The oldest trick for reducing taxes is not effected by the structure of the tax rates. While the rate affects your decisions about whether to take action, the tax moves advocated for years by practitioners are still in use today.
Defer Income
Standard tactics include these: Contribute the maximum amount to a pension fund. Have your bonus at work delayed until after the end of the year. Delay the sale of assets until January. If you are self-employed, delay your December billing so as to collect on the receivables in January.
Accelerate Expenses
This includes paying bills that you would ordinarily pay in January of the following year in December. Examples include paying your last State Estimated Tax payment (due in January) in December to get a deduction this year. If you expect to be in a lower tax bracket next year, pay some EXTRA state tax on or before December 31. Take the deduction this year, then file your State tax return and get the refund. The refund will have to be included as income, but it will shift into next year.
Pay any outstanding medical bills or dental bills. If you are expecting a large medical bill, get the doctor, dentist or orthodontist to agree to a lump sum payment and use the “bunching” strategy. Bunching means taking all the deductions in one year instead of spreading them out -- since medical deductions are subject to a limit based on your income (7.5% of AGI) you will get a deduction in one year by bunching instead of getting no deduction for two years in a row.
If you are self-employed and need a new computer or desk or auto, buy it a little sooner. Caution, the Senate passed a new tax bill and sent it the House of Delegates that would cap the depreciation on autos at only $25,000. Some of us were able to buy a new $40,000 vehicle last year and write off the whole thing. The effective date of this legislation is February 5, 2004. If you buy a new auto now, you may not get the deduction you had been anticipating. Other than autos, other equipment can still be written off under section 179 up to $100,000.
Business Insurance for Your Office - ask your agent for a two-year policy. Now according to IRS, You can pay it and deduct it all as long as the policy covers less than three years.
Match Capital Gains and Losses
Savvy investors look for a method to keep track of their gains and losses throughout the year. That way they can sell some losers to offset their winning positions in the market. Some people offset gains in real estate sales with stock market losses. Matching is an important tool near the end of the year.
Give Stock to Charity
This tried and true method is used to avoid paying tax on the sale of a winning stock position. If you are going to give a gift to a charity anyway, why not cut your cost of that gift by giving a stock that has doubled? It cuts your cost in half, and the charity is no worse off. I have a client who goes to their pastor early in the year and says “this is my gift for the year - I won’t be putting the envelopes in the tray.”
Share Your Income
Give your children some stock to cash in. Their basis is the same as yours, but their tax bracket is lower. Watch out for the tax on children under 14 (Kiddie Tax), but the capital gains rate for people in the 15% and 10% tax brackets is now 5% on capital gains, and is scheduled to go to 0% - that’s right - 0%. So if you have a child in private school or college, don’t pay tuition with after tax dollars. Instead, give them a winning stock and let them cash it in. They may pay little or no tax thereby cutting your cost of supporting them. Check on the various tuition tax credits before having them pay tuition. They may be better off paying for their apartment with their money and paying tuition with your money.
Make the child a part owner of an LLC that owns some assets. The income producing assets could be stocks, bonds, real estate, or any other investment. When the LLC makes money, you still control the LLC, but the income is split on the tax returns of the owners, thereby sheltering some at a lower tax rate on the childs’ returns. Again, be mindful of the Kiddie Tax.
Convert Regular Income to Capital Gains
This is a time consuming strategy that takes several years to develop into a real double tax saving device. Real estate investments may have positive cash flow, but show a loss for taxes. The reason is because the depreciation is basically straight line over 27.5 years, while the amount of principle paid on the loan is on a hyperbolic curve, starting very low and increasing with each payment.
As long as the principle paid is less than the depreciation, you are on the good side of the curve and deducting more than actually spending. When you get on the other side of the curve, you sell the place and pay only the capital gains tax on the sale. This gives you an offset against current ORDINARY income during ownership, and a tax at the lower Capital Gains rates on the sale. In other words, deduct the operating expenses at a 30% rate and pay tax at 15% later.
Avoid the Tax by Doing a Tax Free Exchange
Business property can be exchanged tax-free. The rules are many, but more and more people are taking advantage of this technique. Don’t be afraid to save taxes just because it sounds complex. You hire a company to handle the details, you sell on investment and buy another. This cannot be done with stocks and bonds. It is usually done with real estate or business equipment.
Move!
Your home has its own special tax break. As long as you are willing to move every two years you can pocket the gain without tax up to $250,000 for single people and $500,000 for married couples. I have several clients who look for houses they can get in a good neighborhood and buy it cheap with the anticipation that they will move and pocket the gain tax free in two years. One client has built his own home three times now, and each time has built a larger home that has earned more profit on the sale.
