by Tony Novak, CPA, MBA, MT revised 5/19/2015
Our U.S. federal income tax laws include a number of built-in legal strategies available to reduce income tax liability. No matter what your unique financial position, your ability to lower your income taxes likely depends on understanding and utilizing the opportunities available in five key areas of financial planning: 1) legal format of income generating entities, 2) accounting strategies, 3) use of real estate, 3) use of income deferral strategies, and 5) maximizing tax-free employee and executive benefits.
Adopting one or more of these tax strategies now will result in lower taxes next spring at tax filing time but many strategies need to be planned and executed well in advance. This listing below is meant to highlight the planning possibilities but is not intended to be a complete discussion of all of the details. Keep in mind that the effectiveness of many of these tax strategies is multiplied when they are used in combination.
- For empty nesters. it pays to downsize the home. Married couples can exclude up to $500,000 ($250,000 for single people) of gain on the sale of a home. That means possibly a half million dollars completely free of income tax. No other provision of the federal tax law is as generous. Considering the long term run-up in housing prices in many areas, this may be the time to consider cashing in and trading for a less expensive dwelling. There is no need to reinvest the gain in another house, so this strategy is perfect for empty-nesters who may be ready to downsize. See what the IRS has to say on this topic.
- For self-employed individuals. Stretch tax-advantaged retirement plan deductions. Self-employed individuals can deduct up to 100% of current taxable income sometimes up to $260,000 for contributions to a private pension plan. Individuals who are close to retirement age, are self-employed, have income over $150,000 and work in a small business without many employees typically have the greatest opportunity to shelter earnings from taxes using this strategy. See this new article about setting up your own pension plan. Plan documents must be on place in the year that the deduction is to be taken but the investment may be made in the following year prior to tax return filing. Self-employed individuals at incomes less than that amount are more likely to benefit from a Simplified Employee Pension, Health Savings Account and other similar options. Any of these options can be started quickly and at minimal cost.
- For small businesses. Immediately deduct up to $500,000 for the cost of certain types of capital asset purchased rather than deduct the cost over time as is normally required. This break was nicknamed the "Range Rover write-off" when it was first introduced. The maximum allowed write-off was scheduled to be reduced to $25,000 for 2014 without the "tax extender" laws but is now restored to the full $500,000. 1 The tax benefit is magnified when you finance a purchase and have not actually yet made cash payments. The IRS rules are commonly discussed under the term "Section 179 ".
- For employees. Receive tax-free reimbursement of out-of-pocket health care expenses. Use a Health Savings Account (HSA) if you are self-employed or use a Health Reimbursement Arrangement 2 (HRA) for an employee. For 2014 the plan must be integrated with qualifying health insurance. Read more about HRAs here.
- For lower income wage earners. Long term capital gains are now completely tax free as long as your total taxable income keeps you below the 15% tax bracket threshold. This tax break is based on the lower "taxable income" not the higher "adjusted gross income" amount so that more people actually qualify for this tax break. Taxable income is typically about $10,000 lower than adjusted gross income for single filers (or about $20,000 lower for married filers). That means, for example, a married couple living on one income of $50,000 sells something that they have owned for more than a year and make a $25,000 gain. The entire $25,000 gain is tax free. Also, a separate tax credit is available for low income individuals who make retirement plan contributions. The federal government effectively matches 50% of your deposit with a tax credit. Of course, the problem is that low income people do not have money to make retirement plan contributions. But parents could make a gift of IRA deposits to their children, for example, to effectively earn an immediate 50% return on their investment. Combining these strategies is even more effective: selling a capital gain asset tax-free and putting the proceeds into a tax-deductible retirement contribution and then getting an additional matching tax credit is an amazingly effective tax strategy. The problem, of course, is that most low income people do not have room in their budget for these types of transactions.
Need a personalized strategy to save taxes? Request a flat fee conultation to develope a customized list of possible strategies. This tax planning service is based on your last year's
tax return and adjusted for the changes that you expect for the coming year. The results are presented both in a written report and a brief 10-20 minute personal consultation. The cost of this service is a flat $100. It could be your smartest financial move of the year! Just call 610-572-1724 or send a brief message of introduction to request a personal tax analysis and I will respond on the same business day.
The best tax strategy for your unique situation might not be included on this list but typically can be developed though a tax planning discussion either in person or by telephone. Please call to schedule a time to discuss tax planning ideas.
Before committing to any tax strategy, complete a pro forma tax return (future hypothetical tax return) to test the strategies for your unique situation. Pay special attention to income based phase-outs and the alternate minimum tax.
1 The maximum deduction allowed under Section 179 has varied over time with changing tax laws. It increased to $500,000 and then was scheduled to be reduced to $25,000 for 2014 without the "tax extenders" bill that was recently passed by Congress.
2 HRAs changed in 2014 under the rules for the Affordable Care Act but the same tax benefit will be available under a revised form called a "Limited Purpose HRA". See www.freedombenefits.org for more on starting one of these plans for a small business. The cost for professional assistance with set up is typically about $150 and two days lead time is often required.
3 Recent changes to mortgage banking regulations make these loans unavailable to most working-class Americans so I am now looking for a replacement #10 easy tax shelter. If you have a suggestion, please write me at firstname.lastname@example.org.
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