When someone loses a spouse, there are numerous financial changes that occur. One major change is in their tax situation. In this episode of Friends Talk Financial Planning, John and Bridget delve into specific tax considerations you need to be aware of after losing a spouse. From understanding your filing status to utilizing deductions effectively, get practical insights to help during this challenging time.
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TRANSCRIPT:
John: When someone loses a spouse, there are a lot of changes that happen financially speaking, and one of the big ones is a change in tax situation. In today's episode of Friends Talk Financial Planning, we're going to share some of the specific things that people need to be aware of when they lose a spouse that pertain to their taxes that they might want to think about before the end of the year. Hi, I'm John Scherer, and I run a fee-only financial planning practice in Middleton, Wisconsin.
Bridget: And I'm Bridget Sullivan Mermel. I've got a fee-only financial planning and practice in Chicago, Illinois. And please go ahead and hit subscribe. It helps people find us. We think we provide valuable information, so please help us grow. All right, John, we've got the unfortunate situation that someone's spouse died. And this could be someone who's dealing with their own spouse's death, or it could be a friend or their kids that are dealing with that and are trying to help somebody whose spouse died. So in both situations, I think this is good information. Sometimes a person whose spouse died goes through a period, and this can even last a couple years, of just brain fogginess. And so, I think offering to help and knowing a little bit about this is important.
John: Yeah, that's exactly right. And it's really important, because there's a lot of different financial things that go on.
Bridget: Right.
John: Changing titles on accounts and, I mean, there's just a lot of stuff here. So we wanted to focus specifically on a few of the tax things that change. And as we were thinking about this episode, I've got a friend whose mom died earlier this year. And so, I'm talking with my friend who's helping his dad figure out some things. It's that sort of situation where there's all these other things going on, but for me it was talking to my buddy and saying,
“Hey, make sure you're talking with your dad about some of the things that might be coming down the pike for him. And let me know if I can help navigate some of these things.”
It can be a surprise. We oftentimes don't realize how the tax situation changes. We think about changing the IRA accounts and naming and all these things, and then taxes come in the spring, and you go, “Holy mackerel, that was a big surprise. I didn't realize what was going on here.” And this is one of the cases where, because we know there's going to be a change, there's an opportunity to look and say, “Hey, should we be doing something? Should we be a little proactive with this?” And so that's where this is coming from.
And I wanted also to point out that as we were thinking about this, there are some things that apply if you have children at home, maybe if it's a younger person. I tend to think about the older folks because that's what I've been helping people with, and my buddy, particularly right now. But we'll talk about that, some of those changes here. Let's make sure to bring that up when we get to that spot.
Bridget: Okay, great. So the first thing we want to be mindful of is your status. We think about our status when we're trying to join the country club, but we're not thinking about our status when we file our tax returns. But it's one of those underlying points of the tax return. So you can be single, you can be married filing jointly, but there's a couple of lesser known statuses, too. One is qualifying widower, and another is head of household.
John: Yep. Let's maybe just jump in on those big two. For most people, it's “I'm married filing jointly” or “I'm a single person.” And what are the differences in those? And that's what affects a lot of the people that we're talking about here. And one of the things is the tax brackets, the rates are the same, but what income falls into those rates is really different.
Bridget: Right.
John: We can pull up a little chart here that shows the differences. And I don't know why I picked $80,000 in my head when I was thinking about this but look at taxable income. If we're at $80,000 here in the married filing jointly (you can take a look at that line), we're solidly in the 12% tax bracket. We’re making a nice income and our top brackets 12%. If that same income is in the single bracket (move over one column to the left here), that income is solidly in the 22% tax bracket. So that's what we're talking about with these brackets. And the same amount of income can be taxed at very different rates, depending on if you're single or married filing jointly, in this case.
Bridget: Right. We picked that particular bracket because that's 10%, which is a pretty big shift. And it can be very easy to go from that, which sounds like a better status, but people don't like it.
John: Right. And think about it. And again, I'm thinking about my buddy’s parent’s situation. I don't know all the details about it, but let's say their income was taxable income of $80,000. Mom's gone. What changes in their situation? They were state employees, and the way they selected it, the pension stays the same. The income that they've had for the last five or seven years is going to be the same for dad going forward. So the income hasn't gone down. Social Security is going to change. We're going to lose some Social Security, but it doesn't go to zero. It's something like a third to a half.
Bridget: Right.
John: So Social Security is going to go down, but not away. And then they're in a situation where they have to take minimum distributions from their IRAs. Dad had his, mom had hers. But it's all going to be his going forward. Basically, the same distribution is going to happen. So their IRA distributions are going to be largely the same. Their pension income is going to be largely the same. Social Security is going to go down something, but not a lot. So if they were making $80,000 of taxable income last year, going forward, maybe it'll be $70,000 or $60,000.
Now look at those differences in tax brackets. And I don't think we've really mentioned here what happens when somebody dies. If you're married at any point during the year, when you lose a spouse, this year you get to file as married filing jointly. Next year he's going to be filing as a single taxpayer. So that's where this difference really comes in, going from married filing jointly to single. We know he's going to transition into that tax status going forward, and that's where some of the planning opportunities can come in.
Bridget: Right. And one of the tricks that we're not going to cover here is if you do have kids that are living at home, that are dependents, then you're in a different situation and you want to look up qualifying widower to find out all about that.
John: Right. So that's the takeaway. If you've got kids at home, maybe you’re a younger person, check into that qualifying widower. Make sure that your tax folks don't miss that because that can be one of those corners of the law.
Bridget: And sometimes people who are older might have kids at home. You might be raising your grandkids, or whatever.
John: Yeah. Exactly. So know that if you have kids at home, the same general rules apply, the planning part applies, but the specifics don't necessarily apply.
Bridget: Right. Okay. So the other thing, next thing we want to talk about is the standard deduction. With the tax bracket differences, this is a plus of being signal, actually. When you look at what the standard deductions are, if you have more than the standard deduction, you can itemize, which means that you can deduct your state and local tax, your mortgage interest, and your charitable contributions.
John: Yeah, gift to charity.
Bridget: And maybe a few other things, but those are the three biggest right now. It's a little complicated because the state and local tax is capped at $10,000, so that means a lot of people aren't itemizing anymore. But that cap is the same if you're single or if you're married filing jointly. So if you're married filing jointly and your state and local tax is $16,000, you can only take $10,000. And so, then you have to come up with quite a bit of other expenses to be able to itemize.
In the same situation, your state and local tax goes from $16,000 to $14,000 because of the losing the spouse. But because it's $14,000, you can still take $10,000, then you only need a smaller amount to be able to itemize. So if you've got mortgage interest or you're donating money, you'll be in the ballgame for itemizing what you weren't before. So your tax brackets are going to hurt you, but you might be able to itemize, which is going to help you.
John: Right. And that's where it comes down to one of the takeaways: taking a look at things when there're changes. If everything's the same every year, oftentimes there's not a lot of planning opportunities that come up. This is one where tax brackets are going to change, if we're going to go from married filing jointly to single. And we like to talk about what might happen to today's tax situation depending on Congress and all that, but we just don't know the future.
This is one of the few places where we know that there's going to be a change; there's going to be something we can take action on. And then the other thing is, for so many of us these days, our mortgage interest isn't deductible, if you have one. For donations to charity, when you're married, filing joint, $29,000 is the standard, so until you get over that, you don't get any benefit. If I'm going to be a single taxpayer, it goes down to $14,000 or $15,000 next year.
So for my buddy’s dad, one of the thoughts might be, hey, this year while I'm going to be married filing jointly, I'll just take the standard deduction. So for my charitable donations (maybe we brought in money from mom's funeral, and it's going to go to charity), we might want to wait until January to make that donation because then we'll get credit for it. Based on some of these little nuances, it can be $1,000 of savings by just paying attention to it.
Bridget: Yes, you could push off things that you can deduct but then actually realize more income.
John: Right.
Bridget: So you might say, “Oh, the top of the 12% bracket taxable income when you're married filing jointly is around $95,000, $94,000. Why don't I take more out of my IRA this year? Why don't I do a Roth conversion this year?” And there're more, too. So, depending on your situation, you might want to realize some income while you can still be in that lower bracket. You just reminded me. Four years ago, my mom died, so my dad was in this situation. I kind of forgot that I'd gone through this.
It was exactly what you just described. Their income, pension and Social Securities are this. We know that dad is in that married filing jointly bracket. And, geez, there's some room. Why don't we take this money, and I don't remember the numbers off the top of my head. Why don't we take an extra $15,000 or $20,000 out and pay 12% taxes, because next year he's going to be paying 22% taxes on it. We can do a Roth conversion. That was the exact sort of thing, one year we've got that, but the next year, we're not going to have that.
And I think one of the big takeaways is just doing the planning, just taking a look. With the tax software that Bridget and I use, we can plug in the information, make some of those adjustments. Oh, we know that Social Security is going to change a little bit, then you click a button. What if we're married filing jointly this year? Great. If we click that button next year, here's what that same tax looks like. Okay, let's kind of play with that. And being proactive, I think, is one big takeaway.
Bridget: Yeah. A lot of years people think, “Why am I bothering with this tax planning? It's the same every year. I'm just chugging along.” Okay. Now is the time where tax planning really makes sense. So you're gonna have two years where you're not just chugging along. You've got a lot going on, and it's unfortunate that you have a lot going on in your whole life. And your taxes might not be the top thing on your money, but that's why we are encouraging the other people around you to help. If you know someone who's dealing with losing their spouse, you can help by saying, “Do you want me to help you with some tax mining?”
John: Let's pay attention to this.
Bridget: Yeah. Think about this year.
John: Absolutely. Hey, that's a great place to wrap things up. I'm John Scherer. I run a fee-only financial planning practice in Middleton, Wisconsin.
Bridget: I'm Bridget Sullivan Mermel. I've got a fee-only financial planning practice in Chicago, Illinois. John and I are both taking clients, but we also belong to an organization that's the Alliance of Comprehensive Planners. You can find out more about them acplanners.org and if you're interested in an advisor in your area, that's a great place to look.
John: That's right. And don't forget, hit that subscribe button.
At Sullivan Mermel, Inc., we are fee-only financial planners located in Chicago, Illinois serving clients in Chicago and throughout the nation. We meet both in-person in our Chicago office and virtually through video conferencing and secure file transfer.
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