Income Tax Guide - All About Taxes

1. Avoid Capital Gains on Sales of Real Property

You can exclude up to $250,000 (or $500,000 per married couple) of gain on the sale of your principal residence. This exclusion may be used once every two years.

In addition, you must have claimed the property as your principal residence for at least two of the last five years that you owned it.

2. Deduct Home Mortgage Interest

If you’ve been holding off on buying property, stop renting or leasing your principal residence. Buy a home, and then you can deduct the interest portion of your mortgage payments from your federal income tax.

Mortgage rates are currently are at or near record lows, and several mortgage companies are quoting incredible rates. If you’ve been contemplating the plunge, 2002 may be the year to act.

3. Consolidate Your Debt and Save

If you have any outstanding debts, you may want to use any home equity to consolidate those debts using a home equity loan. Lenders usually provide interest rates than other debtors (credit cards, auto loans, etc.) , and the government allows a deduction for interest paid on all home equity “indebtedness” loans.

This deduction is usually allowed on home equity loans up to $100,000. Check with your tax advisor for more information.

4. Save on Taxes Through Education

A whole slew of tax breaks are designed to encourage higher education. For instance, Coverdell Accounts (formerly known as the Education IRA) allow you to save money on a tax-advantaged basis for the purpose of higher education.

The Hope tax credit provides dollar-for-dollar reductions in taxes for taxpayers, spouses, or dependents attending qualified educational institutions. The Hope tax credit gives up to $1,500 of credit for each of the first two years of college.

Instead of the Hope tax credit, taxpayers can opt to use the Lifetime Learning tax credit. Students wanting to acquire or improve their job skills can have up to 20% of expenses incurred at qualified institutions refunded in the form of a tax credit.

5. Maximize Your Gifting Through Dynasty Vehicles

Transferring assets to grandchildren or even great-grandchildren directly can incur the dreaded Generation-Skipping Transfer Tax.

Instead of gifting directly to your heirs, consider gifting to a “generation-skipping dynasty trust.” A generation-skipping dynasty trust, established on behalf of your loved ones, can avoid estate and gift taxes for up to three generations.

6. Rental Income

If you own rental real estate, rental income is taxable. However, you can sometimes offset substantial rental income through income tax deductions.

Look for deductions that offset passive and active gains. If you’ve been holding off on sprucing up the place, you may also want to consider making some maintenance repairs. They might not only reduce your tax bill, but increase your property’s net worth.

7. Begin Receiving a Monthly Mortgage Check

Turn your home into a tax-advantaged income-producing vehicle through the use of a “reverse mortgage.” By converting your home equity into income, a financial institution can provide you with a monthly check based on the total market value of your home.

Not only does the “reverse mortgage” provide income, but can help reduce taxes by removing one of your largest assets from your estate. Avoid reverse mortgage scams, and do your homework ahead of time. It could be well worth it.

8. Use Tax Credits to Reduce Your Tax Bill

Low income housing projects often reveal tax advantages, as warranted by Congress. Wealthy individuals often develop these properties solely for the purpose of realizing credits, which offset you tax bill dollar for dollar.

Private individuals may still be able to take advantage of these credits by pooling their interests and receiving a share of the tax credits. There are companies that also create partnerships with investors for the sole purpose of receiving low income housing tax credits, prefunded by Congress.

9. Social Security Benefits

If you draw Social Security income, understand “provisional income.” If your provisional income falls beneath certain constraints, you may not have to pay federal income taxes on your Social Security benefits.

To help determine your provisional income, be sure to check out the official Social Security website.

10. The Disappearing Tax

Uncle Sam has eliminated the 15% excise tax on large distributions from 401(k) or other pension plans. However, if those funds remain in the retirement plan when passing to your heirs, the proceeds will be subject to both income and estate taxes at the same time. This repeal of the excise tax presents an excellent planning opportunity for millions of American retirement savers.

11. Investigate Tax-Free Munis

Through diversification, some choose to purchase tax-exempt “IOU’s” known as Municipal Bonds.

Issued by public agencies, municipal bonds have substantially reduced risk, do not incur annual taxation, and are usually not subject to market fluctuation.

12. Don’t Forget T-Notes

When diversifying, some choose to take advantage of U.S. Treasury Obligations. These notes come with the full backing of the U.S. Government. T-Notes also offer state and local tax exemptions.

13. Reduce Taxes When Selling Stock

If you’re in the highest tax bracket, and depending on your age and risk tolerance, avoid “quick sales” when selling stock. Holding stock for at least 12 months will qualify you for the reduced capital gains tax.

It’s much better to pay 20% capital gains taxes than 38.6% income taxes when you wish to redeem your stock certficates.

Check with your financial advisor to make sure growth stocks are appropriate for your own portfolio before investing.

14. Tax-Deferred Annuities

Tax-deferred annuities are retirement alternatives completely avoid probate delays and expenses. Annuity prices and values vary with the market, and there are sometimes penalties for early withdrawal.

Annuities do not have taxes on earnings taken out annually. Instead, money you would have otherwise paid in taxes remains in the annuity each year. Taxes are paid when you choose to withdraw your money. But for the entire time you hold that contract, that tax money is earning interest for you.

Annuities also come in many varieties. Some offer fixed rates of return, while others fluctuation based on market conditions. Other annuities, called variable annuities, allow you to invest in sub-accounts (also called variable accounts) that are managed by professional money managers.

15. Modified Endowments

Modified Endowment Contracts are special contracts, issued by insurers, that combine the benefits of tax-deferred annuities with a death benefit feature.

Not only can you put tax money to work for you, but these contracts can also be combined with advanced estate planning strategies, including dynasty trusts.

16. Exchanging Annuities

You can roll-over a weak under-performing annuity into a stronger, more competitive annuity, without having to pay deferred income taxes.

Thanks to Section 1035 of the Internal Revenue Code, no income taxes are paid on any of your annuity’s growth during the course of the transfer.

17. Use Your Unified Credit

In 2002, every U.S. citizen can shelter up to $1,000,000 from estate taxes at death. But did you know you could use that gift now?

You can use the Unified Credit during your lifetime, and gift up to $1,000,000 completely tax-free ($2 million for couples). This is ideal when gifting appreciating assets that could be worth much more in the future.

The Unified Credit can save significant additional tax dollars when utilized as part of a Shrinking Trust plan. A qualified SaveWealth Advisor can explain more about this strategy.

The Unified Credit will gradually increase until estate taxes completely disappear in 2010. But before you begin celebrating, consider this: current legislation brings estate taxes the very next year in 2011 back to their current levels. And the Unified Credit will only protect your assets at the current $1 million mark.

18. Reducing Taxes Through Trusts

It is easy to minimize the estate tax bill after you and your spouse pass away by doing some basic estate planning.

By setting up an A/B Trust, your Trust will allow you to use you and your spouse’s Unified Credit much more efficiently.

Not only can you save money on estate taxes, but your specific requests will be carried through, and your heirs will see much more of your hard-earned wealth pass to them estate tax-free.

19. Give to Those You Love

When preparing your estate plan, an easy way to reduce immediate income taxes is by bequeathing assets to your spouse.

The Unlimited Marital Tax Deduction allows all property in one spouse’s estate to pass gift tax-free and estate tax-free to the other spouse.

This strategy is ideal for estates under $1 million in net worth. Estates over that value can use estate planning techniques to effectively double the amount of assets that can be transferred to loved ones, estate tax-free.

20. Consider a QTIP

Have you heard about QTIPs? And we don’t mean the one for your ears.

A Qualified Terminable Interest Property Trust (QTIP), similar to an A/B Trust, takes full advantage of the Unlimited Marital Deduction. Unlike an A/B Trust, however, a separate trustee will determine distributions after the second spouse passes away.

The QTIP is especially useful in situations where a second marriage has occurred, and the grantor wishes to ensure children from a previous marriage are partial (if not whole) beneficiaries of the grantor’s estate.

21. Give Today, Save on Taxes Today

You can transfer up to $12,000 per person per year, completely free of gift taxes. This $12,000 gift tax-free level is set by the IRS and will increase every year to account for inflation.

Crummey gifts also allow you to use your current $12,000 annual exclusion when gifting to a trust, instead of a living person. Not only can you reduce gift taxes by making a $12,000 donation, but such gifts can reduce estate taxes by decreasing the size of your estate.

22. Use Advanced Gifting Techniques

Using the Generation Skipping Transfer Tax Exemption, you can save on the potential equivalent of an 80% tax imposed on assets left to grandchildren.

Examine how to use advanced estate planning strategies to accomplish this.

23. Give, Give, Give… and Save on Taxes

If you’re feeling philanthropic, consider establishing a Charitable Remainder Trust (CRT).

By gifting to a CRT instead of an individual, you may avoid capital gains tax on highly appreciated assets held by the trust.

Because you are leaving assets to your favorite charity, you may also receive an income tax deduction. Chances are you’ll also be recognized by the charity for your gift, and increase your take-home income.

Being philanthropic has never been more worthwhile.

24. Continue the Family Name

Carefully prepared Family Limited Partnerships can help you reduce your tax bill, while continuing your family name.

Set up similarly to a regular limited partnership, your estate is split up into limited partner shares and general partner shares. Instead of gifting $12,000 in cash annually to an heir, give away limited partner shares from your new Partnership.

NOTE: FLPs have been under increasing scrutiny by the Internal Revenue Service, and must be prepared with the utmost of care. Do your homework, and work with an experienced estate attorney who has tax expertise.

Through an FLP, you may be able to leverage your gifting without giving up control (since you can retain the General Partner shares for yourself), and protect your estate assets from the creditors of your beneficiaries.

25. Begin Your Own Dynasty

Irrevocable dynasty trusts, structured properly by an experienced attorney, can reduce estate taxes for up to three generations.

A dynasty trust provides excellent hedges for your family against creditors, lawsuits, and divorcing spouses of your children and grandchildren. Plus, in many cases, dynasty trusts can be funded without incurring any gift tax, using your current Unified Credit.

26. Leave a Lasting Legacy

High net worth individuals, looking farther down the road for advanced tax planning, may want to establish a Legacy Trust.

The Legacy Trust combines a Tax-Free Inheritance Trust, Generation-Skipping Dynasty Trust, and an Asset Protection Trust all under one roof.

This proven, irrevocable dynasty trust enhances the benefits of a plain irrevocable trust by minimizing estate taxes and hedging your estate from creditors, judgments, and malpractice suits.

27. Review Insurance Options

If you already own an insurance policy or have been thinking about purchasing life insurance, consider having an irrevocable trust purchase and own the death benefit of your cash-rich life insurance policies.

Technically, an irrevocable trust resides “outside” of your estate. Thus, when the death benefit is distributed, the policies within an irrevocable trust will not be subject to estate taxes.

In addition, your heirs will also avoid having to pay income taxes on those death benefits.

28. To Roth, or Not to Roth

The Roth IRA opens up an excellent savings opportunity, especially for younger retirement-minded savers.

Unlike traditional IRAs, the Roth IRA has a contribution ceiling of $3,000 annually that is not tax-deductible.

The Roth IRA basically uses non-qualified, after-tax money to fund it. However, when it comes time to draw income from your Roth IRA, the proceeds will be 100% tax-free (provided that you hold the Roth IRA for at least five years and you’re over age 59 1/2).

Younger taxpayers, who plan on being in a higher tax bracket later in life, may benefit the most from using this retirement vehicle. Be sure to check with your tax advisor for additional details. And click here for more information on the Roth IRA.

29. Splitting Hairs, Splitting Dollars

When it comes to insurance, you can maximize growth while minimizing taxation through Split Dollar Insurance.

A portion of your policy is earmarked for savings, while the remainder provides tax advantages and a guaranteed death benefit.

By purchasing Split Dollar Insurance, you can access the excellent tax advantages of insurance while reducing your out-of-pocket costs.

30. The Reverse Split

Another mindful way to reduce taxes is through the use of Reverse Split Dollar Insurance.

By funding your company’s pension plan with reverse split dollar insurance, you can build substantial cash values as part of an executive bonus plan. You can also secure a tax-free income, while your corporation maintains rights to the insurance policy’s death benefit.

31. Title Your Business Properly

Investigate the tax advantages inherent in different forms of ownership. Different forms of business come with different rates of taxation.

For instance, corporate taxes are usually higher than individual tax rates, which would apply to sole proprietorships and partnerships.

Of course, corporations are afforded much more liability protection, and the trade-offs of titling your business should be carefully considered.