“The hardest thing in the world to understand is the income tax.”— Albert Einstein
Tax pain…. Albert was right: The U.S. tax code is absurd. In 1913, it was 400 pages long. Since then it’s exploded to 73,954 pages of complex language designed to extract as much money as possible from your wallet.
Who reads all of that? No one. The code is so complex that U.S. tax preparation is one of the major growth industries … not just in America, but globally.
But while the tax man is determined to get his pound of your flesh, there are some important escape hatches for Americans. It may be too late for 2014’s tax year, but there’s plenty of time to prepare for next year … if you start now.
Tax Pain – The Golden Rule: Reduce Your Taxable Income
The fundamental element of any short-term tax strategy is to reduce your taxable income for the calendar year. There are three basic ways to do this.
1. Tax Pain – Gifting
Property acquired by gift or inheritance isn’t included in the taxable gross income of the beneficiary. That makes gifting an ideal way for a family to save tax.
For 2015, you can make tax-free lifetime gifts and bequests of up to $5.43 million. (For gifts or bequests to U.S. citizen spouses, the lifetime limits don’t apply.) Due to the concept known as “portability,” a surviving spouse can use a deceased spouse’s unused gift/estate tax exclusion. You could allocate some of your estate to your heirs, perhaps by creating a tax-deferred offshore private insurance policy.
Bear in mind that the first $14,000 (or $28,000 per married couple) that you gift in 2015 is tax-fee, and doesn’t apply towards your lifetime limit.
Payments made on behalf of another person to an educational institution for tuition, or to a medical provider for medical costs (including insurance), are also excluded from the gift tax, and don’t affect your lifetime cap. You might pay the tuition of a friend’s child, or the medical expenses of an employee. Although President Obama wanted to take it away, you can also still contribute to Section 529 education savings plans up to the annual exclusion amount. Money in these accounts grows and can be withdrawn tax-free, provided it is used to pay for college and related expenses.
Keep in mind that if you make a gift of anything other than cash or marketable securities, you need to get a professional appraisal, especially if it’s a hard-to-value asset, such as real estate or a share in the family business.
2. Tax Pain – Maxing out your retirement contributions
One of the best ways to reduce your taxable income is to max out your retirement contributions. Here’s a summary of the maximum contributions for 2015:
401(k) and 403(b) Plans: Max = $18,000. Persons 50 and older can contribute an additional $6,000, for a total of $24,000.
SIMPLE IRA: Max = $5,500. This jumps to $6,500 if you are age 50 or older. If you have an employer retirement plan, however, the deduction for IRA contributions is being phased out for modified adjusted gross incomes between $61,000 and $71,000 in 2015 (double that for couples). Unlike 401(k) contributions, which generally need to be made by the end of the year, IRA contributions can be made up until the tax filing deadline in April 2015 — that means Wednesday!
SEP-IRA: Max = 25% of compensation up to $53,000. If you’re self-employed and have a SEP-IRA plan, the maximum contribution has increased by $1,000. The amount is limited to the lesser of 25% of your income or $53,000.
Roth IRA Max = $5,500: You can make Roth IRA contributions until your income is between $116,000 and $131,000 in 2015 ($183,000 to $193,000 for couples). If you’re over age 50, there’s a $1,000 catch-up contribution.
3. Tax Pain – Juggling money
An oft-overlooked way to reduce your taxable income is to shift earnings into the following year or next year’s expenses into the current year. This reduces your adjusted gross (i.e., taxable) income.
For example, if possible, defer some 2015 income until 2016. There are many items for which you may be able to control timing: consulting income, self-employment income, real estate sales, gain on stock sales, other property sales and retirement plan distributions. On the expense side, you can prepay 2016 state and local income taxes, take losses on stock sales (up to $3,000 in net losses) and prepay 2016 real estate taxes, anticipated mortgage interest, margin interest and charitable contributions.
So there you have the three steps to reduce your taxable income … plan now for tax savings this time next year.
Offshore and Asset Protection Editor
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