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| Reducing the amount of taxable income Claiming Tax Credits
Reducing your tax rate The AMT
Controlling the Due Date for Taxes Restrictions on Tax Planning
Helping you reduce your individual taxes.
Tax planning is a process of looking at various tax options in order to determine when,
whether, and how to conduct your personal transactions so that taxes are eliminated or
reduced. As an individual taxpayer, you will often have the option of completing a taxable
transaction by more than one method. The courts strongly back your right to choose the
course of action that will result in the lowest legal tax liability. In other words, tax avoidance
is entirely proper.
Although tax avoidance planning is legal, tax evasion — the reduction of tax through
deceit, subterfuge, or concealment — is not.
How a tax plan works.
There are countless tax planning strategies available, particularly if you own a small
business. Some are aimed at your individual tax situation, some at the business itself. But
regardless of how simple or how complex a tax strategy is, it will be based on structuring
the transaction to accomplish one or more of these often overlapping goals:
• Reducing the amount of taxable income
• Reducing your tax rate
• Controlling the time when the tax must be paid
• Claiming any available tax credits
• Controlling the effects of the Alternative Minimum Tax
• Avoiding the most common tax planning mistakes
In order to plan effectively, we can help you estimate your personal and business income
for the next few years. This is necessary because many tax planning strategies will save
tax dollars at one income level, but will create a larger tax bill at other income levels.
You will want to avoid having the “right” tax plan made “wrong” by erroneous income
projections. Once you know what your approximate income will be, you can take the next
step: estimating your tax bracket.
It takes professionals like us to come up with reasonable estimates of future taxes. The
better your estimates, the better the odds that your tax planning efforts will succeed.
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| Reducing the amount of taxable income
Of course, the best way to reduce the part of your income that is subject to tax is to take
full advantage of all available tax deductions, both business and personal. In order to do
this, it is very helpful to work with professionals like us who know what is deductible and
what isn’t, and who understand the special rules that apply to certain types of deductions
such as meals and entertainment, automobile expenses, and business travel.
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| Reducing Your Tax Rate
It may be difficult or impossible to actually lower your tax rate, but there are certain actions
we can assist you with that will have a similar result. These include:
• Shifting income from a high-tax-bracket taxpayer (such as yourself) to a lower-bracket
taxpayer (such as your child).
• Structuring an investment or transaction so that payments that you receive are
classified as capital gains. Long-term capital gains earned by non-corporate taxpayers
are subject to lower tax rates than other income.
• Choosing the most beneficial form of organization for your business (such as sole
proprietorship, partnership, or corporation). If your business income is under $75,000
and your business is not a personal service business like medicine, law, architecture,
engineering, accounting, the arts, or consulting, you may be able to save tax dollars by
incorporating. Otherwise, the sole proprietorship or pass-through entities (partnerships,
LLCs, S corporations) usually offer more tax benefits.
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| Controlling the Due Date for Taxes
For tax planning purposes, it’s often possible to delay your taxes indirectly, by taking
actions that delay the time when particular income items must be reported on your return.
As professionals, we may recommend a strategy that will postpone receipt of income until
the next year, and accelerate payment of expenses into your current tax year. (This will be
much easier to do if you use the cash method of accounting.) In this way you can delay
your tax liability to the next quarter, or even the next tax year.
As a general rule of thumb, you should always try to minimize your taxes in the present
year, even if doing so means you may have to pay slightly more tax in the future.
After all, no one knows what the future holds. The tax laws are constantly changing, and
there’s a good chance that whatever you think you may owe in the future will be different
by the time you get there. Furthermore, economic conditions or personal plans can
change, and your business may look entirely different even one year down the road. In the
worst-case scenario, you could die unexpectedly, and in some cases you can avoid tax
altogether if you die before paying it.
In broad terms, you can minimize taxes in the current year by postponing the receipt of
income so that more of it will be taxed next year, and by accelerating deductions into the
current year.
Postponing income, accelerating deductions. A few specific how-to ideas are listed below
but we don’t recommend you engage in any of these strategies without the assistance of a
tax professional.
• Delay collections—delay year-end billings until late enough in the year that payments
won’t come in until the following year.
• Delay dividends—if you operate your business as a C corporation, arrange for any
dividends to be paid after the end of the year.
• Delay capital gains—if you are planning to sell assets that have appreciated in value,
delay the sale until next year.
• Accelerate payments—where possible, prepay deductible business expenses,
including rent, interest, taxes, insurance, etc.
• Accelerate large purchases—close the purchase of depreciable personal property
or real estate within the current year.
• Accelerate operating expenses—if possible, accelerate the purchase of equipment,
supplies, or the making of repairs.
• Accelerate depreciation—elect to expense the cost of new equipment if you are
eligible to do so, rather than to depreciate the equipment.
Note that any strategies aimed at changing the year in which items of income and
deduction will be accounted for will be much easier to accomplish if you use the cash
method of accounting.
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| Using tax-advantaged retirement plans
Another way to defer the day of reckoning is to plow as much money as you can into
qualified, tax-free retirement plans. In most cases, you or your business will get a tax
deduction for the amount contributed, and you won’t have to pay income tax on the
amounts until you start taking money out of the plan when you retire.
Meanwhile, any income earned on the investments made by the plan will build up, tax-
free. If you are a business owner, you have a great deal of control over the way the plan
is set up, and there’s sure to be a plan that fits into your business goals and retirement
objectives. If you are an employee, you can work within the plan (if any) your employer
provides, or set up your own plan through an IRA account.
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| Claim all the tax credits available to you.
When they’re available, tax credits are generally better for you than deductions would
be, because credits are subtracted directly from your tax bill. Deductions, in contrast, are
subtracted from the income on which your tax bill is based.
So, a dollar’s worth of tax credit reduces your tax bill by a dollar, but a dollar’s worth of
deductions lowers your tax bill by 35 cents if you’re in a 35 percent bracket, by 30 cents if
you’re in a 30 percent bracket, etc. In cases where you have a choice between claiming a
credit or a deduction for a particular expense, you’re generally better off claiming the credit.
As wonderful as tax credits can be, with the IRS (as you’ve probably figured out by now)
there’s almost always a catch so your tax professionals can help you determine what
credits are available to you.
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| The Alternative Minimum Tax (AMT) was intended to prevent higher-income
taxpayers from substantially reducing or eliminating their tax liabilities through
incentives offered by the tax code. In practice, however, the AMT affects even
middle-income taxpayers because the AMT exemption amounts have traditionally
not kept up with inflation. For example, the exemption rates set in 1992 were not
increased until 2001.
As a result, many taxpayers are required to compute their income tax liability twice:
once under the regular method and once again under the AMT method. An individual
will be subject to the AMT if his or her AMT liability is more than the regular tax liability
for the year.
What types of things can trigger the AMT? The most common items that can cause you
to become subject to the AMT are listed below. These items must be added back to
your taxable income in order to compute your AMT:
• All personal exemptions
• The standard deduction, if you claimed it
• Itemized deductions for state and local income taxes, and real estate taxes
• Itemized deductions for home equity loan interest (this does not include interest on a
loan to buy, build, or improve your home)
• Itemized deductions for miscellaneous deductions
• Itemized deductions for any portion of medical expenses that exceed 7.5 percent of AGI
but not 10 percent of AGI
• Deductions you claimed for accelerated depreciation that exceed what you could have
claimed under straight-line depreciation
• Differences between gain or loss on the sale of property for AMT purposes and for regular
tax purposes; these differences most commonly occur as a result of the different depreciation
methods required under AMT, as described above
• Addition of certain income from incentive stock options
• Changes in income from installment sales, since the installment sale method generally can’t
be used for AMT purposes
• Changes in certain passive activity loss deductions
• Seductions relating to oil and gas investments, or drilling or mining operations
• Interest on certain private activity bonds that would otherwise be tax-exempt
If you have large amounts of any items on this list, and your adjusted gross income exceeds the exemption amounts, you’ll definitely want to speak to one of our tax professionals.
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| Restrictions on Tax Planning
Planning is not an exact science. As tax professionals we analyze both the form and
substance of a transaction to determine the possible tax consequences. Generally the
IRS holds that its the substance of a transaction, not its form which determines its tax
consequences. However, a taxpayer who casts a taxable transaction in a particular form
may have a difficult time changing his or her mind later, and then trying to convince the
IRS that the substance of the transaction differs from its form for tax purposes. So, the
general rule is that the IRS may look behind the form of a transaction in order to determine
its substance for tax purposes, but taxpayers are generally locked into the form of the
transaction. The thinking here is that since a taxpayer can freely choose how to set up a
transaction, it’s only fair to require him or her to live with its tax consequences.
Contact Paul Roth-Roffy if you'd like to discuss how we can help you with individual taxation.
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