3 Simple Tricks to Legally. Lower Your Taxes

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1 3 Simple Tricks to Legally Lower Your Taxes 1

2 3 Simple Tricks to Legally Lower Your Taxes By Ted Bauman ALBERT Einstein once said: The hardest thing in the world to understand is the income tax. He was right. Not to put too fine a point on it, the United States tax code is absurd. Back in 1913, the U.S. tax code was a seemingly robust 400 pages. One hundred years later, it has exploded to 73,954 pages of complicated and often indecipherable language, all of which has been designed to seize as much money as possible from your wallet. Between 1993 and 1994, the tax code nearly doubled in size, expanding from 26,300 pages to a ridiculous 40,500 pages. Since then it has nearly doubled again. Who reads all of that? The answer: No one except maybe tax accountants and tax attorneys, because the cost to taxpayers is equally enormous, on top of the taxes themselves. It is estimated to cost more than $200 billion a year to meet the tax code s requirements. And while that may be good news for tax preparers one of the world s major growth industries for most taxpayers, it just adds insult to injury. But all is not lost. While the IRS is determined to grab as big a slice of your wealth as possible, there are still a number of escape hatches available to Americans. This report will show you how you can best beat the tax man. There s still time for you to prepare... save your money from the tax man... and even profit over the long term. Three Ways to Reduce Your Taxable Income The fundamental element at the heart of all strategies for trimming your tax burden is to reduce your taxable footprint. In other words, you must work to make sure the amount of income you leave for the IRS to plunder is as small as it possibly can be by the end of each calendar year. This may seem obvious, but it is surprising how many people more or less let the IRS help themselves to their hard-earned income. There are three basic but often overlooked methods of keeping your taxable footprint to a minimum. No. 1: Gifting Congress has continued to extend the gift-tax limit since This year, you re allowed to make lifetime gifts of up to $5.49 million without paying federal gift tax. So, depending on your circumstances, you may want to take advantage of this by allocating parts of your estate to your heirs. This can be done by creating a foreign tax-deferred annuity, but we ll get to that later in the issue. Under the 2017 exemption, you are allowed to gift $14,000 tax-free per person (or $28,000 per married couple) per year to as many people friends or relatives as you wish, as long as you don t go above the $5.49 million threshold. 2

3 The big point here is that the total amount you gift in any year is excluded from your taxable footprint, which means less for the tax man to get his hands. Your gift is tax-free anyway, under the basic exclusion amount. Such gifts can be reported on your 1040 tax return. If you give more than $14,000 (or $28,000 per married couple) to anyone in 2017, you must report the gift on Form 709. Another big point is that property acquired by gift or inheritance isn t included in gross income of the beneficiary, who won t have to include its value when filing their own income tax return. However, income derived from any gift is taxable for the beneficiary. Moreover, the concept informally known as portability is now permanent, thanks to the American Taxpayer Relief Act of 2012 (ATRA). Portability allows a surviving spouse to use a deceased spouse s unused estate-tax exclusion. With portability, it doesn t matter if you held assets jointly or separately. As a surviving spouse, you can add to your estate the unused portion of your deceased spouse s exemption. For example, if a deceased husband used $2 million of his $5.49 million in lifetime exemptions, his wife could move the unused $3 million into her estate at his death, tax-free. For spouses, the limits on lifetime gifts don t apply. If your spouse is a U.S. citizen, there s an unlimited marital deduction for most gifts, even if they exceed the annual exclusion amount, and you re generally not required to file a Form 709. But beware: A different rule applies if your spouse isn t a U.S. citizen. In that case, you must file a Form 709 gift-tax return if your gifts to him or her total more than $145,000 per year. Gifts to a noncitizen spouse above that annual limit count against your basic exclusion and must be reported. The federal estate-tax exemption has changed often in recent years, causing many lawyers to use a formula clause in trust documents and wills rather than stating a specific dollar amount to be left to certain individuals. For example: I leave to my children the maximum allowable amount that is not subject to federal estate tax, with the remainder going to my wife. If you make a gift of anything other than cash or marketable securities, you need to get a professional appraisal at the time you make transfer, especially if it s a hard-to-value asset, such as real estate or a share in the family business. If you plan to do this, you can make one gift late this year and another early next year, using the same appraisal for both saving on appraisal costs. Finally, payments made on behalf of another person directly to an educational institution for tuition costs or to a medical care provider for medical costs (including medical insurance), are also excluded from the gift tax, and don t affect your lifetime cap. You might pay the school tuition of a friend s child, and it won t affect your lifetime gift cap. (Note: This is different from the tax deduction you get for college and medical expenses for your spouse and dependents.) Federal law also allows you to contribute to Section 529 education savings plans usually for college costs up to the annual exclusion amount. You can set up a separate account for each family member you want to help. Although your contributions to a 529 account are considered gifts, money in these accounts grows tax-free and can be withdrawn tax-free, provided it is used to pay for college, a graduate, vocational or another accredited school or for related expenses. Section 529 also permits lump-sum deposits of as much as $70,000 per person at once ($140,000 for married couples), but you must file a Form 709 gift-tax return, electing to treat the gift as if it had been spread over five years. During this five-year period, you can t make additional annual exclusion gifts to the person benefiting from the 529 plan. 3

4 No. 2: Max Retirement Contributions One of the most important ways to reduce before-tax income is to max out your retirement contributions. The annual contribution limits for Roth IRAs, 401(k)s, 403(b)s and traditional IRAs didn t change this year, but the limit did change for SEP-IRAs. Here s a summary of the maximum contributions for 2017: 401(k) and 403(b) Plans Max = $18,000: If you re employed and contributing to a 401(k) plan, you can contribute up to $18,000 this year. For someone in the 25% tax bracket, contributing the maximum will save you $4,375 in federal income taxes. Of course, if you haven t been doing that all year, there s not a lot you can do now, but workers age 50 and older can contribute an additional $6,000 to their 401(k) in 2017, or a total of $24,000. An older worker in the 25% tax bracket who contributes the maximum amount can reduce their 2014 tax bill by $5,750. Traditional IRA Max = $5,500: You can contribute up to $5,500 to an IRA in 2017, which jumps to $6,500 if you are age 50 or older. If you have an employer retirement plan, however, the tax deduction for traditional IRA contributions is phased out for modified adjusted gross incomes between $61,000 and $71,000 in The income limits for married couples are between $98,000 and $118,000. If only one spouse has a retirement plan at work, the deduction is phased out if the couple s income is between $183,000 and $193,000. Unlike 401(k) contributions, which generally need to be made by the end of the year, IRA contributions can be made up until the tax filing deadline in April SEP-IRA Max = 25% of compensation up to $54,000 in The amount is limited to the lesser of 25% of your income or $54,000, so if you make over $265,000 the most you can contribute is $54,000. Roth IRA Max = $5,500: You can contribute up to $5,500 to a Roth IRA in If you re over age 50, there s a $1,000 catch-up contribution. Eligibility to make Roth IRA contributions is phased out once an individual s income is between $116,000 and $131,000 in 2017 ($183,000 to $193,000 for couples). No. 3: Juggling Money One of the easiest ways to reduce current-year income tax is to shift income into the following year or next year s expenses into the current year. This reduces your adjusted gross (i.e., taxable) income. Tax law allows you to accelerate deductions in the current year and defer income to next year. There are many items for which you may be able to control timing: consulting income, self-employment income, real estate sales, gains on stock sales, other property sales and retirement plan distributions. On the expense side, you can prepay 2018 state and local income taxes, take losses on stock sales (up to $3,000 in net losses) and prepay 2018 real estate taxes, anticipated mortgage interest, margin interest and charitable contributions. Two Common Tax Mistakes One of the most difficult issues many people face is in the treatment of gifts vs. inheritance. There are very different rules when it comes to the tax basis of property i.e. the starting value of the property when calculating capital gains. For example, if your child inherits your property, his or her tax basis would be the fair market value of the 4

5 property on the date you die. That means all appreciation during your lifetime becomes tax-free. If he or she receives the property as a gift from you, the tax basis is whatever your tax basis was. That means your child will owe tax on appreciation during your life, just like you would have if you sold the asset yourself. For example, let s say you have a house with a tax basis of $60,000. The fair market value of the house is now $300,000. If you give the house as a gift, your beneficiary s tax basis would be $60,000. If you bequeath the house and pass away in 2017, the tax basis would be $300,000, its fair market value. If your beneficiary sold the house for $310,000 shortly after she got it: Gift: the taxable gain on the sale is $250,000 ($310,000 minus $60,000). Inheritance: the taxable gain on the sale is $10,000 ($310,000 minus $300,000). That s a big difference. Another common mistake is failure to avoid the alternative minimum yax (AMT). This is the minimum amount of tax the federal government expects you to pay each year. If your regular tax turns out to be less than the AMT, the IRS will add the difference between the two rates to the tax you owe. A permanent inflation-adjusted AMT is now law, removing past uncertainty about Congress enacting an annual fix to ensure the AMT wouldn t catch middle-income taxpayers. The AMT exemption for 2017 is $84,500 for joint filers is and $54,300 for single filers. Although it mainly affects middle-income people, the tricky part of AMT is that certain exemptions fall away if you surpass the alternative minimum taxable income (AMTI). Many regular tax deductions are disallowed or allowed over a longer period of time if you qualify for AMT. Tax rates under the AMT are also different. Because AMTI is based on regular tax income, the calculation (which is done on Form 6251) begins with your adjusted gross income (if you claim a standard deduction) or your adjusted gross income less itemized deductions (if you itemize). You then add or subtract any AMT adjustment to determine your final AMTI. For this reason, if you suspect you re in AMT territory, you need to get to your tax accountant fast. Kind Regards, Ted Bauman Editor, The Bauman Letter 5

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