Why tax planning is so important

What tax planning really means

Tax planning is the art of arranging your affairs in ways that postpone or avoid taxes. By employing effective tax planning strategies, you can have more money to save and invest or more money to spend. Or both. Your choice.

Put another way, tax planning means deferring and flat out avoiding taxes by taking advantage of beneficial tax-law provisions, increasing and accelerating tax deductions and tax credits, and generally making maximum use of all applicable breaks available under our beloved Internal Revenue Code.


While the federal income tax rules are now more complicated than ever, the benefits of good tax planning are arguably more valuable than ever before.

Of course, you should not change your financial behavior solely to avoid taxes. Truly effective tax planning strategies are those that permit you to do what you want while reducing tax bills along the way.

How are tax planning and financial planning connected?

Financial planning is the art of implementing strategies that help you reach your financial goals, be they short-term or long-term. That sounds pretty simple. However, if the actual execution was simple, there would be a lot more rich folks.

Tax planning and financial planning are closely linked, because taxes are such a large expense item as you go through life. If you become really successful, taxes will probably be your single biggest expense over the long haul. So planning to reduce taxes is a critically important piece of the overall financial planning process.


Over the years as a tax pro, I have been amazed at how many people fail to get the message about tax planning until they commit a grievous blunder that costs them a bundle in otherwise avoidable taxes. Then they finally get it. The trick is to make sure you don’t have to learn this lesson the hard way. To illustrate the point, consider the following example.

Example: Josephine is a 45-year-old unmarried professional person. She considers herself to be financially astute. However, she is not well-versed on taxes. One day, Josephine meets Joe, and they quickly decide to get married. Caught up in the excitement of a whole new life, Josephine impulsively sells her home shortly before the marriage. The property is in a great area and has appreciated by $500,000 since she bought it 15 years ago. She intends to move into Joe’s home, which is a dump, but Josephine is a proven genius at remodeling, and she plans to work her usual magic on Joe’s property.

Result without tax planning: For federal income tax purposes, Josephine has a whopping $250,000 gain on the sale of her home ($500,000 profit minus the $250,000 home sale gain exclusion allowed to unmarried sellers).

Result with tax planning: If Josephine had instead kept her home and lived there with Joe for two years before selling, she could have taken advantage of the larger $500,000 home sale gain exclusion available to married joint-filers and thereby permanently avoided $250,000 of taxable gain. If necessary, Joe’s home could have been sold instead of Josephine’s. Alternatively, Joe’s property could have been retained, and the couple could have worked on remodeling it while still living in Josephine’s home for the requisite two years.

Moral of the story? By selling her home without considering the tax-smart alternative, Josephine cost herself $62,500 in taxes (completely avoidable $250,000 gain taxed at an assumed combined federal and state rate of 25%). This is a permanent difference, not just a timing difference. The point is, you cannot ignore taxes. If you do, bad things can happen, even with a seemingly intelligent transaction.

The last word

There are many other ways to commit expensive tax blunders. Like selling appreciated securities too soon when hanging on for just a little longer would have resulted in lower-taxed long-term capital gains instead of higher-taxed short-term gains; taking retirement account withdrawals before age 59½ and getting hit with the 10% premature withdrawal penalty tax; or failing to arrange for payments to an ex-spouse to qualify as deductible alimony; the list goes on and on.

The cure is to plan transactions with taxes in mind and avoid making impulsive moves. Seeking professional tax advice before pulling the trigger on significant transactions is usually money well spent. As we get closer to the end of the year, some of my columns will focus on tax planning strategies that many folks can benefit from. Please stay tuned.

5 Tax Planning Tips for Your Small Business

We’re more than half way through 2014: Where does your business stand in terms of taxes?
Last week, a client of mine had an ugly surprise when I finished his tax return and disclosed he owed a lot of money to the IRS. His first reaction was to be mad at the messenger. However, upon careful reflection, he stated, “Well, I should have come to see you last year when my new product took off the way it did. I knew I was making a lot more money.”




He’s right. Whenever there is a substantial change to your business’s bottom line (in either red or black), it’s time for a visit to your tax pro. In fact, anyone who owns a small business should take advantage of the mid-year off season to sit down with a tax pro to discuss their financial statements and potential tax liabilities.


It’s infinitely easier to strategize and put a plan in place now than to run around at year end upending pails of water on all the little fires that have been brewing all year.


Here are some tips to discuss with your tax pro to improve your tax situation and hopefully keep working capital in your bank account rather than in Uncle Sam’s pocket:
Start a retirement plan. If you’re finally a few bucks ahead and don’t have a retirement fund, now’s the time to start one. Here’s the bonus: it’s deductible!


Consult with a bona fide financial advisor or a representative from your bank to determine whatkind of plan best suits your needs. There are a wide range of vehicles from Individual 401(k) plans to SEP IRAs to SIMPLE plans that may or may not require you to include employees in the plan.
If a plan requires employee participation, do not automatically dismiss it. Opening a retirement plan for your employees could be a meaningful way to give raises that don’t require the additional cost of employer paid payroll taxes. Read IRS Publication 560 for more information.


Analyze your legal structure. Take the time to evaluate whether your business is operating optimally in its existing entity structure. You may have started out as a sole proprietorship and have outgrown it. It is especially important to analyze entity structure if your business is now netting more than $100,000 per year.


Keep in mind that if you incorporate, you will now be required to take money out of the business via payroll rather than simple draws. There is a lot more paperwork involved under this status, but the tax benefits and protection that a corporation offers may prove more beneficial. Always discuss these options with your attorney and tax pro before making a decision.


Provide employee benefits. Employees are our most valuable business asset and should be treated accordingly. There are many employee benefits that are not taxable to either the employee or the business. Check out IRS Publication 15-B, Guide to Fringe Benefits for more information on this topic. You will save money in payroll taxes while you create a happier working environment for your people.


Purchase furniture and equipment. The IRS has always rewarded outlays for capital assets by providing the Section 179 Deduction. This special deduction allows the immediate expensing of capital assets rather than depreciating them over their useful lives. Be warned however. This year, the threshold for purchases decreased from $500,000 to $25,000. However, Congress will be looking at extending that ceiling probably sometime during fourth quarter. You can begin putting money aside for the purchases now.


Perform projections. Take a good look at your financial statements. Run a profit and loss and compare it to the prior year profit and loss through June 30. Are there significant changes? Are you anticipating an increase or decrease in sales and/or expenses through the end of the year? It’s a simple matter to export your data from QuickBooks into Excel where you can play with the numbers to determine what your yearend bottom line will be. Share that information with your tax pro to find out if you must adjust your estimated tax payments accordingly.

Retirees, Get a Jump-Start on Your 2014 Tax Bill

The beach chair is beckoning, but isn’t it also tempting to save a wad of cash? Hold off on the sand and surf for just a bit, and take some time for your midyear tax review. By getting a head start on your 2014 planning, you’re likely to find many strategies to shave your payments to Uncle Sam.


To get started, take out your 2013 return. “Note what is changing for 2014 regarding your income and deductions,” says Martin James, a certified public accountant in Mooresville, Ind. “You need to look at every line item.”

It’s also crucial, according to James and other tax experts, for taxpayers to take a multi-year approach to their annual tax review. James says a move that could trim taxes one year could “create a tax nightmare in the future.” For instance, he says, a taxpayer who reduces her tax tab each year by pulling money from a taxable account—rather than withdrawing from an IRA and paying taxes—could find herself in a higher tax bracket later when it’s time to take required minimum distributions from a large IRA.



The bottom line of your 1040 from 2013 could be sending a loud message if it shows you got a big refund this year or sent Uncle Sam a big check. In either case, you should change the amount of tax withheld from your paycheck or paid quarterly. You also should re-evaluate your withholding if you believe your income will change much from last year, says Rebecca Pavese, a certified public accountant with Palisades Hudson Financial Group, in Atlanta. By making the move now, “you won’t have a large bill due or give the government your money all year long,” she says.

While taxpayers like tax refunds, you’re better off getting bigger paychecks for the rest of this year. “Let that money work for you,” Pavese says, perhaps by investing it or paying off credit-card debt. Withhold too little, though, and you could end up owing a penalty.

If you’re employed, file a revised W-4 with your employer. The more allowances you claim, the less tax will be withheld. If your income will be similar to last year’s, you can figure the appropriate number of allowances to claim with Kiplinger’s Easy to Use Tax Withholding Calculator.

Top off your retirement accounts. You can reduce your adjusted gross income and taxable income by maximizing pretax contributions to tax-deferred retirement accounts. Taxpayers who will be 50 or older by year-end can contribute up to $6,500 to a traditional IRA. If your spouse isn’t working, you can contribute up to the same amount to a spousal IRA as long as you have enough earned income to cover the contribution. If you are covered by a 401(k) at work, you can contribute to a traditional IRA but, depending on your income, you may not be able to deduct the IRA contributions.

Pavese suggests that taxpayers not wait until the last days of the year to make contributions. “The longer your money grows tax deferred, the better,” she says.

If you’re newly retired yet still bringing in income as a consultant or from a small business, be sure to set up one of several types of retirement accounts designed for the self-employed. Jeffrey Cutter, a certified public accountant in East Falmouth, Mass., says one of his clients who retired with a federal pension did not need the income from a new consulting job that paid $85,000 a year. He opened an individual 401(k), which allows him to sock away and deduct up to $52,000 of that income in 2014.

Reduce taxes on investments. Your investments can open a treasure trove of tax-trimming opportunities. Finding tax-trimming gems in your portfolio became especially important when higher tax rates—as well as a new 3.8% surtax on “net investment income”—took effect in the 2013 tax year. As you probably realized during the last tax year, each rate kicks in at a different income threshold.

If you can, try to keep your income below certain tax triggers or from crossing into higher brackets. If you’re planning a Roth conversion, for example, be sure to consider the 3.8% surtax, which kicks in for singles with modified adjusted gross income above $200,000 and for joint filers with AGI above $250,000.

Also keep in mind, James says, that you will pay higher Medicare Part B and Part D premiums if your modified AGI exceeds $85,000 for singles and $170,000 for married couples. And you could be eligible for a tax credit to help pay for health insurance purchased on the new health exchanges if your modified AGI is less than $46,680 for a single and $62,690 for a couple. Those on the cusp of those thresholds should stagger Roth conversions over several years—rather than taking all of the income in a single year. You need to “look at the stealth taxes that happen when AGI goes up,” James says.

Taxpayers who are selling a business, real estate or rental property might consider an installment sale, James says. By deferring the sales proceeds over more than a year, you can defer annual gains subject to the surtax and reduce your AGI, he says. (Net investment income includes interest, dividends, capital gains, annuity payments, rents and royalties.)

Also start your tax loss “harvesting” now, looking “for the dogs in your portfolio” to sell, Cutter says. Once you bank your losses, “see if it makes sense to sell any of your appreciated stock,” he says. You can take the profits for living expenses and use the capital losses to offset the gains dollar-for-dollar.

Taxpayers in the 10% and 15% tax brackets—up to $36,900 for singles and $73,800 for joint filers—are once again eligible for the 0% tax rate on long-term capital gains. Consider this maneuver: If you have appreciated stock you like, you can sell it and pay no capital-gains tax if you stay within the 15% bracket. Then buy back the shares. In the future, when you sell, you’ll only pay tax on the appreciation on the current higher value.

Whether you’re in the crosshairs of the surtax or not, you can trim your tax tab, in both the long and short terms, by keeping an eye on the location of your assets (read Boost Your After-Tax Investment Returns). As a rule of thumb, assets that generate a lot of ordinary income, such as real estate investment trusts and high-yield bond funds, should be placed in tax-deferred accounts where earnings can compound without annual interruptions by the IRS. Taxable brokerage accounts should hold tax-exempt municipal bonds and stock index funds, which generate tax-favored long-term capital gains and then primarily only when you sell. Actively managed funds, which tend to generate ordinary income and short- and long-term gains even if you don’t sell shares, should be in your tax-deferred account.

Save cash on your charitable intent. Congress has yet to extend the popular tax break that allows individuals 70½ and older to transfer up to $100,000 tax-free from an IRA directly to charity. The donation can count toward a required minimum distribution. You can’t deduct the contribution, but this maneuver lowers your AGI compared with taking a taxable distribution and donating it to the charity.

It’s likely that lawmakers will revive this provision but not until after the November elections. For seniors who want to make an IRA charitable transfer, it makes sense to wait on your RMDs and charitable gifts until later in the year. You cannot use this strategy to contribute to a donor-advised fund.

A midyear tax review is a good time to scour your taxable portfolio for appreciated stock that could be used for a charitable donation. “An appreciated security is a very tax-efficient gift,” Pavese says. “If you sell the stock and give the cash to the charity, you’ll have to pay tax on the gain. And you’ll have less money to give to the charity.” If you donate the stock itself, though, you’ll get an income-tax deduction for the market value of the securities, assuming you’ve owned them for more than one year. You can place the shares in a donor-advised fund if you want. That way, you get the deduction this year, but you can decide at a later date which charities will get your money.

Ask your favorite charities if they will take artwork, antiques or real estate. Gifts of tangible personal property worth more than $5,000 must be independently appraised, so line up an appraiser before the year-end dash.

Keep track of what you spend on charitable work. For example, you can deduct the costs of fund-raising activities. If you drive your car for charitable work, you can deduct 14 cents per mile

Retirement Plans for Small Businesses: The Keogh Plan Is Not Extinct

In the not-so-distant past, the Keogh plan was the hottest retirement planning commodity around. But like fax machines and VHS recorders, Keoghs are now regarded by many as relics. Nevertheless, this type of plan still might fit the bill for certain sole practitioners.

Here’s a quick recap. The Keogh plan, named for the Brooklyn, NY Congressman who sponsored the legislation, was intended to provide a viable option for unincorporated small business owners who were otherwise restricted or closed out of qualified retirement plans. (The plan was also called an HR-10 plan after the number assigned to an early version of the bill.) After Congress adopted the Keogh, it quickly became popular among professionals, like physicians and dentists, who were self-employed and employed a small staff.    

There are two main types of Keogh plans: the defined contribution Keogh and the defined benefit Keogh. As you might imagine, these mirror the basic rules for defined contribution and defined benefit plans, including annual limits on contributions, with a few tweaks here and there.

Defined contribution Keogh: The maximum deductible contribution for 2014 is equal to the lesser of $52,000 or 15% of earned income. One variation is a money purchase plan where contributions are based on a percentage of annual income. With this type of plan, you can contribute and deduct the lesser of $52,000 or 25% of earned income.
Defined benefit Keogh: Like other defined benefit plans, the limit for this type of Keogh is based on actuarial computations. The plan may provide an annual retirement benefit equal to the lesser of 100% of earned income for the three highest-paid years or a specific dollar amount adjusted for inflation. The dollar limit for 2014 is $210,000.
But be aware of this tax twist. To compute “earned income” for a plan, your earnings from self-employment are reduced by your contributions and one-half of the self- ­employment tax you pay. Furthermore, note that the maximum amount of compensation allowed for this calculation is limited in 2014 to $260,000.

Most other rules for qualified retirement plans also apply to Keogh plans. For instance, pre-age 59 ½ withdrawals are subject to regular income tax, plus a 10% tax penalty, unless you qualify under a special tax law exception. Required minimum distributions (RMDs) must begin in the year after the year in which you attain age 70 ½.

If you have other employees, you’re required to cover them under the Keogh plan in the same proportion as you do for yourself. Because contributions are based on a percentage,  the actual dollars allocated to yourself can far exceed the amounts contributed for other staff members. For some small business owners, this may give the Keogh an edge over certain other plans like a SIMPLE or a SEP.

Caution: When a plan is “top-heavy,” certain minimum contributions must be made for employees. A plan is top-heavy if more than 60% of contributions or benefits go to key employees of the firm.

Finally, the deadline for contributions to a Keogh plan for the 2014 tax year is your tax return due date, plus extensions, as long as the plan is set up before January 1, 2015. This provides a late-year planning opportunity for procrastinators.

The Keogh plan certainly isn’t as prevalent as it once was due to subsequent tax law modifications and the emergence of solo 401(k) plans. But it’s hardly a dinosaur either. Keogh plans still abound and can provide a fast way for unincorporated business owners to build up a nest egg.

Your Retirement: Navigating the Social Security ‘Tax Trap’

If you haven’t discovered it already, up to 85 percent of your Social Security benefits could be taxed.

As financial advisors, we are often surprised by the number of prospective retirees who come to us for planning and are shocked that they have to pay taxes on their Social Security when they retire.

In fact, in 2012, Social Security beneficiaries paid a total of $45.9 billion in income taxes on their benefits. That’s right!

Sadly, for many people this taxation could be avoided or at the very least, significantly reduced.  You have to plan ahead for it – and that means understanding how taxes work in retirement.

So here’s how it works: First, to determine the taxability of your Social Security, you must take into consideration your combined income, also known as provisional income, which is arrived at by taking 50 percent of your Social Security benefits and adding that figure to all the other taxable and tax-free interest income you receive in retirement. Yes, even municipal bonds are considered in this equation.

If you file as an individual and your combined income is below $25,000, your benefits won’t be taxed at all. If your income is between $25,000 and $34,000, up to 50 percent of your benefits may be subject to tax. For income of more than $34,000, up to 85 percent of your benefits may be considered taxable income.

If you and your spouse file a joint return with combined income below $32,000, your benefits are safe. For income between $32,000 and $44,000, up to 50 percent of benefits may be subject to taxation, and up to 85 percent if combined income exceeds $44,000.

It is possible to have income in excess of these thresholds while keeping your benefits out of the hands of Uncle Sam. Let’s look at a case to see how this plays out.

Case Study:

A married couple, Jerry and Linda, are both 62 and have recently decided to retire. They’re income need is $62,000 per year. As it stands currently, they have $38,000 of income. So they will have to make up the shortfall of $24,000 ($62,000 - $38,000 = $24,000) from their investment assets.

Jerry and Linda have done a good job accumulating assets to make up for the shortfall between their fixed income resources and their desired income need. However, we want to distribute the assets in the most tax-efficient manner. After all, a dollar paid out in taxes is a dollar that never returns!

Current Income:

Interest and Dividends Income..$2,000

Social Security Income.........$18,000

Pension Income.................$18,000

Total Income...................$38,000

Current Assets:

Bank Accounts....$150,000

Mutual Funds.....$300,000

IRA..............$250,000

401K.............$300,000

Total Assets.....$1,000,000

Jerry and Linda obviously could draw $24,000 from any one of the accounts listed above. However, what option would allow them to access it without causing their Social Security benefits to become taxable?  Through our analysis, we found that they could distribute $15,000 from the mutual funds of which only $2,942 is taxable as a gain. The remaining $12,058 would be consider principal and is not taxable.

They could also distribute $9,000 from their bank accounts, which again would be non-taxable. Any interest accrued on the bank accounts is taxed as interest and dividends and is already accounted for in the combined income above.

So as you can see, we devised an income plan that allows them to attain their $62,000 income goal.  But does it muster up to our “tax free” goal? Let’s work through the calculation:

Interest and Dividends Income..........$2,000

50 percent of Social Security Income...$9,000

Pension Income.........................$18,000

Mutual Funds capital gain..............$2,942

Bank Accounts..........................$0    

Combined Income Total..................$31,942

It sure does with $58 to spare! You see, with proper planning Jerry and Linda were able to produce an income of $62,000 without causing one cent of their Social Security to become taxable. Had they made a different choice they could have had a combined income of $53,000 rather than $31,942, causing 85 percent of their Social Security to become taxable.

A fundamental part of any financial plan is the need for a strategy to help prevent or minimize the effect of income taxes on your wealth. If you do not have such a plan, you can lose significant amounts of money that you may never be able to recapture. There are numerous income-tax savings concepts at your disposal. Unfortunately, most people don’t use any, and many use the wrong ones.

To learn more about this and other critical strategies to help make the most out of your Social Security benefits, consider reserving your seat at Shope & Associates’ upcoming Social Security Seminar.  For more information, call Shope & Associates at 734-479-1400.

This is for illustrative purposes only and may not be indicative of your situation.  This is also for informational purposes only and should not be construed as tax advice.  Consult your tax advisor regarding your specific situation.

It's time to get into tax-planning mode

Now that we have closed out the first half of the year, it might pay to review your tax filings. Rather than wait for the end of the year, this is the time to get in tax-planning mode.


Did you owe any tax when you filed 2013’s return? Have any problem paying the balance? What did you to not have this happen? Perhaps the following questions should be considered before making any positive plans.


Have there been any changes in your family structure? Did you get married or divorced? Remember, whatever your status is Dec/ 31,you are that for the entire year. Getting a divorce will mean you are going to file as a single person, which carries with it the highest tax rate.


If recently divorced, are you paying child support? These payments are not deductible but may allow dependents to be claimed on your return. Are you the one paying alimony or receiving it? Alimony is deductible by the payer and must be included as income by the recipient.


Getting married also changes the tax bracket you can file under. How about your dependents? Did you have any new additions to the family? Are there any stepchildren who are now part of the family unit? Did you have anyone else become part of the household? All of these items must be considered while planning for the ultimate filing.


If any of these items are going to increase your liability steps should be taken now. Are you a W-2 employee? Then a change in your exemptions can be made with the payroll department .The more exemptions you claim, the less withholding they will take out. Conversely, the opposite is true. Unless you prefer to have a large refund, then by under claiming you are in effect giving the government an interest-free loan.


How about your income? Has that changed also? Any sales of assets that resulted in a gain? Can you take any stock losses to offset that gain?


If you are retired, are you now going to be receiving Social Security along with your retirement income? How about taking a mandatory distribution from an IRA?


Are you self-employed? Has this been a good year so far? Does that trend appear to continue? Or are you having a loss year? Should you be filing estimated taxes?


These are problems that have to be addressed, as you can wind up by paying too little or too much through tax withholding or estimated tax payments. The best way to determine the answers to these and other questions is to seek out a reputable tax professional and get a positive response.
He or she would probably require a review of your prior year’s returns to give sound and competent tax advice. The fee involved would be worth it and the best part is that it would be tax deductible.
Obviously no one can predict the future, especially the work of Congress when it comes to tax legislation. Being an off-year election, would they be willing to pass something to woo voters to their side? Or will legislation occur after the election as a reward or for retribution of their party’s success or failure? They have been known to act on a moment’s notice if need be.



Crackdown on foreign bank accounts

As recently as last week, the IRS has taken punitive action against those who have had foreign bank accounts any time the past 10 years.
Those that have not been reported may face criminal charges in addition to a 25-percent penalty charge on these accounts. This should be of particular interest to those who have immigrated to this country during that period and have not addressed this issue.

Why Small Business Owners Should Avoid the Trap of A Single Demanding Client

In a great blog post on the subject, Dave Schneider related the case of a business idea he had that went afoul because of the picky nature of his major client. Within this anecdote, there is a real lesson to be learned for small business owners, and that lesson is that, no matter how much they can potentially stand to gain from a client, if they are running their business into the ground trying to please them, then they should step back and compare the value the client has brought them to the negative value of their difficult nature.

Are you constantly going over your budget or time-frame in order to please your client? The profit that your client brings you is not actually profit if it is constantly being eaten into by extra hours and resources. There is a big difference between being nice to a major client by throwing in something extra from time to time in order to keep them satisfied and putting in extra work on every single project they give you because they are never satisfied.

Are they stopping you from working with other clients because of their demands? If the growth of your business is being stymied by the time it takes you to satisfy your one picky customer, you should think to yourself if it makes rational sense for you to continue bending over backwards. If in the time it takes you to work for them you could satisfy two or three other clients, then the money side of the argument for sticking with them may not hold water either.

Lastly, are they constantly asking you to change your product or processes to better suit them? If the product that you are offering is not lining up with the expectations and demands of your client and they are requesting that you modify it, then you should probably not be working with them, since what you offer and what they want are two different things. Simply because there is money to be made, that does not mean that the relationship has the potential to be profitable in the long term