Counseling Older Clients

How to serve a growing segment of the population.

AS AN INCREASING PERCENTAGE OF AMERICANS reaches age 65, counseling older clients will become a more important part of a CPA’s practice.

WORKERS AGE 65 OR OLDER CAN RECEIVE FULL Social Security benefits regardless of earnings; those under age 65 will lose benefits if they earn too much. Taxation of Social Security benefits depends on provisional income. For married taxpayers filing jointly, provisional income between $32,000 and $44,000 means as much as 50% of the benefits may be taxed.

CLIENTS MAY BE ABLE TO EXCLUDE UP TO $500,000 of gain from the sale of a principal residence ($250,000 for single taxpayers) if they meet certain conditions. Generally, to be eligible for the exclusion taxpayers must meet ownership and use tests.

BENEFITS UNDER ACCIDENT OR HEALTH INSURANCE policies generally are not taxed, including payments from an employer-sponsored plan for qualifying medical care. Amounts received under a qualified long-term care insurance policy are also excluded, although the exclusion is limited to $200 per day or the actual cost of care, whichever is greater.

PENALTIES MAY APPLY WHEN RETIREMENT PLAN distributions are taken too early or too slowly. The penalty on early withdrawals is 10%, while violating the minimum distribution rules can mean a 50% penalty. Lump sum distributions may be eligible for special tax treatment.

MARION KOPIN, CPA, is a partner in Bechtel, Kopin & Co. in Amherst, New York. Her e-mail address is . ARLENE HIBSCHWEILER, JD, is an associate professor at the State University of New York, College at Fredonia. Her e-mail address is .

ccording to the Social Security Administration, more than 35 million Americans are 65 or older. The first of 76 million baby boomers will begin retiring in 2010 and by about 2030, senior citizens will make up roughly 20% of the population. These figures suggest that advising older clients can be a significant part of a CPA’s practice today and will grow increasingly important in the future.

Tracking Social Security

Workers age 25 and over now receive an annual statement of Social Security benefits about three months before their birth month. The statement provides estimates of projected retirement, survivors’ and disability benefits. It also shows the worker’s Social Security earnings history, giving the worker an opportunity to correct any errors or omissions.

Workers can also request an estimate of benefits at any time through the Social Security Administration Web site ( ) or by mailing in form SSA-7004, which can be downloaded on the site. The advantage of making a separate request is that workers can provide an exact retirement age as well as an estimate of future earnings for use in making benefits projections. These projections may be more precise than those in the automatic annual statement.

Source: Social Security Administration, .

This article focuses on tax issues that are of particular concern to senior citizens—the taxation of Social Security benefits, the tax consequences of selling a home, deductibility of medical expenses and reporting benefits received from qualified retirement plans and life and disability insurance. Expertise in topics such as these should enable a CPA to provide valuable services to a growing segment of the population.


There is often great confusion among clients about the taxation of and eligibility for Social Security benefits. For many, the primary concern is how much a person can earn before losing benefits. For 2001, workers under age 65 can earn up to $10,680; above that amount they lose $1 in benefits for every $2 they earn. Workers age 65 and older have no earnings limit. A client born before 1938 will be eligible for full Social Security benefits, regardless of earnings, at age 65. However, beginning in 2003, the age at which full benefits are payable will increase in gradual steps from 65 to 67.

A divorced taxpayer can receive benefits on his or her ex-spouse’s Social Security record if the former spouse is receiving Social Security benefits (or is deceased) and the

Marriage lasted 10 years or longer.

Taxpayer is not now married.

Taxpayer is age 62 or older (if the ex-spouse is dead, benefits can be collected at age 60, or age 50 if disabled).

Taxpayer is not entitled to an increased benefit on his or her own record that exceeds half of the ex-spouse’s unreduced benefits.

Benefits eligibility is not related to the taxability of Social Security payments. If a taxpayer’s other income is substantial, a portion of Social Security benefits may be subject to federal income tax under IRC section 86. There is no tax on Social Security for single taxpayers whose “provisional income” does not exceed $25,000 and for married taxpayers filing jointly with provisional income less than $32,000. Provisional income is total adjusted gross income (including wages, interest, dividends and pensions, minus IRA deductions), plus tax-exempt interest and half of Social Security benefits.

Up to 50% of benefits is taxable for single taxpayers with provisional income from $25,001 to $34,000, and for married taxpayers filing jointly with provisional income from $32,001 to $44,000. At this level taxes are payable on the lesser of (1) 50% of benefits or (2) half the difference between provisional income and the applicable base amount ($25,000/$32,000), with some adjustments.

Up to 85% of benefits is taxable when provisional income is over $34,000 for single taxpayers, and $44,000 for married taxpayers filing jointly. At this level, federal income taxes are payable on the lesser of 85% of benefits or 85% of the difference between provisional income and the applicable base amount, again with certain adjustments. Married taxpayers who file separately are taxed on 85% of the lesser of Social Security benefits or provisional income.

Example. Sally is single and has income from sources other than Social Security of $131,472. Her Social Security benefits are $18,930 and her provisional income is $140,937 ($131,472 + 12 of $18,930). Her taxable Social Security is calculated as follows

(A) Provisional income $140,937
  Less applicable amount from line 7 of Social Security worksheet (25,000)


  Less applicable amount from line 9 of the Social Security worksheet ( 9,000)
  ($25,000 +$9,000 = $34,000, the amount above which 85% of Social Security benefits becomes taxable) $106,937
X 85%

$ 90,896

  Plus 50% of $9,000 – Line 12 of Social Security worksheet + 4,500

$ 95,396

(B) 85% x $18,930 Social Security benefit = $16,091  

The smaller of (A) or (B)—$16,091—is the amount of Sally’s taxable Social Security.


A single taxpayer of any age may exclude up to $250,000 of gain from the sale of a residence. This exclusion replaces the $125,000 one-time exclusion that applied before May 7, 1997, and also the gain rollover formerly available under IRC section 1034.

In 2001, a married taxpayer may exclude $500,000 of gain if all of the following are true:

He or she files a joint return for the year.

Either spouse meets the ownership test.

Both spouses meet the use test.

Neither spouse excluded gain from the sale of another home within the past two years.

A taxpayer does not have to report the gain on the sale of a home on his or her return if it does not exceed the exclusion.

A taxpayer meets the ownership and use tests if, during the five-year period ending on the date of the sale, he or she has

Owned the home for at least two years.

Lived in the property as the main home for at least two years.

Example. Peter has owned his home since 1993 and occupied it as his main home for the entire period. In 2001 he sells it for a $200,000 profit. As a single taxpayer he can exclude the entire gain from his 2001 federal tax return.

If a couple does not qualify for the $500,000 exclusion because both do not meet the use test, they can exclude the total of each spouse’s maximum exclusion ($250,000) determined separately as though they were unmarried. Each spouse is treated as owning the residence during the period either spouse owned the property.

Example. Assume the same facts as above except Peter got married on December 31, 1999 and sold his home in 2001 for a $400,000 gain. His wife, Mary, lived in the home during 2000. Peter is permitted to exclude $250,000 of the gain. However, his wife, under IRC section 121, can exclude only $125,000—$250,000 x 12 (Mary’s one-year use divided by the two-year use requirement). The couple’s total exclusion is $375,000.

In the case of joint filers not sharing a principal residence, a $250,000 exclusion is available on a qualifying sale or exchange of one spouse’s residence. CPAs should advise clients that the rule limiting the exclusion to one sale every two years does not prevent a husband and wife from filing a joint return excluding up to $250,000 of gain from the sale or exchange of each spouse’s principal residence—provided each would be eligible if they filed separately.

Example. Connie and Mike married in 2000, and each owned their own home. In 2001, the couple sell the house Mike owned and had lived in since 1990 at a $300,000 profit and live in Connie’s house. Since Connie never lived in Mike’s house, she does not meet the use test. Thus the couple is not eligible to exclude the entire gain on the sale of Mike’s home. However, since Mike meets both the ownership and use tests, they can exclude $250,000 of the $300,000 gain from their 2001 joint federal return.

If a spouse dies before the sale date, the surviving taxpayer is considered to have owned and lived in the property as his or her main home during any period when the deceased spouse owned and lived in it as a main home.

If a home was transferred to the taxpayer by his or her spouse (or former spouse, if the transfer was divorce-related), the taxpayer is considered to have owned it during any period when the spouse owned it. A client is treated as having used property as a main home during any period when he or she owned it and the spouse or former spouse is allowed to live in it under a divorce or separation instrument.

If the taxpayer used the home for business or as rental property and claimed depreciation deductions, he or she cannot exclude the part of the gain equal to any depreciation allowed or allowable as a deduction for periods after May 6, 1997.

If a taxpayer owned and lived in a property as a main home for less than two years before the sale, it may be possible to qualify for a reduced exclusion. Taxpayers who change residences due to employment, health or other unforeseen circumstances may exclude a fraction of the $250,000 (or of $500,000). The fraction equals the time during which the taxpayer met the ownership and use requirements or the time between the prior sale and the current transaction, whichever is less, divided by 24 months.


Under IRC section 213, all taxpayers can deduct certain unreimbursed medical expenses. Deductible expenses that may be especially relevant to older clients include ambulance service, dentures, eyeglasses and contact lenses, hearing aids and the batteries to operate them, special telephone equipment for the hearing-impaired and wheelchairs. Monthly Medicare part B premiums are deductible (although an employee cannot claim the payroll tax used to fund Medicare part A). The cost of other medical insurance, such as a policy that supplements Medicare Part B coverage, can also be claimed. Exhibit 1 summarizes deductible and nondeductible medical expenses.

Medical costs a decedent had paid before death generally are reported on his or her last income tax return. The executor or estate administrator can elect to treat medical bills paid within one year of death as if they were actually paid by the decedent at the time the service was provided. This means the deduction would be taken on the decedent’s income tax return rather than claimed for estate tax purposes. This should be done when the CPA determines the income tax savings will be greater than the estate tax savings. That would be the case, for example, where a decedent’s entire estate was expected to be sheltered by the unified credit ($675,000 in 2001).

A taxpayer can deduct medical expenses only if they exceed 7.5% of AGI. Unclaimed expenses cannot be carried over to later years. CPAs might want to recommend that clients considering voluntary medical procedures, such as having crowns put on several teeth, try to have all work done in one year if they normally do not incur enough medical expenses to claim the deduction. Bear in mind, however, that only expenses actually paid can be claimed—regardless of when the service was performed. In other words, if the last crown is completed in December 2001 but the dentist isn’t paid until 2002, the cost of that crown cannot be added to other dental expenses when calculating the 2001 medical deduction.

Example. Mildred is single. Her unreimbursed medical expenses in 2001, including insurance premiums and Medicare part B, total $11,300. Based on her AGI of $61,000, Mildred will be able to deduct $6,725 ($11,300 less $4,575).

Long-term care. Long-term care insurance premiums are deductible under certain circumstances. The policy must be “qualified,” meaning it meets the conditions specified in IRC sections 213 and 7702B. These conditions include requirements that the insurance contract be guaranteed renewable and have no cash surrender value. There is an annual limit on the amount of the premium that is deductible based on the age of the individual. In 2001, the deduction for someone between the ages of 60 and 70 is limited to $2,290.

Qualified long-term care costs also are deductible. These include diagnostic, preventative, therapeutic and rehabilitative procedures, plus maintenance and personal care costs required by chronically ill individuals. The services must be provided under a plan prescribed by a licensed health care practitioner, who also must certify the chronic illness. Chronic illness exists when a person is unable to eat or bathe, for example, without substantial assistance for at least 90 days.

Legal medical services provided by physicians and other medical practitioners are deductible, as are prescription drugs, insulin and the cost of medical care in a nursing home. The latter includes meals and lodging, if the primary reason for being in the home is to receive medical care. Nursing services, such as paying someone to administer medication, change dressings, or help with bathing and grooming, are deductible—even if not performed by a nurse. However, wages paid for personal or household services cannot be claimed as a medical expense.

Capital improvements a taxpayer makes to a home primarily for medical reasons, such as installing a wheelchair ramp or widening doors, can be deducted in full. When the expenditure also improves the value of the property, as in the case of a swimming pool, CPAs should caution clients that the deduction is limited to the cost of the improvement less the amount by which the project increases the home’s value.

Example. John incurs the following medical expenses in 2001:

$850 for new dentures.

$275 for car and bus to and from his doctor appointments.

$150 for an office visit to a chiropractor to treat a bad back.

$10,000 to install a swimming pool for doctor-ordered back exercise.

$400 to enroll in a doctor-recommended weight loss program.

Of these expenditures, only the first three items, the dentures, medical transportation and chiropractor are deductible in full, and then only to the extent they exceed 7.5% of John’s AGI. After determining that the pool increases the value of his home by $8,000, John can also claim the remaining $2,000 as a medical expense.


Under IRC section 104, benefits a taxpayer receives under an accident or health insurance policy generally are not taxed. This is also true of payments from an employer-sponsored accident or health plan for qualifying medical care under IRC section 105. Similarly, benefits received under a qualified long-term care contract are excluded, although IRC section 101 limits the exclusion to $200 per day (the indexed amount for 2001) or the actual cost of care, whichever is greater. A client who has retired on disability is taxed on the benefits received, unless he or she paid the policy premiums. CPAs would report disability benefits as income on line 7 of form 1040 until the client reaches minimum retirement age, at which time they should be shown as pension income, on lines 16a and 16b of form 1040.

Under section 101, life insurance proceeds paid due to the insured’s death are not taxed. Accelerated death benefits paid to a terminally or chronically ill person can also be excluded, even though received before death. A person is terminally ill if a doctor certifies that he or she is likely to die within 24 months. Chronic illness means the person has a disability that requires long-term care. As with qualified long-term care insurance benefits, the exclusion for accelerated benefits paid periodically to a chronically ill person is limited to the greater of the actual cost of care or $200 per day. Nonperiodic payments to a chronically ill person must be for qualified long-term care costs. The exclusion for accelerated death benefits also applies when the chronically or terminally ill person sells or assigns the insurance policy to a viatical settlement provider—someone in the business of buying life insurance contracts on terminally or chronically ill persons.


Counseling clients on the taxation and distribution of benefits from qualified retirement plans or IRAs can raise many concerns. At the very least, a CPA can provide an important service by helping clients avoid penalties on actual or required plan distributions. For example, under IRC section 72, there is a 10% penalty on distributions from qualified plans or IRAs before age 59 12 . There are exceptions, including distributions on account of an employee’s death or disability or for medical expenses deductible under IRC Section 213. ( Exhibit 2 has a broader list of these circumstances.) The penalty is limited to the part of the distribution includible in gross income. This means, for example, that it would not apply to any part of a distribution that was a return of nondeductible contributions.

Other penalties can affect qualified retirement plans and IRAs. Although some clients may be aware of the applicable penalties, many are not. Because CPAs often meet with clients at least once a year at tax time and often know more about a client’s finances than other advisers, they are ideally suited to remind clients of these restrictions. Helping clients avoid the penalties, such as recommending an IRA payout structure to avoid the 10% early withdrawal penalty, can be a valuable service for older clients who are likely to have significant retirement assets.

Distribution rules. Under section 401(a), clients with assets in qualified retirement plans or IRAs must meet certain minimum distribution rules or face a 50% penalty on the difference between the distribution they should have taken and the actual payout. In general, distributions must begin by April 1 of the calendar year following the later of the year the employee reaches age 70 12 or the year of retirement. For traditional IRAs and 5% owners, payouts must begin by April 1 of the year after age 70 12 , regardless of the actual retirement date.

In January 2001 the Treasury Department issued proposed regulations that simplify the calculation of required distributions from qualified plans and IRAs. The new rules are expected to reduce the amount of required distributions in most cases. The proposed regulations are likely to become final effective January 1, 2002. IRA owners are allowed—but not required—to apply the proposed regulations in 2001. Qualified plan participants cannot take advantage of the new rules until the plans are amended.

Tax rules. Taxation of qualified retirement plan distributions depends on how the proceeds are paid. Periodic payments are taxed under the annuity rules of section 72 if received from a qualified plan when the participant is 75 or older on the annuity starting date and if the annuity payments are guaranteed for at least five years. The annuity rules of section 72 also apply to periodic payouts received from nonqualified plans.

Participants whose annuity starting date is after November 18, 1996 must use the simplified method to calculate the taxable part of a periodic distribution from either a qualified employee plan, a qualified employee annuity or a tax-sheltered annuity, unless the rule discussed above for 75-year-olds applies. Under the simplified method, the retiree’s investment is divided by the number of anticipated monthly payments, as determined by the terms of the contract or following tables published under section 72. This amount is shown on the client’s form 1099R; the example below illustrates how the employer calculates the number.

Example. Dave and Samantha began receiving distributions from a qualified retirement plan on January 1, 2000. Dave’s age at the annuity starting date was 65 and Samantha’s 67. They received distributions of $15,800 in 2000 and have a total investment of $44,000. The couple’s taxable distribution is calculated as follows:

$44,000 260 = $169.23 x 12 payments received in 2000 = $2030.77 excluded

Taxable distribution = $15,800 – $2030.77 = $13,769.23

At the end of 2000, Dave and Samantha had $41,969.23 of unrecovered investment. Following the same rules that apply to periodic benefits taxed under the general annuity rules, Samantha and Dave can recover only their actual cost since their annuity starting date is after 1986. Once they recover this amount, payments will be taxed in full. If Dave and Samantha die before they recover the cost, the balance is a miscellaneous itemized deduction on the final income tax return. It is not subject to the 2% AGI limitation.

Income from nonperiodic payments is taxed in the year of receipt. However, special rules may apply. Participants who turned 50 before January 1, 1986, can elect the pre-1987 rules for lump sum distributions. A lump sum distribution is a payout of a participant’s entire interest that meets certain conditions. An IRA payout cannot qualify as a lump sum distribution.

Under the lump sum rules, the portion of the distribution attributable to service before 1974 can be treated as capital gain and taxed at a 20% rate. The payout for service after 1973 is referred to as the ordinary income portion. It can be reported using 10-year forward averaging if the client participated in the plan for at least five years. A participant can treat the entire distribution as ordinary income but can elect 10-year averaging only once. The sidebar below provides an example.

IRAs. Distributions from a traditional IRA are taxable. If the IRA includes nondeductible contributions, CPAs use form 8606 to calculate the tax-free portion. Qualified payouts from a Roth IRA are not taxable. These are payments made because of death, disability, a qualifying first-time home purchase or made after the account holder reaches age 59 12 . The payments must be made more than five years after the first contribution. When amounts are distributed within five years of a conversion from a traditional to a Roth IRA, the 10% early withdrawal penalty may apply, even if none of the payout is otherwise includible in gross income. For distributions after the five years, the 10% penalty would apply to the taxable portion, if any, of the Roth distribution. Roth IRA contributions may be removed without tax, and regular contributions are treated as being paid out of an account before conversion contributions or earnings.


Many CPAs view the tax advice they give older clients on issues such as Social Security, itemized deductions and retirement benefits as routine. Nonetheless, expertise of this nature is valuable, and will become increasingly important as more Americans reach age 65 and begin to face the challenges discussed here. Any CPA whose practice includes tax compliance must be familiar with issues that regularly arise for senior citizens. Specializing in these areas may represent an opportunity for CPAs who want to expand their tax or estate planning practice.

Taxation of Lump Sum Distributions
Under Pre-1987 Rules

Participants who hit age 50 by January 1, 1986, can elect to have lump sum distributions from qualified retirement plans taxed under the pre-1987 distribution rules. This election is not available to IRA payouts. Under the rules, the capital gain portion of the distribution—attributable to pre-1974 participation—is taxed at 20% and the ordinary income part is eligible for 10-year forward averaging if the taxpayer participated in the plan for at least five years.

Example. Bruce, who was born in 1935, receives a qualifying lump sum distribution of his entire retirement plan interest in 2000. Bruce receives a form 1099-R from his employer showing the capital gain portion of the distribution to be $15,000. The total payout is $200,000, which includes $40,000 of contributions Bruce made.

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