Manage Your Income to Avoid Extra Taxes

Now that the kids college expenses are gone and the mortgage is paid off and we don’t owe anything on the cars, taxes are our biggest expense. This is true even though we are now retired and living off of non-wage income. In fact, we manage our budget to ensure we have enough to pay taxes – estimated and end of year.

We are currently in our ‘low tax’ years, not yet collecting Social Security and not yet being required to take required minimum distributions from retirement accounts – but we still try to manage our income to avoid extra taxes. For instance, since the DOW has gone up so much this year and some of our stocks have soared, we decided to pull out our initial investment amount from one of them and put it into a different investment. Since we already had significant capital gains, we took the profit in an IRA account instead of a taxable one – so that we wouldn’t risk crossing into the next tax bracket.

2013 tax changes.

Extra taxes in 2013 will affect some – hopefully not us. Here is a summary of some of the changes – who is affected and what happens.

Please consult your tax adviser or the IRS for the most current details and their application to your situation.

Everyone under the age of 65 –

What happens? If you itemize your medical deductions, you have to have expenses over and above 10% (as opposed to 7 ½ %) of adjusted gross income in order to deduct.

 Everyone with earned income –

Social Security taxes on earned income bounce back to the level they were in 2010 – 6.2%

Base income level $113,700 and below –

Social Security taxes will now apply to earned income up to the $113,700 amount. If you earn more than that, no more social security is taken out. The change is that you are now paying social security on more of your income.

Base level $200,000 – individual $250,000 couples –

What happens when you go over? An additional 3.8% tax is due on your investment income AND an added 9/10 of a percent on wage income (both to help fund Medicare).

At $250,000 – individual and $300,000 couples –

What happens when you hit these? A phase out starts for personal exemptions and itemized deductions.

At $400,000 individual and $450,000 couples –

What happens when you get there? Everything at the above two levels PLUS you get a new higher tax bracket of 39 6/10 percent AND an increase in the percent of the tax for capital gains – up to 20%.

It is neither required nor unpatriotic to minimize your tax bite. Mark Haynes Daniell in Seven Strategies for the Wealthy Family devotes an entire chapter to tax strategies.

Know that wealthy families cannot avoid paying taxes on any income, where ever earned, if they are American citizens, hold a green card or a passport. This is true no matter where they live.

However, wealthy families can and do structure their assets and manage their incomes to minimize the tax bite.

How wealthy families manage tax liabilities.

Some of the suggestions to reduce income taxes include things such as:

• Doing 1031 exchanges when selling and buying real estate – to postpone capital gains;
• Providing seller financing to spread the capital gains from the sale across several years;
• Being careful on timing on selling at a profit or a loss – to put the loss in a year when your taxes are more;
• Using a business or entity structure to legally offset income with expenses, investing in appreciating assets where taxes on the appreciation are postponed;
• Using asset location to keep the right assets in taxable accounts and the right assets in tax free or tax deferred accounts; or
• Deferring income if they are about to cross a tax bracket threshold.

Some of the suggestions to reduce estate taxes includes things such as:

• Paying college tuition for children and grandchildren directly to the college (this is not considered a gift by Uncle Sam and so is not considered in the Unified Gift and Estate Tax).
• Gifting up to the annual limit to as many people as you want (also not considered in the Unified Gift and Estate Tax).
• Structuring a business to include heirs as partners or members of a corporate so that the rise in asset value is not taxed (Sam Walton did this).
• Donating to non-profit organizations.

Disclaimer: I am not a lawyer or accountant. Consult yours for advice! This post is informational only and not intended to serve as legal or tax advice.

What kind of tax planning do you do?  When do you do it?