Tax Reduction/Minimization Techniques

Question 1

Income Shifting

Answer 1

• a tax planning technique that is based upon shifting taxation to the family member in the lowest tax bracket, so as to reduce the overall taxation to the family unit as a whole.
• governed by the assignment of interest doctrine
• a full transfer of the property must be made
• A client who owns a family business can hire family members pay them salary for their services and then take a tax deduction on those earnings and taxation shifts to the family members in the lower tax brackets. prevents kiddie tax since it is earned income.
• kiddie tax limits the impact of this strategy with income producing assets

Question 2

Intra-Family Transfer of Closely Held Business

Answer 2

-additional income tax savings may be achieved by making gifts of business real estate and/or fully-depreciated business assets to children over the age of 19 and subsequently leasing it from the child. Gives the business a deduction on the lease payments and shifts income taxation to the child in a lower bracket.

Question 3

Deferral of Income

Answer 3

• Tax advantaged retirement savings
• Deferred sales of appreciated assets
• Deferred billing. Cash-basis clients with business income may defer billing of clients until after the end of the year
• delayed bonus payment. employee year-end bonuses may be paid in the following January to cash-basis payments
• stock options. incentive stock options defer income, as well as reduce taxes to capital gain rates.
• deferred compensation
• installment sales
• exchange of like kind assets
• annuities and annuity products

Question 4

Deduction Clustering

Answer 4

• can be useful to reduce taxation in 3 ways:
  1) take the standard deduction on one year and “cluster” itemized deductions together the following year.
  2) unmarried clients have disproportionate incomes and the lower-earning client takes the standard deduction while the itemized deductions are shifted to the higher-earnings taxpayer
  3) businesses and rental expenditures can be delayed and clustered into a tax year where income is higher

Question 5

Examples of Deduction Clustering

Answer 5

• early payment of state income or property taxes. can be made before the year end to increase the deduction.
• early payment of mortgage interest. The first mortgage payment of the next year can be paid in the current year, accelerating the mortgage interest deduction.
• charitable contributions. Make them at the end of the year
• education payments can be accelerated into the current year
• repairs and maintenance on rental properties can be delayed and combined to be completed before the end of the tax year where higher income is anticipated.
• Year end purchase of assets
• review of asset acquisitions
• year end purchases
• purchases of supplies

Question 6

Investment Strategies to Manage Tax Liability

Answer 6

• tax loss harvesting
• holding securities until they become long-term instead of short-term gains
• utilizing index funds
• utilizing dividends that have a more preferential tax treatment compared to corporate bonds
• use muni bonds
• tax swap bond strategies
• using a collar
• owners of worthless securities have 7 years to file retrospective claims for tax refunds
• suspended passive activity losses can be used to generate tax-free income if the client purchases another passive investment to generate income that the suspended losses can be used to offset.