It’s a never-ending pursuit: trying to interpret the ever-changing tax code to make use of all of the deductions to which you are entitled. While tax-saving opportunities exist for almost everyone, in the form of IRA contributions and deductions for real estate taxes and mortgage interest, individuals with higher incomes may overlook some special opportunities.
The executive who considers those options now, and selects the most applicable, can soften the blow when taxtime 1996 rolls around.
- Contribute directors’ fees to retirement accounts. Compensation for serving on a board of directors, even if you are also an employee of the company (if the compensation is sufficiently segregated from your wage income), may enable you to contribute to a tax-deferred retirement account and receive a current income tax deduction for the amount contributed.
- Make gifts to the next generation to encourage building individual retirement accounts. Children and grandchildren with earned income can contribute up to $2,000 ($2,250 with a nonworking spouse) annually to tax-deferred IRAs. To encour age the maximum contribution, give them an amount at least equal to the after-tax cost of the IRA contribution.
- Use gift tax ex-clusions, including paying medical and educational expenses. Each year, a donor may give $10,000 ($20,000 if a spouse joins the gift) per donee with no federal gift tax consequences. In addition, a donor can pay certain medical and educational expenses of the donee without gift tax liability. Use these “exclusions from gift tax” to the maximum each year for every child, grandchild, and other close relatives.
- Use all or part of the unified credit for federal estate and gift taxes. Each individual can transfer, either during life or upon death, $600,000 ($1.2 million if the spouse joins) free of federal estate and gift taxes. If you can afford to use this credit during life, do so as early as possible. It can save up to 55 percent of the appreciation on the gifted assets in estate taxes.
- Use all or part of the federal generation-skipping exemption. Each individual can transfer, either during life or upon death, $1 million ($2 million if the spouse joins) free of the 55 percent federal generation-skipping tax. To maximize the amount of wealth transferred to future generations, consider using this exemption-and possibly leveraging it with life insurance-as soon as / it’s affordable. Gift tax returns may have to be filed to allocate part of the GST exemption.
- Change your residence. Moving to another state may not only save income tax, but others-such as estate, property, and sales taxes-as well.
- Withdraw IRA funds for 60 days. Rather than borrowing short-term funds, consider using IRA funds for up to 60 days. The tax bonus: If your retirement accounts are likely to be subject to the 15 percent excise tax for excess distributions, earnings from the IRA during the 60-day period are not reportable as retirement income-that is, not subject to the excise tax.
- Consider renting to children in college. Most college expenses have increased faster than the consumer price index. Rather than pay rent, consider purchasing property to rent to the student.
- Compare capital gains tax rates inside and outside retirement plans. In some cases, it’s advantageous for individuals near retirement to invest in equities outside their retirement accounts so they can obtain the favorable 28 percent rate. Retirement plan distributions almost always are taxed at ordinary income tax rates, which can top 39.6 percent.
- Avoid the potentially costly combination of capital gains, AMT and state and local taxes. Rules for the alternative minimum tax have not fundamentally changed, but the rates for taxable income above $175,000 have increased to a maximum of 28 percent, the same as the capital gains rate. With large capital gains, the risk of paying AMT increases substantially and should be anticipated. The AMT has a profound effect on tax planning, particularly for payments-such as state income taxes-that are not deductible. Careful multiple-year planning helps determine when to pay state income taxes in the event of large capital gains.
- Don’t sell appreciated assets to fund charitable gifts. There are significant benefits to both the donor and the charity if appreciated assets are given outright to a public charity instead of selling them and donating the after-tax proceeds. The savings depends on how much capital gains tax would have been paid on the sale, but it can be significant. Changes in the AMT open the door to making substantial gifts without paying this additional tax.
Larry C. Rabun is a tax partner in the Washington office of Deloitte & Touche LLP, an accounting, auditing, and management-consulting firm. Jerry Leamon is the national managing director of tax services at the Wilton, CT-based firm.