Tame Your Taxes: 7 fundamentals of tax planning

Posted Dec 7, 2018 at 11:37 AM Updated Dec 7, 2018 at 11:37 AM  on Columbia Daily Tribune 

I would like to introduce you to seven fundamentals of tax planning that I learned from the American Institute of Certified Tax Coaches in 2011. I will also reveal six advanced tax planning strategies for wealthier taxpayers.

Seven tax reduction planning fundamentals:

1. Income Shifting. This involves purposely structuring transactions to move income to other people or entities or future years to minimize taxes.
2. Expense Shifting. We identify a client’s biggest expenses and search for tax provisions that allow them to deduct it.
3. Tax Loopholes. Tax loopholes, in my mind, represent legal but unintended tax breaks. The complex nature of the Tax Code occasionally results in new and unintended tax breaks that remain law until Congress passes a new law to close the loophole.
4. Tax Credits. Congress motivates taxpayers through tax incentives to take certain actions. These are often temporary. Examples include the First Time Homebuyer Credit and the Residential Energy Credit.
5. Tax Exempt Income. The Tax Code identifies certain types of income that are not subject to tax ever. The most common example would be municipal bonds. The federal government cannot tax income of state-issued debt instruments and vice-versa.
6. Tax Deferred Income. Tax deferred income is not as good at tax exempt income, but this can be a powerful tool for a prudent investor who might be able to double his deferred taxes before paying the tax due.
7. Tax-advantaged Investments. This covers a broad range of investment vehicles, including annuities and life insurance. The key is to make sure to match the vehicle to your situation.

After taking three articles to educate my readers on the Home Office Deduction, I concluded that I could cover more ground if I didn’t focus on the details. Also, the rest of this article is designed to help wealthier taxpayers.

• Tax breaks for wealthier taxpayers
• Conservation Easement (CE)
• Cost Segregation (Cost Seg)
• Closely-Held Insurance Company (CHIC)
• Revocable Living Trusts (RLT)
• Charitable Remainder Trusts (CRATs & CRUTs)
• Nonqualified Retirement Plans (Sec. 7702)

1. Conservation easements seem too good to be true. They are a tax-advantaged way to preserve our country’s natural beauty. Congress loves it. They raised the contribution limit from 30 percent to 50 percent of AGI. The owners of a tract of land decide to permanently conserve it by forbidding future development. Restricting the use of this land forever reduces its value. Theoretically, the difference between its current value and its best use is the economic loss related to this action for which the owners are allowed a significant tax break.
2. Cost Segregation involves having an engineering study done to reclassify certain components (like plumbing, HVAC, electrical, communications and envelope) of a building into assets that can be depreciated over much shorter useful lives than a building. I will give you my first-hand example. Last year, I purchased a business condo in Cherry Hill. I paid $275,733 for it. The Cost Seg Study reclassified $101,854 (about 37 percent) as personal property. I was able to take $101,854 as a Sec. 179 deduction the first year, compared to $1,306 in depreciation on that $101,854. (Note: someone in the top tax bracket would have saved more than $50,000 in income taxes.)
3. CHICs are a great tool for business owners with risk exposure. This strategy allows them to self-insure through third-party experts. A special code section allows a business owner to deduct up to $2.2 million to set up a CHIC. There must be an insurable risk to insure, but that is what the experts are for. Years later, when you are ready to get your investment back, it is taxable at capital gains rates, thus shifting this income to a lower tax bracket and later years.
4. I am not an attorney, so I cannot issue an opinion on the legality of the next two items that involve trusts, but I can mention the tax benefits. It is always wise to consult competent legal counsel before making big decisions. A Revocable Living Trusts allows you to transfer assets to your heirs efficiently and privately. It also avoids probate.
5. The two types of Charitable Remainder Trusts (CRT) are Charitable Remainder Annuity Trusts (CRATs) Charitable Remainder Unitrusts (CRUTs). The grantor has his attorney set up a CRT and then contributes highly appreciated property to it. After the CRT sells the asset, the funds are then invested for the benefit of the grantor/recipient. When the CRT terminates, a charity receives the remaining assets. The benefits include: removal of the asset from the estate, no capital gains tax on the sale, a charitable contribution deduction and taxable distributions to the recipient are spread out over years.
6. The Section 7702 nonqualified retirement plan has many benefits. Because it uses after-tax funds inside a life insurance vehicle, no distributions are subject to income taxes. You can take money out to pay for the kids’ college. I prefer it to 529 plans. In retirement, you pull money out tax free, because the distributions are technically loans. The firm I work with designs these plans to have the greatest amount going toward investment growth and only the legal minimum to the life insurance benefit. They also use a hybrid investment that goes up with the market but never loses money.

In conclusion, I disclosed seven fundamentals of proactive tax reduction planning and revealed six ways for wealthier taxpayers to save money.

Aric E. Schreiner, CPA, PFS, CTC, is a managing member at Columbia CPA Group, LLC.