Year-End Permanent Tax Savings

2016 will be closing quickly.  Like the Cubs, you can finish strong and put your finances in order for 2017.  One way to carry out this task involves a few simple techniques outlined by Sheryl Rowling in her article, “Permanent Tax Savings and Techniques (1.)”

Why is this important?

Every year taxpayers tell the Internal Revenue Service (IRS) a story.  A story about how their income originated and about important financial activities, like how much they saved in retirement accounts (found on the W2 for an employee’s work-sponsored plans), charitable giving, and business deductions.  Beyond these basic categories, your tax return reveals more information about your family.  Here are a few examples: that you may have student loan debt because you take a student loan deduction or that you may have a child in college.  Your tax return may suggest that you have a large portfolio; think about how much you report in dividends and interest.  For itemized filers, your tax return may reveal that you have a large home based on your mortgage deduction.

The aggregation of your tax data gives the IRS a good idea of your financial situation.

The Big Bad Wolf

Now imagine the IRS as the Big Bad Wolf in a financial story about the Three Little Pigs.  In this version, the wolf has the capability to rewrite parts of the story he doesn’t like.  big-bad-wolfWhich part will he likely retell?  Of course, it will be the part where he visits the third pig’s house.  Our nemesis will likely choose a way to blow down the house.  Now, not only will the wolf destroy all the homes, he will be able to gobble up not one but all three little pigs.

In the same way that our Big Bad Wolf will retell the story to his advantage, the IRS has the ability to influence your annual income story.  Think about how laws change and the interpretation taking place if you receive an audit.

Like the Big Bad Wolf, we can rewrite the story, this time introducing a cousin piggy who has built an underground bunker.  Here, the wolf has no building to blow down.  If properly stocked, all the little pigs will be safe for a long time.  Here is where you get to be the cousin piggy who built the bunker.

How to build your bunker

First, the cousin focuses on understanding a few basics about the wolf, specifically that thebunker strength of the wolf comes from his lung capacity.  So your objective will be to take away his breath.

Sheryl outlines tactics for knocking the wind out of the IRS by knowing that the “goal is to decrease taxes so that some or all of the reduction is never paid back to the government.”  Better yet, permanent tax savings may be realized by moving income from higher tax brackets to lower tax brackets or recognizing income without paying any tax.

Ideas for consideration (from the article.)

  1. Avoid short-term capital gains: Because ordinary rates are typically two times higher than long-term rates, review your trading and the turnover rates of your active mutual funds in retail brokerage accounts.
  2. Defer income to years subject to a lower tax bracket: This is where year-end planning may pay off. What will your income be for 2016?  What will it be for 2017?  Is there income you may defer into 2017 that may be taxed at a lower rate?
  3. idea-lightbulbRecognize zero-capital-gain tax opportunities: If you are in the 15 percent bracket or less, capital gains are not taxed up to a certain point. You may need to balance this opportunity with the chance to take money from your tax-deferred accounts and convert them to Roth at a rate of 10 percent or 15 percent, never paying tax again.
  4. Hold appreciated investments until death: The beneficiary receives a step-up in basis, thus avoiding any capital gains tax. However, Sheryl does address the possible volatility of the investment and the chance that it may go down, offsetting the potential tax benefit.
  5. Use the asset location theory: The author suggests that “moving appreciating investments to taxable accounts has the potential to permanently save the difference between ordinary and capital-gains rates on the appreciation.”
  6. Convert to Roth IRAs: Moving money, during a low-income year, from a tax-deferred account like an IRA to a tax-free account such as a Roth may help save in taxes paid over your lifetime.

As always, check with your tax advisor for specific advice about your situation.  Should you have questions or concerns, you can contact me at 317-805-0840 or