Think quickly what is your single largest expense? For many of my clients, their largest expense is taxes. Some people try to rein in their budget and save money by clipping coupons, cutting down on the number of times eating out, buying a cheaper off-brand at the grocery store, or buying a fuel efficient vehicle.
When I was chief financial officer and we needed to save money in our corporate budget, we would look first at the largest expense items, see what we could cut there, and then work our way down through smaller expenses. A 10 percent reduction in our largest expense was much more beneficial than even a 50 percent reduction in our smallest expense.
So if taxes are one of your largest expense items, may I suggest putting real quality time and resources into reducing that expense first. I don’t suggest letting the tax tail wag the dog, but if you can reduce your largest expense item by 10 percent, it is probably worth more to you than skipping a night at the restaurant here and there.
Tax idea 1 — retirement planning
Our country needs self-sufficient retirees who can provide for themselves, and the government provides generous incentives to do so. If you don’t take advantage of these incentives — this free government money — you cannot go back later and claim these funds. We have shown many people how to save hundreds of thousands of dollars through pension planning, and several of these clients had previously been told that their pension plan contributions were already maximized.
Get a second opinion on your pension planning from a proactive planner or if you don’t have a pension plan, consider starting one. This one area could possibly be the biggest contributor to your tax savings and financial security.
One of my clients asked, “I could have been saving around $100,000 per year for the past decade?” Sadly, this was the case, and once the years have passed it is difficult or impossible to go back and get those tax dollars.
Although some pension planning ideas are available after the end of the year, the majority require action before the last day of the year. If you missed the boat on this one in 2012, there is always 2013.
Tax idea 2 — standard deduction for itemizers
Ever wonder what the standard deduction is for? Even those who pay no property tax, mortgage interest or charitable contributions still get the benefit of the standard deduction. You may be paying $12,200 in itemized deductions and the guy next door may be paying $0 in itemized deductions, yet you both get the same write-off.
Well, here is your chance to get more of your fair share of this benefit. We have had success with clients grouping all of their itemized deductions for two years into one year, and then taking the standard deduction in the other year.
Some itemized deductions are difficult to move, and in some cases you may not pick up the entire $12,200 increase in deductions, but even if you pick up two-thirds that amount and you are in the 25 percent federal and 5 percent state bracket, that could mean an additional $2,400 in your pocket every other year! Say this process takes a couple of hours of your time to implement — that is a cool $1,200/hour in tax savings not bad!
Tax idea 3 — liberate passive losses
I had a client with several years of suspended passive losses that looked like they might never get to be deducted. This is because you can only deduct a passive loss against passive income. Here are a couple of ideas to liberate those suspended losses, either reduce the passive loss by shifting expenses to a category that can be deducted, or generate passive income.
For example, if you have a rental property that is generating losses, you could consider taking out a mortgage on your primary residence and shifting the deduction there, or purchasing one of the many investments that generate passive income and allow your suspended losses to shield that income from taxation.
Remember that you are limited in the amount of home equity interest you can deduct. Just don’t pass away with suspended passive losses, or the benefit may be lost forever.
Tax idea 4 — tax credits
A few years ago, one of my friends told me about a free electric car that you could get through tax credits. I quickly told him this follows the old axiom, “if it sounds too good to be true, it most likely is.” However, in this case my friend was right!
Many tax credits are frequently missed, including the small-business health insurance credit, education credits, and other general business credits. Some education credits are roughly equivalent to a full-ride scholarship, and some entire industries or businesses are built on tax credits. Make sure you investigate options in this area.
Tax idea 5 — tax deferred exchange
If you have rental properties or other highly appreciated assets, you may know that when you sell one of these assets you do not have to pay the tax now if you exchange the property into a “like-kind asset.” We have helped clients exchange millions of dollars of highly appreciated real estate into income-producing replacement property with no tax bill.
In addition, many replacement properties give the owner the benefit of additional depreciation deductions that reduce the amount of tax paid on that replacement property income.
So, you may ask, what happens to the gain? The gain is deferred into the replacement asset, which can be donated to charity, gifted to children or grandchildren, or simply held on to for the rest of the owner’s life. Each of these strategies may result in little or no tax. I like to think of this as harvesting fruit from the orchard rather than chopping down the tree for the temporary benefit of firewood.
Caveat — As you are improving your situation, don’t forget about Congress’ sneaky trick — the alternative minimum tax! When you see a nice “tax reduction” gift from Congress, if it is not married to a similar change in the alternative minimum tax, the new deduction may be worthless.
As you look at different scenarios, make sure you take the AMT into consideration, otherwise all your planning may be for naught. Make sure that you run your tax computation for both regular and alternative minimum tax to give greater assurance that your planning efforts will pay off.
Read next week’s column for five more tax saving ideas.
Do not rely on any information stated or calculations made herein as tax or legal advice. Consult your independent tax adviser or attorney for tax or legal advice on which you rely.
Rich Wagner, CPA, MAcc, is a tax reduction and investment expert. If you’d like more ideas on protecting , saving and growing your money, call him at 801-657-4459, or email at [email protected].