Although it may seem that the tax laws have cut off all the avenues for reducing your taxes, there are still some good ways to shelter income from the tax man.
The first step is to make sure you’re already taking advantage of all the deductions to which you’re entitled. Keep good records for substantiation, and don’t be afraid to write off allowable deductions.
Here are some ideas everyone should consider:
YOUR HOME
- Favorable tax laws, inflation, and appreciation have combined to make your home the ultimate tax shelter.
- Home mortgage interest and property taxes are deductible. Home mortgage interest includes interest on any loan (up to a maximum of $1 million) to acquire, build or improve your home (or a second home), and interest on home-equity loans (where available) up to $100,000.
- Up to $250,000 of profit on the sale of your home is not taxed if you’re single ($500,000 for couples) and you meet certain ownership and use requirements.
- When you die, the increased value of your home is not subject to income tax. Your heirs’ basis in your home is its fair market value at your death. So given the right circumstances, you may forever avoid income tax on the appreciation in the value of your home.
EMPLOYEE RETIREMENT PLANS
- Next to your home, participation in a retirement plan offered by your employer is your best tax-cutting strategy. Since your account is pooled with other employees’ accounts, you receive the benefit of professional investment advisors and the better rates of return available to larger blocks of investors. You aren’t taxed on the earnings in your retirement account until you begin withdrawing the funds.
KEOGHS AND DEDUCTIBLE IRAs
- You may be able to reap tax savings if your tax rate during your working years is significantly higher than your tax rate when you retire. For example, a self-employed person who makes tax deductible contributions to a Keogh during the years when she is in the 39.6% tax bracket, then withdraws the money at retirement when she’s in the 15% tax bracket will have saved significant tax dollars.
TAX-FREE MUNICIPALS
COLLEGE FUNDING
- If you need to fund college education for your children, you can shift assets to your children and have the income taxed in their low brackets as long as their unearned income stays under the amount that triggers the "kiddie tax" ($1,300 for 1997).
- If your income is not too high to disqualify you, consider buying Series EE savings bonds to pay for college expenses. The interest on these bonds is tax-free. Also consider education IRAs, a ROTH IRA, or a regular IRA to build college savings. Amounts withdrawn from IRAs for college expenses qualify for favorable tax treatment.
RENTAL REAL ESTATE
- Rental real estate still offers good tax shelter opportunities if you’re willing to actively manage the property. You can write off up to $25,000 in losses against your earned income such as wages, if your adjusted gross income is under $100,000. This deduction phases out for taxpayers with income over $100,000. Special rules apply if you are a real estate professional, so get details.
YOUR FAMILY
In a given family group, the various members may have tax brackets ranging from 15% for children or elderly family members, to 28% for young working family members, and 39.6% for middle-aged family members. Tax planning for the family group should consider these brackets and take full advantage of the tax-cutting opportunities that are available.
Some of the ways families might use the tax law to their advantage include:
- Choosing the most advantageous filing status.
- Planning to maximize the tax benefits of the personal exemption.
- Shifting income to children age 14 and older or up to the "kiddie tax" limit for younger children.
- Hiring a child in your business. Wages paid to a child may provide for income-splitting – that is, having those dollars taxed in your child’s tax bracket (presumably lower) rather than in your higher bracket.
- Timing marriage or divorce to minimize the tax cost.
OTHER SHELTERS
- Investment vehicles such as deferred annuities, nondeductible IRAs, U.S. savings bonds, and certain insurance products feature the compounding of earnings without a current tax. You pay tax later when you withdraw the money. The combination of compounding without tax and a lower rate at withdrawal can mean substantial tax savings.
There are other tax-cutting strategies in addition to those mentioned here. If you would like assistance in selecting tax planning strategies that make the most sense in your situation, contact our office.
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Cay
Pooley, EA