Come On, Tell Me – How Can I Save on Taxes?

Frankly, there isn’t a ‘trick’ to tax planning. All tax planning is:

1. Timing
2. Character
3. Following the rules

How you are able to apply these 3 things is dependent on the type of taxpayer you are, where you live, and how you earn your money.

But….tax planning is still ‘just’ a variation on the above 3 concepts.

1- Timing

When do you receive your income? When do you incur your expenses? These are timing questions. If you’re a taxpayer who does not have control over when you receive your income or when to incur an expense, then take this off of your current tax planning opportunities list (put it on your goal “Something to work towards list”).

1. Can you tell your boss to wait to give your compensation until the next year because you’re expecting rates to go down or next year is a low-earning year? Can you tell your boss to pay next year’s commission/salary this year because you know next year you’re going to have a big income event and you don’t want to make it worse from a tax perspective? Maybe you are the boss or an executive and you do have control over these things.
2. Alternative Compensation is a broad term that covers the multiple legal ways that executives and business owners may change when their income is recognized (timing).
3. The same considerations are applicable for expenses. Do you have the ability to push or pull expenses into/out of a particular tax year? If you do, you can do some planning based on your financial tax pattern and/or what you or your tax professional knows about current and upcoming tax law.
4. Consider the tax-deductible (or potentially tax-deductible) expenses you or your business incur. Does it make sense to make them in one year better than another year? This is tax planning.
5. Perhaps you generally take the standard deduction, but you have charitable intent. Then maybe it makes sense to group your charitable deductions in 1 year (or every other year) so that they’re large enough to create a year when itemized deductions exceed the standard deduction so you actually get a tax benefit from your charitable contributions.

There are certainly avenues to change the timing of income and expenses that any taxpayer should consider, of course, important in these considerations is not thinking of the timing in isolation – also consider the character and the applicable tax rules.

2- Character

Different types of income are taxed differently. Why is this the case? Well….that’s actually a topic for a different newsletter, because the answer is “for a whole bunch of reasons.” Basically, the tax law is partially designed for revenue generation, but also to encourage/discourage certain economic behavior.

But for now, let’s just explain about a few different types of income (the character of that income) and how changing the character of income can help save in taxes.

What are some income types? Earned, Capital Gain/Loss, Tax Deferred, and Investment. And of course – we’re talking about tax law here….so there are of course subcategories of each of these characters of income/losses (i.e. passive/active, long-term/short-term, realized/unrealized, qualified/unqualified, etc.)

What do I mean about changing the character of income? Is that really possible? Sometimes, yes, with appropriate planning and following the rules.

1) Earned income is generally taxed at the highest income tax rate – your specific income tax rate. Not unilaterally ‘the’ higher income tax rate.

2) Long-Term Capital Gains are generally taxed at a rate lower than the earned income tax rate. So do you have an asset you’re selling at a gain? Is there a way for it to be long-term and thus subject to a lower tax rate? (See notes below regarding Knowing the Rules, because it may not be as simple as waiting for a year).

3) Investment income includes things like interest, dividends, and the gain/loss on sale of investments. There are opportunities within these characters of income for tax planning.

• Qualified dividends are generally taxed at a lower rate vs. non-qualified dividends (of course, then you have to ask ‘what’s a qualified dividend’)
• Interest can be tax exempt (some are tax exempt from federal, some are tax exempt from state, etc)
• The gain on the sale of investments could be taxed at long-term rates or even rolled over to a new investment (something called a Sec 1031 Exchange).

4) Tax-deferred income is what the term implies, the earnings on these type of accounts don’t get taxed until later (and there are also some accounts that are taxed-never).

5) And some types of income are excluded from taxation all together – i.e. the gain on the sale of a personal residence.

Yes, there are rules that must be understood and followed to get these preferred tax treatments. But the point is, these are considered “changing the character of income.”

3- Following the Rules

Tax and tax forms are NOT Substance Over Form. Meaning, to get the respective tax treatment you want, one must follow the appropriate form, rules, and process that the IRS (or state) lays out. Frankly, this is why that sound-bite you heard about a great tax savings idea doesn’t actually get done. Frequently ,researching and following the proper compliance takes hours of work and it fails the cost benefit analysis. Or, your financial facts don’t meet the criteria for the deduction.

The tax code is nearly 7,000 pages…when you include IRS Regs and guidance it’s over 70,000 pages, and Google has over 875,000,000 results if you search for ‘Tax Planning”.

What does that mean? There are a lot of rules!

Tax planning opportunities range from straightforward (i.e. invest in tax-preferred vehicles before investing in a non-tax-preferred investment accounts) to complex (i.e. executing a §1031 exchange). But in all cases, there’s a way to do it.

For example – people often ‘tell’ their tax professional that they can write off their truck for business. Well – for most business owners, it’s significantly easier to write off mileage vs. writing of the vehicle. 1) the vehicle has to be used more than 50% for business – how do you prove it was used more than 50% for business? Track mileage. And ‘writing off the truck’ is in reference to something called a §179 depreciation deduction.

No, the business owner doesn’t buy the truck and put the expense on the Profit and Loss stmt. There are record-keeping requirements, steps, and forms to be completed and tracked each year to get this 100% depreciation deduction (writing off the truck). And…each year it has to be revisited in case that prior tax benefit needs to be recaptured. And….if you later sell that vehicle, there could be a recapture of the tax benefit, etc.

When you talk to your tax professional about a deduction, do they reply ‘it depends’ or do they reply ‘it’s potentially deductible’? Tax law has to be followed per your particular tax facts and there’s an evaluation and research process to determine if you are a fit for a particular tax planning action. And then, determining how to report it is another process.

1) “If I buy a house, I can write off the interest – right?” Maybe

• How much is the mortgage?
• Is it a mortgage vs. a Line of Credit?
• How many houses do you have?
• Are you going to be itemizing deductions?
• Are you going to be living in it as your primary residence?

2) “Doesn’t Georgia have a bunch of new tax credits?” Yes, but…..

• Georgia has passed several new laws and tax credits that could be beneficial. And of course, each one of these has a specific form to be completed.
• For several of them, the taxpayer must apply and get approval before getting the credit.

So...whatever you’ve been thinking about tax saving strategies, “Can’t I just….” It’s probably been thought of. And if it is allowed and a valid tax strategy – be sure to follow the proper steps. The IRS ‘allows’ deductions, ‘allows’ tax-preferred investments, etc., none of these are required. So it’s up to you, the taxpayer, to figure out the appropriate hoops to jump through for your specific tax fact pattern.

In summary, if I were forced to respond about a ‘trick’ to tax planning, it would be to first earn as much as you possibly can, and then invest in tax planning strategies. Meaning, that never in my 30 years of working in the tax field have I ever heard a partner say “Please don’t pay me anymore, I don’t want to get bumped up to the next tax bracket’. Until we’re at a 100% tax rate, a taxed $1 is still way better than no $1. So instead of trying to cap income, be prudent with expenses such that when you are earning money, you have disposable income with which to invest in tax-preferred ways (i.e. investment, passive income, tax credits, etc.)

Finally, note, this newsletter is about tax planning considerations for income tax, but keep in mind, different types of taxes are also subject to tax planning opportunities (payroll taxes, self-employment taxes (basically payroll taxes), estate taxes, state taxes, etc.). And of course, tax minimization is appropriate tax planning. Tax evasion, however, is illegal. So remember for successful tax planning, one must apply the applicable rule(s) for that item!

If your organization is looking to understand how the tax code impacts them, I’m here for you.

When I speak to new business owners, I teach them strategies for tax planning then they can feel more comfortable making informed decisions. When I speak to new executives, I teach them ‘why’s’ of alternative compensation so they feel more comfortable making an employment decision. And when I speak to taxpayers in their prime earning years, I teach them the strategies available to them regarding the alphabet soup of the tax code to accomplish those incremental base hits that help over the long-term.

If you're interested in learning more about how your team or organization can benefit from understanding how the tax code impacts them, don't hesitate to reach out.

Book a free call with me, and let’s strategize making your next event meaningful.

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About Cecily Welch

Cecily Welch demystifies complex financial issues so people can make informed decisions and turn goals into financial action. She began her career as a national and international auditor. Cecily has continued to provide client focused accounting and financial expertise for both large and small CPA firms. Cecily is adept at helping people understand how their financial decisions help them meet their life goals. And because no financial decision should be made in isolation, she is dedicated to educating others on the impacts of tax policy as an advocate for taxpayers, earning her the moniker as ""The Accountant I Can Understand?”.

She's been published in the Wall Street Journal, 3-time guest on Georgia Public Radio/NPR on Second Thought with Celeste Headlee, and created a 3 series webinar on business financials for Cobb County, GA.

In addition to being a licensed CPA in both Illinois and Georgia, Cecily has more than 30 years experience as a certified financial planner (CFP?) and a public accountant. She earned her Bachelor of Accounting from North Carolina A & T State University and MBA from the University of Wisconsin-Madison. She is an active member of several non-profits and professional associations, including:

City of Atlanta, Governing Board of the Inspector General (formally the Board of Ethics and Independent Compliance)

AICPA IRS Advocacy & Relations Committee, Appointed

Georgia Society of Certified Public Accountants (GSCPA), Leadership Council, Tax Task Force - Former Chair, Former Board Member

Internal Revenue Service Advisory Council (IRSAC) - Three year appointment (2011-2013) Sub-Chair Small Business and Self Employed