How to use savvy tax planning to maximize your wealth
Financial independence is when you have enough income generated from your investments that you no longer need to work to continue your current standard of living. Therefore, in order to achieve financial independence, you must acquire assets that generate income, rather than converting your sweat (work) into income. In many cases, people are very good at the work part of the equation, but due to poor planning, they have less to save and it takes longer to achieve their financial independence. Tax planning is a good way of working smarter rather than harder.
By a significant margin, the easiest way to move towards financial independence is to maximize your contributions to your employer’s retirement plan. If they have a 401K, this allows you to contribute in 2012 $17,000 tax-free ($22,500 if you are over 50).
Are you thinking you don’t make enough to save? If you are 45 and have not a dollar in savings, you must save 40 percent of every dollar you make to acquire enough wealth by age 65 to support 60 percent of your current standard of living. This alone should re-tool your thinking and at a minimum, maximize your 401K, simple IRA’s, etc. If your employer doesn’t have a retirement plan, contribute $5,000 to a regular or Roth IRA ($6,000 if you are over 50).
If you don’t have taxable income (approximately half of Americans don’t pay income tax), ask your employer to add a Roth 401K option to their retirement plan. While you don’t get a deduction for the Roth contribution, you can withdraw the contribution tax free regardless of age, and the income can be withdrawn tax free after age 59-1/2.
If you are a business owner with a retirement plan, you should have the ability to still make a contribution for 2011 by the extended due date of your business return. If you are a business owner and aren’t worried about your retirement because you are counting on selling your business, which will be more than enough to retire, think about if you owned 100 percent of General Motors. After the bankruptcy, you would have been broke. Diversification of your investments is a good idea. Talk to your investment advisor about this!
Pay attention, too, to your depreciation deduction.
Between IRC section 179 elections, bonus depreciation, and cost segregation studies on real estate, you have a lot of flexibility to determine what your taxable income will be. Cost segregation, an IRS approved tax strategy, increases near term cash flow by utilizing shorter recovery periods to accelerate the return on capital from your investment in property. The difference is a change in depreciation from a 39-year period down to five-, seven-, or 15-year depreciation period.
There are a few more things to ponder, too.
Regardless of your political perspective, know that Congress and the White House left on vacation without their work complete. They did extend the payroll tax holiday for employees for the first two months of 2012, leaving significant uncertainty for taxpayers. To do so, they approved a complex apportionment formula to be used in filing 2012 tax returns. Among the more important individual tax provisions that Congress and our president left unaddressed for 2012 are:
* Increased exemption levels for the individual alternative minimum tax and personal tax credits allowed against regular tax and the AMT.
* Deduction for state and local general sales taxes.
*Above-the-line deduction for qualified tuition and related expenses.
* Deduction for elementary and secondary school teacher expenses.
* Expansion of adoption credit and adoption assistance programs.
* Parity for exclusion from income for employer-provided mass transit and parking benefits.
* Treatment of premiums for mortgage insurance deductible as interest that is qualified residence interest.
Among the business tax provisions that were left unaddressed were:
* 100 percent bonus depreciation.
* Increased section 179 expensing limit of $500,000 with $2 million phase-out threshold and expanded definition of section 179 property.
* Research and development credit.
* 15-year straight-line cost recovery for qualified leasehold improvements, restaurant buildings and improvements, and retail improvements.
* Wage credit for employers of active-duty military members.
Ironically, planning for 2012 requires you do some crystal ball gazing. Depending on if you think these provisions will be extended should direct you towards effective tax planning for 2011 and 2012. Some key points:
* The top federal tax bracket for 2012 is 35 percent. Beginning in 2013, that maximum ordinary income tax rate increases to 39.6 percent.
* Capital gains rates increase from 15 percent to 20 percent beginning in 2013.
* Investment income has an additional tax of 3.8 percent beginning in 2013
Here are some planning pointers:
Make sure you have the right income in the right year. This year, consider deferring deductions or accelerating income into higher tax years. Make sure that your expected return on investment is less than the increase in tax, year over year.
Given the uncertainty on what is going to happen with the 2013 tax rates, consider extending your tax returns to postpone making any binding elections. By doing this, you will be able to see how much depreciation deductions you want to take in 2011 and 2012 once 2013 becomes clearer.
This list of courses is not everything you can do to minimize your tax burdens, so I highly encourage everyone to consult with their accountant. They will be able to proactively and meticulously review your situation and suggest the best plan of action to maximize your wealth. Everyone’s situation is different, so having that type of personalized attention will yield greater savings immediately and in the long term.
There are times when speaking to a new client, the discussion often turns to tax planning. I like to tell people about our Bosma Group “No tax guarantee.” I simply state that, once we calculate their taxable income, we send them an accounting bill for that same amount. Voila, $0 taxable income, $0 tax. This is our tongue-in-cheek way of saying that not paying taxes should not be your goal. Rather, increasing your after-tax wealth should be.
Michael D.Bosma, a certified public accountant, is managing shareholder of Bosma Group.Contact him 786-4900 or email@example.com.
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