Joseph E. Companik, CPA, P.C. - Tax Saving Strategies

Tax Saving Strategies

Here are a few tax saving ideas and strategies. This information is intended to be general in nature. There may be specific limitations to any of the ideas below and they may not be advisable for all taxpayers. Please call our office for more details to see if any of these strategies will work in your personal tax situation or in your business.

Consider the form of your business

There are many different ways to structure your business; sole proprietorship, corporation, LLC, S-corporation or partnership, to name the most popular. However the tax consequences among the choices vary significantly. Depending on your situation you could save thousands of dollars per year in taxes just by structuring your business differently. For example, "C" corporations (or regular corporations) face a double level of taxation on most of their earnings.

Incorporate as an S-Corporation

Under the right circumstances, electing to be classified as an S-corporation can save $3,000 to $7,000 in taxes per year. This is accomplished by paying only Social Security and Medicare taxes on wage income, not all income derived from the business.

Pay your children through your business

Wages paid to your children under age 18 are exempt from Social Security or Medicare taxes. This savings is available for sole proprietorships or LLCs/partnerships owned jointly by a husband and wife. In addition to saving these payroll taxes you also receive a deduction for the wages paid. Since parents are generally in a higher tax bracket than their children, this could result in an additional 30% savings in taxes by shifting the income from the parents to the children.

Using wages paid to children to fund an IRA

Individuals with earned income are allowed to contribute to IRA accounts. Using children's wages (such as in the example above) to fund an IRA will allow the child to receive a tax deduction on their personal return if needed. If a deduction is not needed then a Roth IRA can be established. Although an IRA is normally established to fund retirement, distributions can be taken out penalty free if used for qualified college education expenses.

Investments made in your children's names

The first $950 of investment income earned by a child is not subject to tax. The next $950 of investment income is taxed at the child's tax rate, which is generally lower than the parent's tax rate. Shifting income among family members can result in a lower overall tax rate.

Retirement Planning

One of the largest deductions available to taxpayers are contributions made into qualified retirement plans. Depending upon your income you could be able to contribute up to $46,000 per year into a retirement plan and receive a tax deduction. One plan in particular, the Simple Plan, allows an annual dollar for dollar contribution up to $11,500 ($14,000 if 50 years old or older) of earnings. All other plans generally require contributions based on a percentage of earnings. The Simple Plan works very well for a side business or a spouse's business who is not the primary family earner and where the income earned is not currently needed.

Saving for College

Tax deferred and tax free earnings are available for monies invested and used for qualified college expenses. Internal Revenue Code §529 plans, Education IRAs, and Education savings bonds are all available to help fund college expenses and provide tax saving benefits.

Control your Tax Timeline

Time your income and expenses. Control when you receive income or incur expenses. For example, if you push your December billings back so that the payments are received the following year you can defer the taxes on that income and pay them at a later date. The opposite can be done with expenses. Look at expenses you will incur in January, February and March and make those purchases before year-end, if possible. In most cases if payment is made before December 31, or if you are purchasing assets, you can deduct those expenses in the year of purchase. This allows you to accelerate your deductions and achieve a tax savings a year earlier.

Watch your Tax Rate

Income taxes are assessed on a progressive scale. That means the more you earn, the higher your tax rate will be. Monitor your annual income to estimate what your tax rate will be and structure your transactions accordingly. For example, if you exercise stock options in one year and move into a higher tax bracket you may not want to withdraw monies from an IRA or sell more stock until the next year because that income will also be taxed at a higher rate. You may wish to speed up some of your deductions. Make charitable donations before December 31, prepay property taxes or pay your estimated state taxes before the end of the year. Look at what you may normally spend or donate in the following year and consider doing it in a high tax year.

The opposite planning can also be done in a low income tax year. If your income is lower in one year take advantage of the lower tax brackets by selling stock, stock options or properties. Also, push your deductions back into the following year.

Certain deductions and credits are reduced or eliminated if your income exceeds various levels. Diligent attention to your income along, with careful planning, may preserve the full benefit of these credits.

Capital Expenditures

Under the most recent tax law changes significant deductions are available for purchases of capital assets used for business. Specifically, until December 31, 2010, Internal Revenue Code §179 allows an immediate deduction of up to $250,000 in capital expenditures used for business. This deduction is available even if the assets are purchased and placed into service as late at December 31st. This is a great year-end tax planning tool and works very well with the previous two strategies.

Like-Kind Exchanges

Instead of selling business and investment property, Internal Revenue Code §1031 allows you to defer taxes by exchanging this property for other qualifying investment and business property. This is a common strategy for rental properties but can be used for other business and investment assets as well. For example, if you have a rental property and would incur a taxable gain upon the sale, you could sell the property and reinvest the proceeds into another rental property and not pay taxes until the replacement property is ultimately sold. CAUTION: this is not a transaction that you can do yourself. The IRS requires a very specific procedure to be followed. If not followed correctly the transaction will be taxable.

Sale of Qualified Small Business Stock

Up to $100,000 ($50,000 if single) of losses on the sale or disposition of qualified small business stock may be deducted against ordinary income in the year of sale, as opposed to the normal capital loss limitations of $3,000 annually. Internal Revenue Code §1244 allows this deduction provided the stock is part of the first $1,000,000 of capital raised by the business, you are the original purchaser of the stock, you are an individual owner (not a corporation or trust), and you received the stock in exchange for money or property not services.

Further, Internal Revenue Code §1202 allows you to exclude up to 50% of the gain on the sale of small business stock if held for more than 5 years. Also, the gain on the sale may be rolled over towards the purchase of other small business stock.

Mortgage Points

Points paid on mortgage debt used for the acquisition, construction or improvement of a principal residence are deductible in the year paid. Points paid on the refinance of a loan are deductible over the life of the loan. However, if you refinance a second time or sell the home, the unused portion is deductible in that year.

Points are deductible as an itemized deduction. If you are not able to itemize deductions in one year (perhaps because the home purchase occurred late in the year and your standard deduction is higher than your itemized deductions), still keep track of your points. You can choose to deduct points over the life of the loan. The deduction of points is preserved and the unused portion becomes deductible if you refinance or sell the home at a later date.

Dividend Tax Rate

Qualified dividends are taxed at a 15% tax rate whereas, normal interest is taxed at ordinary income tax rates. Converting interest paying investments to dividend producing assets can produce a tax savings as high as 20%.

Tax Free Investments

Investments in local municipal bonds are tax exempt for Federal tax purposes. Also, investments in municipalities within the State of Arizona are exempt from Arizona state taxes, producing a double tax savings. Converting taxable interest paying investments to non-taxable municipal bonds can produce a tax savings as high as 35%.

Capital Gains Tax Rate

Capital assets (such as stock or real estate) owned for more than one year are taxed at a lower tax rate than assets owned less than a year. The long-term capital gains tax rate for 2009 is 15%. If you are in the 15% tax bracket or lower the long-term capital gains tax rate drops to 5%. Beginning in 2008 the long-term capital gains tax rate for taxpayers in the 10% or 15% bracket drops to zero.

Careful review of your investments and identifying long-term assets can produce a tax savings as high as 20%.

Capital Loss Deductions

Capital losses on the sale of assets can be deducted in full against other capital gains. In addition, $3,000 of capital losses in excess of capital gains can be deducted against all other income (which is possibly taxed at a higher rate). Review your portfolio before year-end and sell capital assets that will incur a loss (provided it is a sound investment decision to sell) to achieve the deduction. CAUTION: if capital losses are deducted against capital gains you may only be saving taxes at a rate of 15%. However, if you wait to take a capital loss deduction until a year in which you do not have capital gain income you may be able to save taxes at a rate of up to 35%.

Pre-Tax Accounts

Take advantage of employer offered medical and dependent care accounts. The tax code allows you to set aside part of your wages, before taxes, to be used for qualified medical and dependent care expenses. These pre-tax deductions will generally provide a higher tax savings than other credits or deductions on your tax return.

Manage your Interest

Interest paid on a home equity loan is generally deductible. However, interest paid on an automobile loan or on credit card debt is not deductible. Rearranging your debt can convert otherwise non-deductible interest into a qualified deduction. In making these arrangements it is important to compare the interest rates, as well as determining if there are any fees for creating the loan.

Sale of a Principal Residence

Up to $500,000 (MFJ, $250,000 if single) of gain on the sale of a principal residence can be excluded from tax if you lived in the home two out of the last five years and have not excluded the gain from a previous sale within the past two years. Proper planning and foresight can eliminate a significant amount of taxes.

Bad Debts Deduction

A deduction is available for uncollectible debts. If you have written documentation to support a loan and it has become uncollectible there may be a capital loss deduction available.

Repayment of Benefits

There is a deduction available if you have been required to repay benefits, such as social security or disability income, that you have previously paid taxes on.

Installment Agreements

Instead of selling an asset for cash you could accept a note instead. The gain on the sale will then be taxed as income in the years the payments are received and not entirely in the year of sale. This is a great way to defer your taxes and control your tax rates.

Tax Credits and Deductions

Various credits and deductions are available that can produce significant tax savings. For example, there are credits or deductions for college education expenses, the purchase of clean burning fuel vehicles or solar products, student loan interest, and investments in low income property to name a few. Some popular tax credits and deductions are:

• College Tuition

• Student Loan Interest

• Education Expense up to $250

• AZ School Credit

• AZ Working Poor Credit

Group Your Deductions

If you are close to itemizing deductions, instead of using the standard deduction consider "bunching" your deductions into one year. For example, incur medical expenses all in the same year; prepay your property taxes, license your vehicle for two years or donate more to charities in one year and less in another. You can alternate between claiming the standard deduction in one year and itemizing in another year.

Record Keeping

Keep accurate and timely records. There is very little tax planning that can be done after the fact. If you have good records on an ongoing basis, you can estimate your taxes and then be in a better position to capitalize on the above strategies. Also, good records help support your deductions. For example, a detailed log of your business mileage will provide the support for potentially thousands of dollars of deductions. Without the log your deductions could be disallowed if audited.

Contact Your Tax Advisor Regularly!

Okay, this may be a shameless plug, but the moral of the story for tax planning is that it needs to be done proactively. There is very little tax planning that can be accomplished after a transaction has occurred or the year has ended. Consider the tax implications of major financial decisions. If you have a tax advisor, use this resource when planning your financial moves so they can be structured to minimize taxes.

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Joseph E. Companik, CPA, P.C. - Quality Tax and Accounting Services Since 1994.

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All tax-related information on this website is provided for general information purposes only

and does not constitute tax advice. Individual’s specific tax situations vary and in order to

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