This is not a suggestion to use tactics that are illegal. We are not trying to evade taxes but rather avoid them by using exclusions, credits and certain deductions to legitimately reduce liability. Exclusions involve income that does not have to be reported such as interest on municipal bonds. Municipal bond interest may provide an investor the opportunity to have an income stream from his or her investments, at a risk level that is appropriate, without the additional expense of tax liability. Most fixed income investments such as CDs, corporate bonds and U.S. Treasuries are designed to pay out interest income as the form of return to the investor which are taxable. Avoiding tax involves producing a permanent reduction in tax liability. Credits provide dollar for dollar reductions in tax liability. Qualifying child care expenses are an example. Finally, deductions such as alimony paid will reduce taxable income on a permanent basis. The key is to identify those exclusions, credits and deductions that apply to your specific situation.

Deferring Tax

This concept allows for the taxpayer to get a current tax liability reduction by shifting the liability to be paid into the future. It is a postponement of paying taxes rather than an elimination of paying the tax owed. Using these techniques may provide for the ability to pay lower tax rates in future years where earned income is lower than in peak years. One of the more commonly used strategies is contributing the maximum allowable amounts to tax deferred retirement plans that produce no tax liability on the amount of income earned to make the contribution (ex: IRA's and 401ks). The taxation on the growth of the assets can be deferred until a future date when those assets are used to generate income to live on in retirement. Other vehicles such as Roth IRAs allow for tax-free distributions in retirement; although the contribution is not tax deductible when made, it still provides for tax free growth of the contributions in the plan. Deferral of taxation during the deferral period allows for more money to be working for the individual to accumulate wealth.

Conversions

This technique provides for more highly taxed income to be more favorably taxed. One common method is converting ordinary income into long-term capital gains which may be taxed at a more favorable rate. Short term capital gains rates are treated as ordinary income and subject to the taxpayer's marginal tax rate. These are gains on investments held for 12 months or less. With this in mind often an investor can wait more than 12 months for the favorable long-term capital gains rates. For instance waiting to sell a collectible item, such as artwork, for more than 12months will produce a 28 percent maximum tax rate on the profits. This may be significantly less than current income tax rates. The same can be true for long term capital gains rates on other investments such as stocks. If the tax payer is in the 39.6 percent marginal tax bracket and waits to sell an investment in company stock for long term capital gains rates the rate applied is 20 percent not 39.6 percent as would be required if it were a short term capital gain.

At Elek & Noss CPAs we can help you devise a plan to help reduce your liability and increases the amount of money you retain and utilize.  For more information or to get started on your plan for next year, please contact our office at 440-926-9300.

Article written by James Liotta
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