All of the following strategies are not applicable to everyone, and none should be used without first seeking the advice of a Certified Public Accountant (CPA) as tax laws are constantly changing and vary depending on each individual situation. Some strategies are applicable only for business owners. These are noted with a double asterisk **.
Strategy # 1
Defined Contribution Plans
IRAs, 401(k)s, 403(b)s, SEP IRAs, and SIMPLE IRAs
A defined contribution plan is a plan that:
- An individual benefits from during retirement depending on the contributions made individually to the plan during their working years from earned income (example: an IRA) or
- A company plan (examples: a 401k, 403b, SIMPLE IRA or SEP IRA plan) that a person has where they work, and they make individual contributions to the plan, plus their company matches up to a certain percentage of their contribution.
The contributions and investment performance of the assets in the plan determine its value. Like a typical savings account, a defined-contribution account contains a specific balance at any given time, which is equal to the market value of the assets accumulated in the account.
Individual IRAs
The maximum contribution for an individual IRA per year is:
- $5,500 per person – OR –
- $6,500 per person if the individual is over the age of 50
The tax deduction depends on the individual’s level of income, as well as eligibility and contributions to a company qualified plan (information below on company plans).
Note: The following company plans cannot be combined with each other.
Company sponsored 401(k)s
The maximum contribution per year is:
- $18,000 per person
- Additional $6,000 for individuals whose age is 50+ years
Company sponsored 401(k)s also may include additional employer match and contributions, up to $53,000 total, over one year depending on the individual’s income.
Non profit sponsored 403(b)s (examples: schools, churches, etc.)
The maximum contribution per year is:
- $18,000 per person
- Additional $6,000 for individuals whose age is 50+ years
Non-profit sponsored 403(b)s may also include additional employer match and contributions, up to $53,000 total, over one year depending on that individual’s income.
Employer SEP IRAs
The maximum contribution per year is:
- 25% of compensation, or $53,000
This contribution comes entirely from the employer, not the employee.
Employer SIMPLE IRAs
Individual contribution can be up to:
- $12,500
- Additional $3,000 more if the individual is over the age of 50
Plus, there can be up to a 3% match of salary from the employer.
Strategy # 2**
A Defined Benefit Plan
A defined benefit plan provides a fixed, pre-established benefit for employees at retirement. Employees often value the fixed benefit provided by this type of plan. On the employer’s side, businesses can generally contribute (and therefore deduct) more each year than in a defined contribution plan. However, defined benefit plans are often more complex, and thus, they can be more costly to establish and maintain than other types of plans.
The maximum that an employer can contribute to a defined benefit plan for the benefit of an employee is:
- $210,000 in one year
This figure depends on the age of the employee. The older an employee is, the more that can be contributed into a defined benefit plan by the employer.
Defined benefit plans are a great alternative for older, small employers with high incomes that wish to contribute large pre-tax amounts in addition to a defined contribution plan for retirement.
Example: an older small business owner with a $400,000 net income may be able to contribute up to $53,000 in a defined contribution plan, plus an additional $210,000 in a defined benefit plan for a total of $263,000.
In an effective tax bracket of 40%, the income tax savings from a combination of the two plans could be $100,000 or more.
Strategy # 3
Income Timing
Retirement Income
Timing of retirement income includes analyzing expenses and savings and determining if withdrawals from pre taxed retirement accounts can be deferred until the following year. This could lower the income tax burden on unneeded withdrawals and possibly avoid moving into a higher tax bracket.
Earned Income
Timing of employment income includes analyzing expenses and savings and determining if several weeks to several months of paychecks could go entirely into a defined contribution plan (Strategy #1) if the plan has not been maxed out for the year. This could lower the income tax burden and possibly avoid moving into a higher income tax bracket.
Strategy # 4**
Business Equipment Purchases
Instead of waiting until next year to replace or purchase new needed business equipment (computers, copiers, phone system, etc), purchase it before the end of the year so the expense can be deducted this year.
Strategy # 5
Real Estate Property Taxes
Paying this year’s property taxes, that are due in January or February, before the end of the year makes it deductible for this year. If you wait until January or February to pay this year’s property taxes, it is not deductible for this year but will count toward next year. In a high income year you could pay last year’s taxes in January and this year’s taxes in December.
Strategy #6**
Business Insurance Premiums
Pay business insurance premiums due in January before the end of the year to deduct the cost for this year.
Strategy # 7
A Donor Advised Fund
Open a donor advised fund (think of it like a giving bank account), and pre-fund your favorite charitable cause(s) before the end of the year for the tax deduction this year. Then, give from your donor advised fund to your favorite qualified non profit charity(s) whenever you feel is the best time. This is a great idea for anyone who has had a one time windfall of cash that puts them in a higher tax bracket for the year. Examples include a large oil and gas royalty check, large bonus check, etc. Up to 50% of adjusted gross income may be put into a donor advised fund for a tax deduction.
Strategy #8
Medical Expenses
If possible, try to lump all major health care expenses into one tax year in order to meet itemized deduction limits. In computing regular income taxes, medical expenses are deductible only to the extent that they exceed 10% of adjusted gross income, or 7.5% of adjusted gross income if age 65 or older.
Strategy # 9
Restructure Passive Income
Example 1: Use of a Real Estate Investment Trust (REIT)1 that uses cost segregation to rapidly depreciate real estate components with shorter lifespans than brick and mortar like heating and air systems, light fixtures, etc. to offset taxable income
Example 2: Use of sector based investments that can potentially generate ongoing tax efficient income
Example 3: Municipal bonds that generate tax free income (these may still be subject to alternative minimum tax)
1 Investing in Real Estate Investment Trusts (REIT) involves special risks such as potential illiquidity, as well as devaluation based on adverse economic and regulatory changes. As a result, the values of real estate may fluctuate resulting in the value at sale being more or less than the original price paid. Real estate is a long-term investment.
Strategy # 10
Donate Required Minimum Distributions (RMDs)
If congress extends this provision like they have the past several years, in December at the last minute you can donate Required Minimum Distributions (RMDs) from qualified plans if you are over age 70.5 to charity.
Strategy #11
Open a Charitable Gift Annuity
A charitable gift annuity is a way to make a gift to your favorite charity and still receive an income for yourself or others, now or later in the future. It is a contract under which a charity, in return for a transfer of cash or other property, agrees to pay a fixed sum of money for a period measured by one or two lives.
Taxpayers who itemize deductions can claim a charitable deduction for a portion of the original gift. This deduction can result in significant income tax savings. The deduction is equal to the amount of the contribution, less the present value of the payments that will be made to the donor and/or other beneficiary during a lifetime.
Strategy #12
A Charitable Remainder Trust
A charitable trust is great for large assets (typically above $1,000,000), with a small cost basis that would generate a large tax burden if sold. It is not good for small charitable gifts.
A charity serves as trustee of the charitable remainder trust and manages or invests the property so that it will produce income. The charity pays the individual (or someone that is named) a portion of the income generated by the trust property for a certain number of years, or for one’s whole life.
The payment period is specified by the associated individual in the trust document. At the time of death or the end of the time period that is set, the property goes to the charity.
In addition to helping out a favorite charity, several tax advantages are gained from this arrangement. One can take an income tax deduction, spread over five years, for the value of the gift to the charity.
Things begin to get tricky when determining the amount of the deduction. The value of the gift is not simply the value of the property; the IRS deducts from that value the amount of income that is likely to be received from the property.
For example, if $1,000,000 is donated, but the giver expects to receive $500,000 back in income (based on life expectancy, interest rates, and how the trust document is set up), the value of the gift is what is left.
Strategy #13
A Charitable Lead Trust
A Charitable Lead Trust is the opposite of a Charitable Remainder Trust in that it generates a potential income stream for a nonprofit organization(s) of choice from assets that are donated. After the income goes to a charity, or charities, for a number of years, the assets eventually are returned back to family members or other beneficiaries.
Strategy #14
Sales Taxes
If a Form 1040 is filed and one itemizes deductions on Schedule A, you have the option of claiming either state and local income taxes or state and local sales taxes (you cannot claim both). By saving receipts throughout the year, the total amount of sales taxes can be added up and claimed towards itemized deductions.
If all your receipts were not saved, one can still claim state and local sales taxes by filling out a worksheet under this topic on the IRS website.
If one is planning on buying a new car in January or February that has a large sales tax associated with it because of the size of the purchase, buy it before the end of the year to deduct the sales tax this year.
Strategy #15
Health Savings Account (HSA)
Only an eligible individual may contribute to an HSA. An HSA sponsored by an employer, the employee, or both, may contribute to an HSA. Family members may also make contributions to an HSA on behalf of another family member, as long as that family member is an eligible individual. The maximum contribution for 2015 is:
- $3,350 for individuals – OR –
- $6,650 for families
A $1,000 catch up provision is allowed for individuals age 55 and older not enrolled in Medicare.
Strategy #16
Tax Loss Harvesting
A widely used strategy for deferring capital gain recognition is tax loss harvesting. Recognizing losses before the end of the year, rather than waiting for a stock to turn around, can have three benefits:
Tax losses shelter current capital gains from other equities from tax, and it can effectively defer tax on those gains into the future.
Losses in excess of gains can be deducted currently up to $3,000 annually, sheltering ordinary income derived from salary, interest, and dividends from tax.
Losses in excess of gains and the $3,000 limit can be carried over and deducted in future years.
Strategy #17**
Create a Small Business
A small business is a tax favored investment because business losses are deductible in full against earned income. Many home based businesses are started by non-working spouses in order to generate losses against a working spouse’s earned income. Small businesses may employ children, and they can be used to shift income to kids without concern for the kiddie tax on unearned income of a child.
Other Tax Strategies
Do not forget about many other tax deductions that may not be considered year end tax strategies. These include but are not limited to:
- the mortgage loan interest deduction
- moving expenses
- student loan interest deduction
- casualty and theft losses not covered by insurance
- unreimbursed employee expenses
- tax preparation fees
- investment advisory fees
- legal fees
- education to improve job skills
- certain tools and uniforms used or worn on the job
- unreimbursed travel and lodging fees for business
- employee home office supplies
- self employed health insurance
and the list goes on.
As mentioned at the beginning of this report, none of these strategies should be used without first seeking the advice of a Certified Public Accountant (CPA) as tax laws are constantly changing and vary depending on your individual situation.
This report is for educational purposes only and is not intended to replace the advice of your personal financial advisor, accountant, CPA, or legal advisor.
