A young new adviser once approached me and asked, “what book can I read this weekend to gain your tax knowledge.” I smiled as I thought of the decade of effort studying tax law in graduate school, working with tax clients at Deloitte and serving as CFO of multiple companies that forged the ability to see tax savings opportunities. I've also had people come to me with deductions that were not only in error but in my opinion bordering on tax evasion or illegal. Don't even go there, it's not worth it.
There are a plethora of people who will happily take your money and show you strategies that may equate to tax evasion that can destroy your life. I recommend taking all the available deductions to the full extent possible, without running the risk of destroying your financial future by seeking out overly aggressive or illegal strategies to save taxes now and pay dearly later.
We frequently find plenty of relatively simple tax strategies that are overlooked or underused but can be of great advantage to you. Last week, I provided five ideas to potentially save a lot of money in taxes. As promised, here are five more.
Tax idea 6 — get a second opinion
Sometimes we feel that with all the technology we have available to us we can just do our own tax planning. Very simple tax preparation, possibly, but tax planning? I don’t think the technology is quite there yet. We have seen new clients try to save money by doing taxes on their own, and have then shown them where they have left thousands of dollars on the table.
Sometimes we have amended previous returns and gotten thousands of dollars back, but the IRS generally allows you to go back only three years, so in some cases, thousands of dollars were left on the table in previous years, never to be recovered.
If you are dead set on preparing your own return, I recommend at least getting a second opinion from a proactive tax planning expert to see what you may have left on the table. We have clients who received more than 10 times the fee charged in tax savings, and sometimes practitioners will perform this second opinion service for free, in hopes of creating goodwill and possible future business.
Tax idea 7 — excess RMD distributions
The federal government always gets its tax! Not only does it tax earnings, but it wants to make sure that we recognize enough earnings to keep the government wheels rolling. Required minimum distributions (RMDs) must be taken each year from your IRA after age 70½, so the government can tax you on these funds.
If you don’t take enough out, the results are rather draconian. Up to 50 percent of the amount you should have taken as distribution, but didn’t, can be taken away in taxes — ouch! Many people take only what they have to, which is a good idea in many cases, but in some cases, you may want to take out more than you need.
We have instructed some clients to increase their IRA withdrawals above and beyond the amount required to be distributed via RMD because they are in a low enough tax bracket that little or none of this additional withdrawal will be taxed. They don’t have to spend this money, but it is a nice way to get it run through the tax systems at little or no tax cost so that it can be spent outside the IRA or pension plan in a later year when they may be in a higher tax bracket. This is one of those benefits you have to use or you lose it. You can’t go back and take those distributions after year end.
Tax idea 8 — harvest capital losses and defer capital gains
When it comes to taxes, gains do not necessarily equate to more income tax. Even with the new 2013 higher tax rates on capital gains for those with income in higher brackets, there are many strategies that can reduce or eliminate altogether the tax on capital gains. For example, when the market declined in 2007 and 2008 we helped clients recognize the tax losses, and now the investments have appreciated, but are in tax efficient funds so those gains have not been taxed.
One of our clients recognized more than $500,000 in losses on the client's tax return, but has actually gained hundreds of thousands of dollars that have not been taxed.
Tax idea 9 — donate gains or step up basis
Proper tax planning and investing may generate large untaxed capital gains. How do you reduce that tax hit? Rather than donating cash to your favorite charity, donate the property that has large capital gains instead, and you may be able to avoid tax on the entire gain, permanently.
Furthermore, if you want to give money to a child or grandchild, why not transfer these highly appreciated shares to your child instead, and let the child sell the shares. In many cases, the child may pay little or no taxes on capital gains, but still receive the same economic benefit.
Consider taking advantage of the step up in basis at death by deferring these gains throughout life and then after you pass away, if properly structured, your heirs can sell the assets the next day and pay no tax!
On a side note, beware of annuities that may convert capital gains into ordinary income, thereby removing the opportunity to use these capital gains strategies. Furthermore, non-annuitized withdrawals require all gains to be distributed and taxed as ordinary income, before you get any of your original purchase amounts back. There are some instances where an annuity might make sense, just make sure you understand the tax impacts before you invest.
Tax idea 10 — tax managed investments
Be smart about your investments, pick funds that are tax managed or attempt to match gains with losses or have very low turnover so that you're not constantly generating gains that you have to pay tax on. Taxes have a tremendous negative impact on your overall return.
When you compare investments, make sure you include the tax effect of gains on dividends, interest and capital gains from schedule B and D of your return. Focus on the after tax return, because it matters more what you keep than what you earn.
People complain about the market, but over the last decade our clients have almost doubled their money in a boring, well-diversified, inexpensive portfolio with little turnover, and without ever leaving the market.
Don’t worry about the market, you cannot control the market, but you can control taxes and fees paid, so focus on the things you can control and forget about the things you can’t.
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.
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 firstname.lastname@example.org