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Top ten easy tax shelters

by Tony Novak, CPA, MBA, MT
revised 2/24/2014

There are many legal strategies available to reduce income tax liability built into our federal tax laws. Adopting one or more tax strategies now will result in lower taxes next spring. This listing below is meant to highlight the planning possibilities but is not intended to be a complete discussion of all of the details.

  1. For empty nesters... it pays to downsize the home. Married couples can exclude up to $500,000 ($250,000 for single people) gain can be excluded on the sale of a home. That means possibly a half million dollars completely free of income tax. No other provision in the tax law is as generous. Considering the recent run-up in housing prices in many areas, now may be the time to consider cashing in and trading for a less expensive dwelling. There is no need to reinvest the gain in another house, so this is a perfect for empty-nesters who may be ready to downsize. See what the IRS has to say on this topic.
  2. For self-employed individuals... Stretch tax-advantaged benefit plan deductions. Self-employed individuals can deduct up to 100% of income or up to $205,000 for contributions to a private pension plan and usually more than 100% of total health care costs. High income people close to retirement age who are self-employed and work in a small business typically have the greatest opportunity to shelter earnings from taxes. Lower income self-employed individuals who have the discipline to save will benefit from a Roth IRA, Health Savings Account and other options.
  3. For small businesses... Immediately deduct the cost up to $500,000 of capital asset purchases used for business (rather than deduct the cost over time). This break has been nicknamed the Range Rover write-off when it was first introduced.1 The tax benefit is magnified when you finance a purchase and have not actually yet made cash payments. This tax break was meant to provide extra spark to the economy, and it seems to be working. The IRS rules are commonly discussed under the term "Section 179".
  4. For employees... Receive tax-free reimbursement for out-of-pocket health care expenses. Use a Health Savings Account (HSA) if you are self-employed or use a Health Reimbursement Arrangement2 (HRA) if you are an employee. This should be an easy way to save $1000 per year in taxes.
  5. For low income wage earners... a tax credit is available for low income individuals who make retirement plan contributions. The federal government effectively matches 50% of your deposit with a tax credit. Of course, the problem is that low income people do not have money to make retirement plan contributions. But parents could make a gift of IRA deposits to their children, for example, to effectively earn an immediate 50% return on their investment.
  6. For investors... eliminate taxable dividends and short term capital gains. Mutual funds held outside of a retirement plan are not tax-efficient for most investors. Exchange-traded funds, on the other hand eliminate all of the unwanted taxable distributions and put tax control in the hands of the investor.
  7. Use a deferred compensation plan. Despite recent tightening of rules for stock options and deferred compensation plans using corporate-owned life insurance, it is still easy to defer income using an employee benefit plan in other ways.
  8. Take advantage of cash value life Insurance. All investment gains and death benefits are tax free to your named beneficiary. Living benefits taken in the form of policy loans are also tax-free in a properly constructed policy. No other financial vehicles offer this generous tax treatment. Pay the maximum premium allowed into your policy to maximize the tax benefits. US taxpayers should use a domestic life insurance company since the IRS is now cracking down on insurance used to move assets outside the country.
  9. Take advantage of non-cash tax deduction for real estate depreciation. If you have rental properties, you may write off part of the purchase price and fix-up costs up to $25,000 per year even if most of the purchase price was borrowed.
  10. Use asset-based mortgages. for affluent individuals make it easy to finance 100% of the value of a primary home or vacation house. The interest is deductible and at today' s low interest rates, many are using a "cash out" refinancing to free funds for investments and other ventures.3

The best tax strategy for your unique situation might not be included on this list but typically can be developed though a tax planning discussion either in person or by telephone. Please call to schedule a time to discuss tax planning ideas.

Before committing to any tax strategy, complete a pro forma tax return to test the strategies for your unique situation. Pay special attention to income based phase-outs and the alternate minimum tax.

1 This article was originally written under the tax law for 2006 and the amounts allowed under Section 179 have increased since then, fortunately rising faster than the price of Range Rovers and other capital goods.

2 HRAs will change in 2014 but the same tax benefit will be available, perhaps under a different benefit plan acronym.

3 Recent changes to mortgage banking regulations make these loans unavailable to most working-class Americans so I am now looking for a replacement #10 easy tax shelter. If you have a suggestion, please write me at onlineadviser@live.com.

Related resources

Tax planning checklist

Tax and financial planning data organizer

Status: available for reprint

Portions of the article are based on expired tax law and may now be obsolete.

This article is available for republication in its entirety without charge after obtaining the express written permission of the author.

Please e-mail a request to the author that includes the name of the requestor (individual and corporate) and the intended destination of publication.

 

 


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