How to Create A Plan To Reduce Your Taxes For The New Year
There is general agreement that the ‘tax dog should never wag the investing tail.’ However, your financial advisor must consider all possible tax implications and endeavor to maximize the money you have available for your retirement and other financial goals when he develops your tax strategies.
The Tax Cut & Jobs Act (TCJA) was a game-changer that massively changed the rules and the tax strategies required to navigate the new landscape. Fortunately, we have one season behind us.
The IRA contribution limits for 2021 are $6,000 for taxpayers under 50 and $7,000 for those that turned 50 or older during the year. Some taxpayers, depending on their earnings, will also be able to make a pre-tax contribution to a Traditional IRA and a contribution or after-tax contribution to a Roth IRA.
The main advantage of these deductions is that the money you contributed to an IRA grows tax-free (in the case of a Roth) or tax-deferred until withdrawn in retirement, resulting in a lower taxable income during the years leading up to retirement.
If you are self-employed, it makes sense to make contributions to a SEP-IRA. For the 2022 tax year contribution limits go up to $56,000 and can be made right until your tax filing date (including extensions for the calendar year). You can open your account at any time before the filing date (including extensions).
Your business must make your contributions, and can deduct it as a business expense. Your earnings will grow tax-deferred until withdrawn during retirement. If hampered by the limits for the 20% pass-through deduction for your business by the section 199-A rules, these deductions might help you to stay within the imposed restrictions.
Any type of business entity can open a SEP-IRA. Business owners can choose whether to fund their SEP and for how much, every year. The SEP-IRA is an outstanding choice for small family-owned businesses and anyone self-employed.
A SIMPLE IRA is not only suitable for small businesses but also the self-employed. The contribution limit for 2022 is $14,000. Employers must match contributions (three percent) or make a two-percent non-elective contribution for all employees. These contributions are deductible business expenses. SIMPLE plans are ideal for businesses that employ fewer than 100 people, and only certain business entities can open an account. As soon as the account is funded, it becomes 100% vested to the employee.
It should be imperative to you as an investor to evaluate the accounts in which your assets are held. If you have taxable, tax deferred, and tax-free retirement accounts, the (account) location of your assets can have tax implications.
It all depends on the type of assets you hold. As an example, equities that you own with a view to long-term capital gains you should house in a taxable account. Qualified dividends from the same are eligible for preferential tax treatment. However, interest generating investments (like bonds) should go into a tax-deferred account, which will allow you to defer the taxes on your income until retirement, or forever in the case of a Roth account.
You can mitigate the negative tax implications of these investments if they are housed inside an IRA.
- Commodities & Futures
- Hedge Funds
- Private Equity
- Structured Settlements
RMDs For Charity
If you are 70 years and six months of age, or older you can entertain your charitable inclinations and gain the tax advantages that flow from it if you make use of your required minimum distributions (RMD) to make charitable donations.
The RMDs come from retirement accounts (e.g., IRAs), and the distributions are taxed at ordinary rates. Under the TCJA, many people won’t be able to itemize deductions anymore, especially older people without a mortgage. These taxpayers might want to make charitable contributions regardless of whether they can gain any tax advantages from it or not.
If you make a qualified charitable distribution (QCD), you cannot claim a charitable deduction, but the amount of your QCD reduces your RMD that is subject to federal taxes. It can also reduce your income that determines your payment of Medicare Part B.
How QCDs Work:
- You have to be 70½ years old when you make the distribution.
- You can direct an amount of up to $100,000 from your all of your RMDs together to a qualified charitable organization that is eligible to receive tax-deductible contributions.
- You cannot support a donor-advised fund, private foundation, or similar entity.
- You cannot gain anything from the donation, not even an invitation to attend a charity function.
You can direct QCDs from:
- Traditional IRA accounts.
- Inherited IRA accounts.
- SEP-IRA accounts.
- SIMPLE IRA accounts.
All distributions have to be directed from your account made out by check to the charitable organization.
If you plan to leave your employer in 2022, the disposition of your 401(k) or employer-sponsored plan is critical for both your retirement and tax plans.
We urge you to do a trustee-to-trustee transfer to roll your assets over into an IRA account. If you don’t, you might trigger a taxable event because you withdrew your funds in cash before doing the rollover. At your ordinary tax rate, which is due on withdrawals (PLUS a 10% penalty for those under 59 ½ years old), this could be very costly.
Rollovers to an IRA offer:
- 401(k) plan
- Profit-sharing plan
- 403(b) plan
- Governmental 457(b) plans
- You benefit from continuous tax-deferral of the money until you withdraw it at retirement.
- You can invest these funds consistent with your investment and financial planning strategies.
- You get to consolidate your retirement savings.
- You get to diversify your retirement assets into alternative assets if you wish.
Do you hold company stock in your retirement plan?
Under the rules of net unrealized appreciation (NUA), your shares of company stock can be distributed to a taxable brokerage account. At the same time, the rest of your retirement assets rollover to a regular IRA account. As a result, you will pay tax on the value of the shares on an original cost basis. If you hold on to the shares for at least a year afterward, you will pay tax at preferential long-term capital gains rates on any shares you subsequently sell. If your shares made tremendous gains after you acquired them, you are in for substantial tax savings. At the same time, you benefit from tax diversification if you already own significant tax-deferred retirement accounts.
Roth conversion is an essential strategy for some investors. With a Roth conversion, the amount you convert from your Traditional IRA account becomes taxable at the end of the year. We currently pay very low rates, which makes a Roth desirable. If you earn a variable income (incentive compensation, for example), a Roth conversion can make much sense in the years when your income is lower.
Under the TCJA, a Roth conversion is no longer re-characterizable, which means once done, it’s forever. When in doubt, consider doing your Roth conversions late in the year to be sure.
One advantage of Roth conversions is certainty. No one knows how tax laws will change down the road. If you hold a part of your of your retirement assets in a tax-free account makes it a lot easier to plan your withdrawals when you enter retirement. At the same time, Roth IRAs are free from the required minimum distribution, which hits a Traditional IRA when you reach the age of 70½. If you plan to leave your assets to your heirs, this is a powerful estate planning opportunity – if you do not need these funds to sustain yourself during retirement.
Self-Employee Tax Preparation
Being self-employed offers certain benefits like freedom and the ability to organize your work the way you want it. At the same time, however, it comes with added responsibilities, such as paying your own FICA taxes and retirement contributions. This sometimes looks like a heavy burden for many, especially when it comes to strategies for tax planning. FAS CPA & Consultants are happy to give you some ideas of how to do tax planning as self-employed.
How are Self-Employment Taxes Calculated
As a sole proprietor, contractor or statutory employee, you will normally file a Schedule C and the net profit on there would have to be included in Schedule SE, which will then be filled with Form 1040 for your federal tax return. The figure on these forms will be used to calculate the amount of income tax you owe and how much Social Security and Medicare contributions you will have to make.
Pay Estimate Taxes On Time
As an employee your Social Security, income tax and Medicare are automatically withheld by the employer every month. As a self-employed individual, however, you will have to take care of that yourself. You are required to make quarterly estimated payments on your taxes and failure to do so can result in tax penalties and interests. It gets even more complicated if you have employees, but FAS CPA & Consultants have set up a new service helping self-employed taxpayers stay on top of their tax planning. If you have questions, we will be happy to answer them.
Employ Family Members to Save Taxes
Another good strategy for tax planning as a self employed would be employing your family members. As you pay your employees for carrying out specific tasks related to the business you would be able to reduce the amount of income tax you owe. However, you have to be careful about:
- Compensating your employees, who are also your family members with a reasonable amount of money for the tasks they perform.
- Complying with child labor laws when employing a minor
- FICA taxes (if you hire a family member who is under 18, you wouldn’t have to pay FICA taxes on their wages).
- Withholding taxes from wages you pay to your family members. As an employer you will be required to withhold income taxes, Social Security and Medicare taxes and in some cases, state taxes.
Set Up a Employer-Sponsored Retirement Plan
Being self-employed means you will have to make arrangements for your retirement yourself. Setting up an employer-sponsored retirement plan has many benefits, both tax and non-tax based.
Tax benefits for self-employed
- Immediate federal tax deduction
- Contributions to the plan with pretax dollars
- Deferral on taxes until a payout is made
- 401(k) with Roth contributions don’t bring immediate tax benefits, but future qualified contributions are not a subject to federal income tax.
Retirement plans for self-employed include:
- Simple 401(k)
- Simple IRA
- Individual 401(k)
- Keogh plan
- Simplified Employee Pension (SEP)
It is always advisable to consult with a tax planning professional such as a CPA to make sure that the retirement plan you choose if right for your business. FAS CPA & Consultants will offer the best solutions for your individual circumstances.
Make Use of All Business Deductions to Minimize Taxes
You should take full advantage of deductible business expenses that are both ordinary and necessary. This is a fantastic strategy for tax planning as a self-employed. You can deduct expenses like:
- Office rent
- Home office expenses
- Office furniture
- Technological equipment
- Business related utilities
Some expenses that are both for your business and your personal consumption can be deducted partially. FAS CPA & Consultants would be glad to show you how to lower your taxable income by maximizing your business expenses deductions.
Use Health-Care Expenses Deductions to Save Taxes
You can deduct up to 100% of the health insurance you pay for yourself, your spouse and dependents if you are self-employed. You also have the opportunity to deduct contributions made to a Health Savings Account. If you use the money in it to cover qualified medical expenses for yourself, your spouse or any of your dependents this is not included in your adjusted gross income, but if the money is spent on non qualifying medical expenses, then it is added to the adjusted gross income and a subject of a 20% penalty tax. There are some exclusions, which can be best explained by a tax accountant.
Advice For Cutting Your Tax Bill
Most taxpayers are interested in corporate spinoffs these days. How soon after a spinoff can I acquire one or either of the companies involved without putting the tax-free nature of the spinoff in jeopardy?”
The companies must demonstrate that any subsequent acquisition did not form part of the spinoff plan. Many taxpayers believe that a two-year embargo prevents companies from taking over firms that had been involved in a spinoff, but this is untrue. The law is more nuanced than that. At the moment, ten major spinoffs are pending. Eight were completed in the past few years.
Leveraged spinoffs are very popular. The spinoff company borrows money to pay a preliminary dividend up to the parent, but the obligation is left with the subsidiary. This is a feature of all current spinoffs. Take the recent spinoff by Merck, for example. Here a group of products is spun off, and in the process, $9 billion is extracted from the ‘NewCo.’
A Sound Approach
The conduit theory clearly explains why corporations pay no taxes on dividends received from soon-to-be-spun-off subs. The parent is required to use the dividends to retire debt or repurchase stock; it is merely a conduit for the funds that it is bound to pass on to shareholders and creditors.
Another strategy of interest is credit-loss recognition by the banks. It used to be that companies would recognize a loss only when it became probable. Not so under the new regulations. Now companies have to predict expected credit losses over the lifetime of a financial asset. The FASB (Financial Accounting Standards Board) provides no recommendation and specifies no method for predicting the same and no evaluation for the use of particular inputs. This will result in earnings declines for lenders in 2021. It is regrettable. Although no one is keen on too much regulation, at least members of the same industry should account for things in a very similar way.
Take Note Of Accounting Choices
Accounting choices can make a significant impact on investment. Investors should always be on the lookout for companies that change the life of their depreciable assets. Those that lengthen the life of assets to stretch out the depreciation period are reducing expenses. The same goes for revenue recognition, which is hampered by complicated implementation guidelines.
Complicated Implementation Guidelines
Things become very complicated when multiple deliverables provide both goods and services. They typically allocate a transaction price between them and recognize revenue only when an obligation has been satisfied.
Regulators are currently investigating ‘Under Armor’ for this type of improper revenue recognition. Companies that faced revenue recognition problems in the past include Quantum, MIMedx, and Infosys.
For as long as the standards for revenue recognition remain vague, these issues will plague corporations. It often leads to honest errors in the timing of revenue realization.
Another company with deferred revenue liabilities is Tesla. Tesla investors are also arguing about Tesla’s accounting choices. Investors rarely agree over the rapidity with which a company is lowering its reserves, whether it is over-reserved or whether inventory should be written down. This type of criticism is often not warranted, and the new credit-loss recognition rules will make matters worse.
When Accounting Issues Created Investment Opportunities
MGM Resorts is selling its hotels (including the Bellagio, MGM Grand, and Mandalay Bay) to a partnership, including Blackstone Group (BX). The properties in question are valuable and accrued substantial gains, while the book value remains relatively small. By selling it to a leveraged partnership of which MGM is part, it avoids significant gains for tax purposes and allows the company to raise cash while deferring the taxes on the profits for as long as fifteen years.
In the example above, MGM will contribute the hotels to the partnership. The partnership will borrow money equal to the fair market value of the hotels. The partnership will distribute this money within 90 days. As long as MGM guarantees the loan (even on a limited basis), the company will not be taxed on the proceeds before the loans are fully repaid.
The company will only show the fair market value of the guaranty on its balance sheet. This amount will be nowhere near the full exposure they have. The odds of MGM ever honoring the guaranty is minuscule. So most of the numbers will never reach the balance sheet.
For 2021 a taxpayer can gift $11.6 million by removing the assets from the base on which a wealth tax would be imposed while avoiding a gift tax at the same time.
An individual taxpayer can donate (give away) up to $11.6 million form their estate (and the basis on which a wealth tax can be imposed) free from any gift tax. By 2026 this amount will revert to $5 million.
Another option is to donate appreciated stocks and securities. The taxpayer can claim a charitable contribution deduction for the full fair market value of the securities and does not have to pay any capital gains tax on the appreciation of the securities during their holding period of the securities.
A qualified charitable distribution from an individual retirement account is an otherwise taxable distribution made directly from the IRA trustee to a qualified charity after the owner reached the age of 70 and a half years.
The distributions are limited to $100,000 per annum. The benefit is derived from the fact that amounts distributed in this manner are excluded fro the donor’s gross income – unlike typical IRA distributions.
Real Estate Investment Trusts
Real estate investment trust dividends offer opportunities. The new tax law allows investors to exclude 20% of a qualified REIT dividend from gross income.
Taxpayers who gain from the sale of securities or other appreciated assets can defer these gains from the sale by investing the proceeds in a Qualified Opportunity Fund (QOF). The reinvestment allows the tax liability to be delayed for a substantial period.
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Mistakes To Avoid In Tax Preparation
Not even veterans in the field are immune to tax preparation blunders. It is imperative to keep a list of the most common errors just to be on the safe side. Based on recent research by Bloomberg Tax & Accounting, here are some of the most common mistakes,
At the moment, crypto is all the rage. Taxpayers must take heed of the fact that the IRS treats cryptocurrency as property for federal income tax purposes. This means that every capital gain or loss on crypto transactions (subject to any limitations on capital losses) must be recognized for tax purposes.
The IRS is midst a massive compliance campaign coupled with improved enforcement in the crypto space. Added to these efforts is the addition of the new cryptocurrency question on Form 1040. Errors in tax preparation can result in an IRS audit.
Never assume that you know the precise date for filing your return. It is not necessarily April 15th.
If the due date falls on a Saturday, Sunday, or legal State or Federal holiday, filing is still timely when filed on the first business day following the same. It is possible to have separate filing dates for federal and state filings.
Remember to include all the people who qualify as dependents. Failure to do so will affect your taxpayer filing status, and you might end up paying a lot more tax than you had to. Babies born at the end of the year qualify as dependents for the full year. Take care to claim all children, parents, or relatives for whom a taxpayer provides at least half of the support they get. This will maximize a taxpayer’s head of household filing status, the child tax credit for dependent care expenses, and the credit for ‘other dependents.’
Dividends And Interest
Some taxpayers file before all their 1099s arrive in the mail. It is imperative to remember to include all the amounts received on your tax return. Dividend and interest income omitted can cost you much money in interest and penalties that weren’t accounted for on your return.
Earned Income Tax Credit(EITC)
Taxpayers who work but earn less than a certain amount can benefit from the EITC. It reduces the amount of tax you have to pay. It could create a refund – even if the tax liability is zero and nothing has been withheld. Double-check eligibility. The IRS will scrutinize EITC filings more studiously.
Although a taxpayer’s filing status is more often than not straightforward, it is not always the case. Since filing status has a direct impact on deductions and credits, it can hurt a taxpayer’s pocket when confusion prevents him or her from applying the most advantageous filing status available to them.
Taxpayers whose spouse recently died or who are recently separated or divorced and who have children younger than 24 years of age or who support other dependants might be able to file as married or head of household. It requires thoughtful consideration to determine the most beneficial status.
When taxpayers younger than 59½ make early withdrawals from their retirement accounts, they are eligible for an additional 10% tax on the amount withdrawn. Sometimes an exception exists, and this needs to be checked. It is imperative to inform your accountant that you made early withdrawals or if you rolled over retirement funds into another qualifying account. If a taxpayer fails to report the same, it can amount to an omission or underreporting tax liability.
Reduce Your State Taxes Dramatically
The best way to cut your state taxes is to move away from the high tax states like New York and California. Move to low tax states like Florida or Nevada. Very few relocators regret their move. For the average New Yorker, it costs 14.7% of their income to stay there. By moving to Florida, the rate can be cut in half, according to studies done by the Cato Institute.
Interest in moving for tax purposes peaked after the 2017 federal tax overhaul, which capped state and local tax deductions at $10,000 per year.
Experts offer the following advice: take your time; do your research. Advance preparation is critical. Start planning a couple of years before making a move. In 2016 almost 600,000 people (net) moved away from the 25 highest tax states to the 25 lowest tax states, says the Cato Institute. In the top tax states, the average portion of income, sales, and property taxes equaled just under 10% of personal income, in comparison with the average 7.6% for the low tax states.
High Tax States Losing Population
- New York
Low Tax States Gaining Population
During the planning stage, calculate what you will save by moving to specific locations. Consider long-term savings also – think about savings made by selling your business, appreciated shares in the stock market, tap in on your inheritance and more. However, remember to cap your savings by including your costs of relocation. Do not forget to consider your losses of connection with your family and community, call it an emotional tax if you will.
Beware Of These Tax Scams During Tax season
|Abusive Tax Shelters||Trusts and syndicated conservation easements used to avoid paying taxes||The IRS is committed to stopping complex tax avoidance schemes and those who create and sell them.|
|Be on the lookout for people peddling tax shelters that sounds too good to be true|
|When in doubt, seek an independent opinion|
|Excessive Claims: Business Credits||Improper claims of the fuel tax credit and the research credit||The fuel tax credit is limited to off-highway business use, including farming.|
|The research credit often involve failures to participate in or substantiate qualified research activities or satisfy the requirements related to qualified research expenses|
|Fake Charities||Groups masquerading as charitable organizations solicit donations.||Be wary of charities with names similar to familiar or nationally-known organizations|
|Make sure that your hard-earned money goes to real charities|
|Go to IRS.gov for the tools you need to check out the status of charitable organizations|
|Falsify Padding Deductions on Returns||Falsely inflate deductions or expenses on the tax return to pay less or receive a larger refund||Do not overstate deductions or costs and do not improperly claim credits such as the Earned Income Tax Credit or Child Tax Credit|
|Falsifying Income to Claim Credits||Invent income to qualify for tax credits erroneously (like the Earned Income Tax Credit)||File the most accurate tax return possible. You are legally responsible for everything on your return. This scam can lead to large bills and payment of back taxes, interest and penalties.|
|Frivolous Tax Arguments||Do not use frivolous arguments to avoid paying taxes.||Unreasonable and outlandish claims about the legality of paying taxes are thrown out of court every day. The penalty for filing a frivolous tax return is $5,000.|
|Identity Theft||Be alert to tactics aimed at stealing your identity. Identity thieves use your Social Security number to file fraudulent tax returns in your name for their benefit.||The IRS aggressively pursues criminals that file fraudulent tax returns using someone else’s Social Security number.|
|Inflated Refund Claims||Some tax preparers ask clients to sign a blank return and promise a big refund and charge fees based on the percentage of the refund.||These fraudsters use flyers, phony storefronts, and word of mouth to find victims.|
|Offshore Tax Avoidance||Hiding money offshore.||The IRS is very successful in enforcement against offshore cheating. Those who hide money offshore is best served by coming in voluntarily and getting caught up on their tax-filing responsibilities.|
|Phishing||The use of fake emails and websites looking to steal personal information.||The IRS will never contact a taxpayer via email about a bill or tax refund. Never click on emails claiming to be from the IRS. Beware of scam websites and emails.|
|Phone Scams||Phone calls from criminals impersonating IRS agents.||There has been a surge of phone scams over the past years as con artists threaten people with police arrest, deportation, and license revocation.|
|Return Preparer Fraud||Tax preparers that scam clients perpetrate refund fraud, identity theft and other scams||Beware of unscrupulous return preparers.|
Readers should note that this article is only intended to convey general information on these issues and that FAS CPA & Consultants (FAS) in no way intends for the contents of this article to be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. This article cannot serve as a substitute for such professional services or advice. Any decision or action that may affect the reader’s business should not rely solely on the contents of this article, but should rather be consulted on with a qualified professional adviser. FAS shall not be responsible for any loss sustained by any person who relies on this presentation. This article is subject to change at any time and for any reason.
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