your 2020 return and pay any taxes, interest, and penalties due. Your 2021 income will go down when you file an amended return for that tax year, and you’ll get a refund. The total tax may be less than if you include one-third of the distribution on your 2022 return.
[MARCH 7 MOAA WEBINAR: What SECURE Act 2.0 Means for Your Retirement]
5. Don’t Listen to Rumors
There has been a persistent rumor that if you have a VA disability rating, that same percentage of your military pension is tax free. For years, I’ve pushed back against that gouge. I’m no longer alone.
In an April 2022 decision (T.C. Memo 2022-42), the tax court made it clear that if you are receiving a military pension based on longevity, the taxable amount of the pension is not reduced based on the percentage of your VA disability rating.
If you were thinking about reducing the taxable portion of your pension based on this rumor, consider rethinking your decision. If you’ve done it in the past, consider amending your tax returns.
This tax court decision doesn’t affect the Strickland Decision and IRR 78-161, which allow you to reduce the taxable portion of your military pension for the VA offset that should have been taken if your award is less than 50% and retroactive. It also doesn’t affect tax calculations if you are receiving Combat Related Special Compensation (CRSC).
Most people don’t really enjoy dealing with taxes. But paying attention to the details not only helps make sure your return is accurate but could even save you some money.
Col. Curt Sheldon, USAF (Ret), CFP®, EA, is a Life Member of MOAA and the president of C.L. Sheldon & Company, LLC, a financial and tax planning firm.
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