END TAX SAVING STRATEGIES:
How do you accumulate assets for retirement when income and employment
taxes take such a large bite out of your take-home pay? How do you get the
greatest benefit from your itemized deductions? What opportunities are there to
reduce taxes through an employee-benefit programs? This Financial Guide provides
a checklist, which you can use to see what opportunities may be available to
Avoid or Defer
Since the demise of the tax shelter, strategies for saving individual
income taxes are harder to come by. But they do exist. This Financial Guide
provides tax saving strategies for deferring income (often through the use of
retirement plans), and maximizing deductions. It includes some strategies for
specific categories of individuals, such as those with high income and those who
Before getting into the specifics, however, we would like to stress the
importance of proper documentation. Many taxpayers forgo worthwhile tax
deductions because they have neglected to keep receipts or records. Keeping
adequate records is required by the IRS for employee business expenses,
deductible travel and entertainment expenses, and charitable gifts and travel.
But don’t do it just because the IRS says so—neglecting to track these
deductions can lead to overlooking them. You also need to maintain records
regarding your income. If your receive a large tax-free amount, such as a gift
or inheritance, make certain to document the item so that the IRS does not later
claim that you had unreported income.
To use the checklist, quickly scan the listed items. They are of general
application only and should be tailored to your specific situation. If you think
one of them fits your tax situation, discuss it with your tax adviser.
Deferring the taxability of income makes sense for two reasons. Most
individuals are in a higher tax bracket in their working years than during
retirement. Deferring income until retirement may result in paying taxes on that
income at a lower rate. Additionally, through the use of tax-deferred retirement
accounts you can actually invest the money you would have otherwise paid in
taxes to increase the amount of your retirement fund. Deferral can also work in
the short term if you expect to be in a lower bracket in the following year or
if you can take advantage of lower long-term capital gains rates by holding an
asset a little longer.
The 2001 Tax Relief Act makes deferral even more rewarding. It reduces
income tax rates each year 2001 through 2006, thereby encouraging deferral of
current income to lower-rate future years. And, in 2002 and after it
substantially increases tax deductions or exclusions for amounts put into
tax-deferred investment accounts. Thus, more funds can grow tax-free, to be
taxable when withdrawn at generally lower rates.
TIP: You can achieve the
same effect of deferring income by accelerating deductions—for example, paying a
state estimated tax installment in December instead of at the following January
Max Out Your 401(k) or Similar Employer Plan
Many employers offer plans where you can elect to defer a portion of your
salary and contribute it to a tax-deferred retirement account. For most
companies these are referred to as 401(k) plans. For many other employers, such
as universities, a similar plan called a 403(b) is available. Check with your
employer about the availability of such a plan and contribute as much as
possible to defer income and accumulate retirement assets.
TIP: Some employers match a
portion of employee contributions to such plans. If this is available, you
should structure your contributions to receive the maximum employer matching
If You Have Your Own Business, Set Up and Contribute to a Retirement Plan
If you have your own business, consider setting up and contributing as
much as possible to a retirement plan. These are allowed even for sideline or
moonlighting businesses. Several types of plans are available which minimize
the paperwork involved in establishing and administering such a plan.
Contribute to an IRA
If you have income from wages or self-employment income, you can build
tax-sheltered investments by contributing to a traditional or a Roth IRA. You
may also be able to contribute to a spousal IRA —even where the spouse has
little or no earned income. All IRAs defer the taxation of IRA investment income
and in some cases can be deductible or be withdrawn tax free.
To get the most from IRA contributions, fund the IRA as early as possible
in the year. Also, pay the IRA trustee out of separate funds, not out of the
amount in the IRA. Following these two rules will ensure that you get the most
possible tax-deferred earnings from your money.
Defer Bonuses or Other Earned Income
If you are due a bonus at year-end, you may be able to defer receipt of
these funds until January. This can defer the payment of taxes (other than the
portion withheld) for another year. If you're self employed, defer sending
invoices or bills to clients or customers until after the new year begins. Here,
too, you can defer some of the tax, subject to estimated tax requirements. This
may even save taxes if you are in a lower tax bracket in the following year.
Since tax rates are scheduled to fall each year 2001-2006, under the 2001 Tax
Relief Act, most taxpayers will be in a lower tax bracket in 2002 than in 2001,
lower in 2003 than in 2002, and so on. Note, too, that the amount subject to
social security or self-employment tax increases each year.
Accelerate Capital Losses and Defer Capital Gains
If you have investments on which you have an accumulated loss, it may be
advantageous to sell it prior to year-end. Capital losses are deductible up to
the amount of your capital gains plus $3,000. If you are planning on selling an
investment on which you have an accumulated gain, it may be best to wait until
after the end of the year to defer payment of the taxes for another year
(subject to estimated tax requirements). For most capital assets held more than
12 months the maximum tax is reduced to 20%. However, make sure to consider the
investment potential of the asset. It may be wise to hold or sell the asset to
maximize the economic gain or minimize the economic loss. This advice continues
to apply even though the 2001 Tax Relief Act did not reduce capital gains
tax rates for 2001 or after.
Watch Trading Activity In Your Portfolio
When your mutual fund manager sells stock at a gain, these gains pass
through to you as realized taxable gains, even though you don't withdraw them.
So you may prefer a fund with low turnover, assuming satisfactory investment
management. Turnover isn't a tax consideration in tax-sheltered funds such as
IRAs or 401(k)s. For growth stocks you invest in directly and hold for the long
term, you pay no tax on the appreciation until you sell them. No capital gains
tax is imposed on appreciation at your death.
Use the Gift-Tax Exclusion to Shift Income
You can give away $10,000 ($20,000 if joined by a spouse) per donee, per
year without paying federal gift tax. You can give $10,000 to as many donee's as
you like. The income on these transfers will then be taxed at the donee’s tax
rate, which is in many cases lower. Note, special rules apply to children under
age 14. Also, if you directly pay the medical or educational expenses of the
donee, such gifts will not be subject to gift tax.
Invest in Treasury Securities
For high-income taxpayers, who live in high-income-tax states, investing
in Treasury bills, bonds, and notes can pay off in tax savings. The interest on
Treasuries is exempt from state and local income tax. Also, investing in
Treasury bills that mature in the next tax year results in a deferral of the tax
until the next year.
Consider Tax-Exempt Municipals
Interest on state or local bonds ("municipals") is generally exempt from
federal income tax and from tax by the issuing state or locality. For that
reason, interest paid on such bonds is somewhat less than that paid on
commercial bonds of comparable quality. However, for individuals in higher
brackets, the interest from municipals will often be greater than from higher
paying commercial bonds after reduction for taxes. Gain on sale of municipals
is taxable and loss is deductible. Tax-exempt interest is sometimes an element
in computation of other tax items. Interest on loans to buy or carry
tax-exempts is non-deductible.
Give Appreciated Assets to Charity
If you’re planning to make a charitable gift, it generally makes more
sense to give appreciated long-term capital assets to the charity, instead of
selling the assets and giving the charity the after-tax proceeds. Donating the
assets instead of the cash prevents your having to pay capital gains tax on the
sale, which can result in considerable savings, depending on your tax bracket
and the amount of tax that would be due on the sale. Additionally you can obtain
a tax deduction for the fair market value of the property.
TIP: Many taxpayers also
give depreciated assets to charity. Deduction is for fair market value; no loss
deduction is allowed for depreciation in value of a personal asset. For
contributions of property, whether appreciated or not, you must file an
information return on contributions of $501-$5,000, and you need a qualified
appraisal on contributions over $5,000 (except for publicly traded securities).
Keep Track of Mileage Driven for Business, Medical or Charitable Purposes
If your drive your car for business, medical or charitable purposes, you
may be entitled to a deduction of 34.5, 10 and 14 cents per mile respectively,
using 2001 rates. You need to keep detailed daily records of the mileage driven
for these purposes to substantiate the deduction.
Take Advantage of Your Employer’s Benefit Plans to Get an Effective
Deduction for Items Such as Medical Expenses
Medical and dental expenses are generally only deductible to the extent
they exceed 7.5% of your Adjusted Gross Income. For most individuals,
particularly those with high income, this eliminates the possibility for a
deduction. You can effectively get a deduction for these items if your employer
offers a Flexible Spending Account, sometimes called a cafeteria plan. These
plans permit you to redirect a portion of your salary to pay these types of
expenses with pre-tax dollars. Another such arrangement is a Medical Savings
Account which is available for some small businesses. Ask your employer if they
provide either of these plans.
Check Out Separate Filing Status
Certain married couples may benefit from filing separately instead of
jointly. Consider filing separately if you meet the following criteria:
One spouse has large medical expenses, miscellaneous itemized deductions,
or casualty losses.
The spouses’ incomes are about equal.
Separate filing may benefit such couples because the adjusted gross income
"floors" for taking the listed deductions will be computed separately. On the
other hand, some tax benefits are denied to couples filing separately. In some
states, filing separately can also save a significant amount of state income
If Self-Employed, Take Advantage of Special Deductions
You may be able to expense up to $20,000 for 2000, $24,000 for 2001, in
equipment purchased for use in your business immediately instead of writing it
off over many years. Additionally, self-employed individuals can deduct a
portion of their health insurance premiums. You may also be able to establish a
Keogh, SEP or SIMPLE plan, or a Medical Savings Account, as mentioned above.
If Self-Employed, Hire Your Child in the Business
If your child is under age 18, he or she is not subject to employment
taxes from your unincorporated business (income taxes still apply). This will
reduce your income for both income and employment tax purposes and shift assets
to the child at the same time.
Take Out a Home-Equity Loan
Most consumer related interest expense, such as from car loans or credit
cards, is not deductible. Interest on a home-equity loan, however, can be
deductible. It may be advisable to take out a home-equity loan to pay off other
Bunch Your Itemized Deductions
Certain itemized deductions, such as medical or employment related
expenses, are only deductible if they exceed a certain amount. It may be
advantageous to delay payments in one year and prepay them in the next year to
bunch the expenses in one year. This way you stand a better chance of getting a