9 Smart Tax Saving Strategies for High Net Worth Individuals

9 Smart Tax Saving Strategies for High Net Worth Individuals

The Tax Cuts and Jobs Act (TCJA) voted by Congress in late 2017 introduced significant changes to the way individuals and businesses file their taxes. The key changes included the doubling of the standard deduction to $12,000 for singles and $24,000 for married couples filing jointly, the elimination of personal exemptions, limiting the SALT deduction to $10,000, limiting the home mortgage interest deduction to loans of up to $750,000 versus $1,000,000 as well as comprehensive changes to itemized deductions and Alternative Minimum Tax.

Many high net worth individuals and families, especially from high tax states like California, New York, and New Jersey, will see substantial changes in their tax returns. The real impact won’t be completely revealed until the first tax filing in 2019. Many areas remain ambiguous and will require further clarification by the IRS.

Most strategies discussed in this article were popular even before the TCJA. However, their use will vary significantly from person to person.  I strongly encourage you to speak with your accountant, tax advisor or investment advisor to better address your concerns.

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1. Home mortgage deduction

While a mortgage tax deduction is rarely the primary reason to buy a home, many new home buyers will have to be mindful of the new tax rule limiting mortgage deductions to loans of up to $750,000. The interest on second home mortgages is no longer tax deductible.  The interest on Home Equity Loans or HELOCs could be tax deductible in some instances where proceeds are utilized to acquire or improve a property

2. Get Incorporated

If you own a business, you may qualify for a 20 percent deduction for qualified business income. This break is available to pass-through entities, including S-corporations and limited liability companies. In general, to qualify for the full deduction, your taxable income must be below $157,500 if you’re single or $315,000 if you’re married and file jointly. Beyond those thresholds, the TJLA sets limits on what professions can qualify for this deduction. Entrepreneurs with service businesses — including doctors, attorneys, and financial advisors — may not be able to take advantage of the deduction if their income is too high.

Furthermore, if you own a second home, you may want to convert it to a rental and run it as a side business. This could allow you to use certain tax deductions that are otherwise not available.

Running your business from home is another way to deduct certain expenses (internet, rent, phone, etc.). In our digital age, technology makes it easy to reach out to potential customers and run a successful business out of your home office.

3. Charitable donations

All contributions to religious, educational or charitable organization approved by IRS are tax deductible. The annual limit is 50% of your AGI (aggregate gross income) for most donations and 30% of AGI for appreciated assets.

While most often people choose to give money, you can also donate household items, clothes, cars, airline miles, investments, and real estate. The fair value of the donated items decreases your taxable income and therefore will reduce the amount of taxes due to IRS.

The TCJA made the tax planning for donations a little bit trickier. The new tax rules raised the standard deduction to $12,000 for singles and $24,000 for married couples filing jointly. In effect, the rule will reduce the number of people who are itemizing their taxes and make charitable donations a less attractive tax strategy.

For philanthropic high net worth individuals making charitable donations could require a little more planning to achieve the highest possible tax benefit. One viable strategy is to consolidate annual contributions into a single large payment. This strategy will ensure that your donations will go above the yearly standard deduction threshold.

Another approach is to donate appreciated investments, including stocks and real estate. This strategy allows philanthropic investors to avoid paying significant capital gain tax on low-cost basis investments. To learn more about the benefits of charitable donations, check out my prior post here.

4. Gifts

The TCJA doubled the gift and estate tax exemption to almost $11.18 million per person and $22.36 per married couple. Furthermore, you can give up to $15,000 to any number of people every year without any tax implications. Amounts over $15,000 are subject to the combined gift and estate tax exemption of $11 million.  You can give your child or any person within the annual limits without creating create any tax implications.

Making a gift will not reduce your current year taxes. However, making gifts of appreciated assets with a lower cost basis can be a way to manage your future tax payments and pass on the tax bill to family members who pay a lower tax rate.

5. 529 Plans

The TCJA of 2017 expanded the use of 529 plans to cover qualifying expenses for private, public, and religious kindergarten through 12th grade. Previously parents and grandparents could only use 529 funds for qualified college expenses.

The use of 529 plans is one of the best examples of how gifts can minimize your future tax burden. Parents and grandparents can contribute up to $15,000 annually per person, $30,000 per married couple into their child college education fund. The plan even allows a one–time lump sum payment of $75,000 (5 years x $15,000).

Parents can choose to invest their contributions through a variety of investment vehicles.  While 529 contributions are not tax deductible on a federal level, many states like New York, Massachusetts, Illinois, etc. allow for state tax deductions for up to a certain amount. The 529 investments grow tax-free. Withdrawals are also tax-free when used to pay cover qualified college and educational expenses. 

6. 401k Contributions

One of the most popular tax deductions is the tax-deferred contribution to 401k and 403b plans. In 2018 the allowed maximum contribution per person is $18,500 plus an additional $6,000 catch-up for investors at age 50 and older. Also, your employer can contribute up to $36,500 for a maximum annual contribution of $55,000 or $61,000 if you are older than 50.

The contributions to your retirement plan are tax deductible. They decrease your taxable income if you use itemized deductions on your tax filing form. Not only that, the investments in your 401k portfolio grow tax-free. You will owe taxes upon withdrawal at your current tax rate at that time.

7. Roth conversion

Roth IRA is a great investment vehicle. Investors can contribute up to $5,500 per year. All contributions to the account are after-tax.  The investments in the Roth IRA can grow tax-free. And the withdrawals will be tax exempt if held till retirement. IRS has limited the direct contributions to individuals making up to $120,000 per year with a phase-out at $135,000. Married couples can make contributions if their income is up to $189,000 per year with a phase-out at $199,000.

Fortunately, recent IRS rulings made it possible for investors who do not qualify for direct contributions, to use a two-step process known as backdoor Roth and take advantage of the long-term Roth IRA benefits. Learn more about Roth IRA in our previous post here. 

8. Health Spending Account

A health savings account (HSA) is a tax-exempt saving account available to taxpayers who are enrolled in a high-deductible health plan (HDHP) The funds contributed to this account are tax deductible. Unlike a flexible spending account (FSA), HSA funds roll over and accumulate year over year if not spent. HSA owners can use the funds to pay for qualified medical expenses at any time without tax liability or penalty. The annual contribution limits for 2018 are $3,450 per person, $6,900 per family and an additional $1,000 if 55 or older. The owner of HSA can invest the funds similar to the IRA account.

In effect, HSAs have a triple tax benefit. All contributions are tax deductible. Investments grow tax-free and. HSA owners can make tax-free withdrawals for qualified medical expenses.

9. Municipal bonds

Old fashioned municipal bonds continue to be an attractive investment choice of high net worth individuals. The interest income from municipal bonds is still tax exempt on a federal level. When the bondholders reside in the same state as the bond issuer, they can be exempted from state income taxes as well.

Final words

If you have any questions about your existing investment portfolio, reach out to me at stoyan@babylonwealth.com or +925-448-9880.

You can also visit our Insights page where you can find helpful articles and resources on how to make better financial and investment decisions.

About the author:

Stoyan Panayotov, CFA is the founder and CEO of Babylon Wealth Management, a fee-only investment advisory firm based in Walnut Creek, CA. Babylon Wealth Management offers personalized wealth management and financial planning services to individuals and families.  To learn more visit our Private Client Services page here.

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Disclaimer: Past performance does not guarantee future performance. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. The content of this article is the sole opinion of the author and Babylon Wealth Management. The opinion and information provided are only valid at the time of publishing this article. Investing in these asset classes may not be appropriate for your investment portfolio. If you decide to invest in any of the instruments discussed in the posting, you have to consider your risk tolerance, investment objectives, asset allocation, and overall financial situation. Different investors have different financial circumstances, and not all recommendations apply to everybody. Seek advice from your investment advisor before proceeding with any investment decisions. Various sources may provide different figures due to variations in methodology and timing,

14 Effective ways to take control of your taxes

In this blog post, I will go over several popular and some not so obvious tax deductions and strategies that can help you decrease your annual tax burden. Let’s be honest.  Nobody wants to pay taxes. However, taxes are necessary to pay for pensions, social services, Medicaid, roads, police, law enforcement and so on. Most people will earn a higher income and grow their investments portfolios as their approach retirement. Thus they will gradually move to higher tax brackets and face a higher tax bill at the end of the year. IRS provides many tax deductions and breaks that can help you manage your tax burden. Taking advantage of these tax rules can help you reduce your current or future your tax bill.

These are general rules. I realize that we all face different circumstances. Use them as a broad guideline. Your particular situation may require a second opinion by an accountant, a tax lawyer or an investment advisor.

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1. Primary residence mortgage deductions

Buying a first home is a big decision. Your new neighborhood, school district, nearby services are all critical factors you need to consider before making your choice. If you own a primary residence (sorry, a vacation home in Hawaii doesn’t count), you can deduct the interest on your mortgage loan from your taxable income for the year. Your property taxes are also deductible. These incentives are provided by the Federal and state governments to encourage more families to buy their home.

There are two additional benefits of having a mortgage and being a responsible borrower. First, your credit score will increase. Making regular payments on your mortgage (or any loan) improves your credit history, increases your FICO score and boosts your creditworthiness. Your ability to take future loans at a lower rate will significantly improve. Second, your personal equity (wealth) will increase as you pay off your mortgage loan. Your personal equity is a measure of assets minus your liabilities.  Higher equity will boost your credit score. It is also a significant factor in your retirement planning.

Buying a home and applying for a mortgage is a long and tedious process. It requires a lot of legwork and documentation. After the financial crisis in 2008 banks became a lot stricter in their requirements for providing mortgage loans to first buyers. Nevertheless, mortgage interest on a primary residence is one of the biggest tax breaks available to taxpayers.

 

2. Home office deductions

Owning a home versus renting is a dilemma for many young professionals. While paying rent offers flexibility and lower monthly cash payments it doesn’t allow you to deduct your rent from your taxes. Rent is usually the highest expense in your monthly budget. It makes up between 25% and 35% of your total income. The only time you can apply your rent as a tax deduction is if you have a home office.

A home office is a dedicated space in your apartment or house to use for the sole purpose of conduction your private business. It’s usually a separate room, basement or attic designated for your business purposes.

The portion of your office to the total size of your home can be deductible for business purposes. If your office takes 20% of your home, you can deduct 20% of the rent and utility bills for business expense purposes.

 

3. Charitable donations

Monetary and non-monetary contributions to religious, educational or charitable organization approved by IRS are tax deductible. The annual limit is 50% of your AGI (aggregate gross income) for most donations and 30% of AGI for appreciated assets.

Most often people choose to give money. However, you can also donate household items, clothes, cars, and airline miles. The fair value of the donated items decreases your taxable income and therefore will reduce the amount of taxes due to IRS.

Another alternative is giving appreciated assets including stocks and real estate. This is one of the best ways to avoid paying significant capital gain tax on low-cost investments. For one, you are supporting a noble cause. Second, you are not paying taxes for the difference between the market value and purchase cost of your stock. Also, the fair market value of the stock at the time of donation will reduce your taxable income, subject to 30% of AGI rule. If you were to sell your appreciated assets and donate the proceeds to your charity of choice, you would have to pay a capital gain tax on the difference between market value and acquisition cost at the time of sale. However, if you donate the investments directly to the charity, you avoid paying the tax and use the market value of the investment to reduce your taxable income.

 

4. Gifts

Making a gift is not a standard tax deduction. However, making gifts can be a way to manage your future tax payments and pass on the tax bill to family members who pay a lower tax rate. You can give up to $14,000 to any number of people every year without any tax implications. Amounts over $14,000 are subject to the combined gift and estate tax exemption of $5.49 million for 2017.  You can give your child or any person within the annual limits without creating create any tax implications.

Another great opportunity is giving appreciated assets as a gift. If you want to give your children or grandchildren a gift, it is always wise to consider between giving them cash or an appreciated asset directly.  Giving appreciated assets to family members who pay a lower tax rate doesn’t create an immediate tax event. It transfers the tax burden from the higher rate tax giver to the lower tax rate receiver.

 

5. 529 Plans

One of the best examples of how gifts can minimize future tax payments is the 529 college tuition plan. Parents and grandparents can contribute up to $14,000 annually per person, $28,000 per married couple into their child college education fund. The plan even allows a one–time lump sum payment of $70,000 (5 years x $14,000).

529 contributions are not tax deductible on a federal level. However, many states like New York, Massachusetts, Illinois, etc. allow for state tax deductions up to a certain amount. The plan allows your contributions (gifts) to grow tax-free. Withdrawals are also tax-free when using the money to pay qualified college expenses.

 

6. Tax-deferred contributions to 401k, 403b, and IRA

One of my favorite tax deductions is the tax-deferred contribution to 401k and 403b plans. In 2017 the allowed maximum contribution per person is $18,000 plus an additional $6,000 catch-up for investors at age 50 and older. In addition to that, your employer can contribute up to $36,000 for a total annual contribution of $54,000 or $60,000 if you are older than 50.

Most companies offer a matching contribution of 5%-6% of your salary and dollar limit of $4,000 – $5,000. At a very minimum, you should contribute enough to take advantage of your company matching plan. However, I strongly recommend you to set aside the entire allowed annual contribution.

The contributions to your retirement plan are tax deductible. They decrease your taxable income if you use itemized deductions on your tax filing form. Not only that, the investments in your 401k portfolio grow tax-free. You will owe taxes upon withdrawal at your current tax rate at that time.

If you invest $18,000 for 30 years, a total of $540,000 contributions, your portfolio can potentially rise to $1.5m in 30 years at 6% growth rate. You will benefit from the accumulative return on your assets year after year.  Your investments will grow depending on your risk tolerance and asset allocation. You will be able to withdraw your money at once or periodically when you retire.

 

7. Commuter benefits

You are allowed to use tax-free dollars to pay for transit commuting and parking costs through your employer-sponsored program.  For 2017, you can save up to $255 per month per person for transit expenses and up to $255 per month for qualified parking. Qualified parking is defined as parking at or near an employer’s worksite, or at a facility from which employee commutes via transit, vanpool or carpool. You can receive both the transit and parking benefits.

If you regularly commute to work by a bike you are eligible for $20 of tax-free reimbursement per month.

By maximizing the monthly limit for both transportation and parking expenses, your annual cost will be $6,120 ($255*2*12). If you are in the 28% tax bracket, by using the commuter benefits program, you will save $1,714 per year. Your total out of pocket expenses will be $ 4,406 annually and $367 per month.

 

8. Employer-sponsored health insurance premiums

The medical insurance plan sponsored by your employer offers discounted premiums for one or several health plans.  If you are self-employed and not eligible for an employer-sponsored health plan through your spouse or domestic partner, you may be able to deduct your health insurance premiums.  With the rising costs of health care having a health insurance is almost mandatory.  Employer-sponsored health insurance premiums can average between $2,000 for a single person and 5,000 for a family per year. At a 28% tax rate, this is equal to savings between $560 and $1,400. Apart from the tax savings, having a health insurance allows you to have medical services at discounted prices, previously negotiated by your health insurance company. In the case of emergency, the benefits can significantly outweigh the cost of your insurance premium.

 

9. Flexible Spending Account

Flexible Spending Account (FSA) is a special tax-advantaged account where you put money aside to pay for certain out-of-pocket health care costs. You don’t pay taxes on these contributions. This means you will save an amount equal to the taxes you would have paid on the money you set aside. The annual limit per person is $2,600. For a married couple, the amount can double to $5,200. The money in this account can be used for copayments, new glasses, prescription medications and other medical and dental expenses not covered by your insurance.  FSA accounts are arranged and managed by your employer and subtracted from your paycheck.

Let’s assume that you are contributing the full amount of $2,600 per year and your tax rate is 28%. You effectively save $728 from taxes, $2,550 * 28%. Your actual out-of-pocket expense is $1,872.

One drawback of the FSA is that you must use the entire amount in the same tax year. Otherwise, you can lose your savings. Some employers may allow up to 2.5 months of grace period or $500 of rollover in the next year. With that in mind, if you plan for significant medical expenses, medication purchases or surgery, the FSA is a great way to make some savings.

 

10. Health Spending Account

A health savings account (HSA) is a tax-exempt medical savings account available to taxpayers who are enrolled in a high-deductible health plan (HDHP) The funds contributed to this account are not subject to federal income tax at the time of deposit. Unlike a flexible spending account (FSA), HSA funds roll over and accumulate year over year if not spent. HSA owners can use the funds to pay for qualified medical expenses at any time without tax liability or penalty. The annual contribution limits are $3,350 per person, $6,750 per family and an additional $1,000 if 55 or older. The owner of HSA can invest the funds similarly to IRA account and withdraw without penalty when used for medical expenses.

 

11. Disability  insurance

Disability premiums are generally not deductible from your tax return. They are paid with after-tax dollars. Therefore, any proceeds received as a result of disability are tax-free. The only time your benefits are taxable is when your employer pays your disability insurance and does not include it in your gross income.


12. Life insurance

Life insurance premiums are typically not deductible from your tax return if you are using after-tax dollars. Therefore, any proceeds received by your beneficiaries are tax-free.

Life insurance benefits can be tax deductible under an employer-provided group term life insurance plan. In that case, the company pays fully or partially life insurance premiums for its employees.  In that scenario, amounts more than $50,000 paid by your employer will trigger a taxable income for the “economic value” of the coverage provided to you.

If you are the owner of your insurance policy, you should make sure your life insurance policy won’t have an impact on your estate’s tax liability. In order to avoid having your life insurance policy affecting your taxes, you can either transfer the policy to someone else or put it into a trust.

13. Student Loan interest

If you have student loans and you can deduct up to $2,500 of loan interest.  To use this deduction, you must earn up to $80,000 for a single person or $165,000 for a couple filing jointly. This rule includes you,  your spouse or a dependent. You must use the loan money for qualified education expenses such as tuition and fees, room and board, books, supplies, and equipment and other necessary expenses (such as transportation)

14. Accounting and Investment advice expenses

You may deduct your investment advisory fees associated with your taxable account on your tax return.  You can list them on Schedule A under the section “Job Expenses and Certain Miscellaneous Deductions.” Other expenditures in this category are unreimbursed employee expenses, tax preparation fees, safe deposit boxes and other qualifying expenses like professional dues, required uniforms, subscriptions to professional journals, safety equipment, tools, and supplies. They may also include the business use of part of your home and certain educational expenses. Investment advisory fees are a part of the miscellaneous deduction.  The entire category is tax deductible if they exceed 2% of your adjusted gross income for the amount in excess.

 

About the Author: Stoyan Panayotov, CFA is a fee-only financial advisor based in Walnut Creek, CA. His firm Babylon Wealth Management offers fiduciary investment management and financial planning services to individuals and families.

Disclaimer: Past performance does not guarantee future performance. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. The content of this article is a sole opinion of the author and Babylon Wealth Management. The opinion and information provided are only valid at the time of publishing this article. Investing in these asset classes may not be appropriate for your investment portfolio. If you decide to invest in any of the instruments discussed in the posting, you have to consider your risk tolerance, investment objectives, asset allocation and overall financial situation. Different investors have different financial circumstances, and not all recommendations apply to everybody. Seek advice from your investment advisor before proceeding with any investment decisions. Various sources may provide different figures due to variations in methodology and timing,  Image Copyright: www.123rf.com

5 Ways to increase the impact of charitable donations

Traditional Charitable Strategies

Charitable contributions are an excellent way to help your favorite cause, your church, a foundation, a school or any other registered charitable institution of your choice. Americans made $373.25 billion of charitable donations in 2015, which was 4.1% higher than 2014. The average annual household contribution was $2,974. In 2015, the majority of charitable dollars went to religious institutions (32%), educational organizations (15%), human services (12%), grantmaking foundations (11%), and health organizations (8%).

Charitable donations are also a powerful tool to reduce your overall tax liability to IRS. By carefully following the tax law and IRS rules you can substantially increase the impact of donations. Here is what you can do.

1. Meet the requirements

In order to receive tax deductions for your gift, donations need to meet certain requirements. Some of the most important rules are:

  • You have to give to qualified charitable organizations approved by IRS. The charity can be public or private. Usually, the public charities receive more favorable tax treatment.
  • You need to have a receipt for your gift.
  • You need to itemize your tax return.
  • Donations apply for the same tax year when you make them. For most individuals the tax year and calendar year are the same. For some companies, their tax year may end on a different date during the calendar year (for example, November 1 to October 31)
  • All gifts are valued at fair market value. Depending on your donation, the fair market value may not be equal to the initial cash value.
  • You have to transfer the actual economic benefit or ownership to the receiver of your gift.

 

There are many ways to give. Some are straightforward, others are more complex and require professional help. Each one of them has its rules, which you need to understand and follow strictly to receive the highest tax benefit.

2. Give Cash

Giving money is by far the easiest way to make contributions to your favorite charitable cause. IRS allows for charitable donations for as much as 50% of your aggregated gross income. Any amounts more than 50% can be carried over in future years. However, it’s imperative that you keep a record of your cash donations.

 

3. Give Household goods

You can donate clothes, appliances, furniture, cars and other household items in good condition. The items will be priced at fair value, In most cases, the value will be lower than what you paid for them. This category is also subject to the 50% limit of the AGI.

Donating household items is a perfect way to clean your closet from old clothes and shoes that you haven’t worn for years. You can even donate your old car that has been collecting dust in the garage. Moreover, if you plan to do a kitchen remodel, you can give your old cabinets and appliances to charities like the Salvation Army. Remember to keep the receipts of these items in case IRS asks you for them.

 

4. Donate Appreciated assets

One of the most popular tax-saving strategies is donating appreciated assets directly to charitable organizations. This approach is subject to 30% of AGI for donations given to qualified public charities. Appreciated assets can include publicly traded stocks, restricted stocks, real estate, privately help companies, collectibles, and artwork. The main caveat to receive the highest tax benefit is to give the appreciated asset directly to the charitable donations instead of selling it and gifting the remaining cash amount.  This way you will avoid paying a capital gain tax on the sale of your asset and deduct the full fair value of your asset.

 Let’s look at an example. An investor at 28% tax bracket is considering donating an appreciating stock to her favorite charity. She can sell the stock and give the proceeds or donate the shares directly. The current market value of the stock is $100,000. She purchased it more than one year ago for $20,000. The total capital gain is $80,000.

 Planning charitable donations

 

By giving the stock directly to her favorite, the investor is achieving three major goals. First, she is not paying a capital gain tax on the proceeds of the sale. Second, she can use the full fair value of the stock (instead of the proceeds from the sale) to reduce her tax liabilities. Third, the charitable organization receives an asset with a higher value, which they can sell tax-free.

 

5. Make direct IRA charitable rollover

Donations made directly from your IRA, and 401k accounts are another way of reducing your tax bill. If you reached 70 ½, you could make up to $100,000 a year in gifts to a charity directly from your IRA or 401k accounts. Those contributions count towards the required annual minimum distributions you must take once you reach 70 ½, They also reduce your adjusted gross income. To be compliant, you have to follow two simple rules.

Your plan administrator has to issue a check payable to your charity of choice. Therefore the funds have to transfer directly to the charitable organization. If the check is payable to you, this will automatically trigger a tax event for IRS. In that case, your IRA distribution will be taxable as ordinary income, and you will owe taxes on them. The second rule, you have to complete the transfer by December 31 of the same calendar year.

 

About the author: Stoyan Panayotov, CFA is a fee-only financial advisor based in Walnut Creek, CA. His firm Babylon Wealth Management offers fiduciary investment management and financial planning services to individuals and families.

Disclaimer: Past performance does not guarantee future performance. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. The content of this article is a sole opinion of the author and Babylon Wealth Management. The opinion and information provided are only valid at the time of publishing this article. Investing in these asset classes may not be appropriate for your investment portfolio. If you decide to invest in any of the instruments discussed in the posting, you have to consider your risk tolerance, investment objectives, asset allocation and overall financial situation. Different investors have different financial circumstances, and not all recommendations apply to everybody. Seek advice from your investment advisor before proceeding with any investment decisions. Various sources may provide different figures due to variations in methodology and timing. Image Copyright: <a href=’http://www.123rf.com/profile_dizanna’>dizanna / 123RF Stock Photo</a>