What the IRS Does Not Want You to Know and Your CPA Hasn’t Told You

The amount of income tax a person will pay over a lifetime is huge.? The government knows that there are almost unlimited?strategies you could employ to pay them less income tax.? It may surprise you that there are two different income tax systems in the United States, and YOU can choose which system to participate in.? The IRS does not have an evangelical division nor do they send out missionaries to share the good news.? The roadmap to paying them less already exists. Congress has provided it.?You can order your free copy of this masterpiece today – its only 6,800 pages long.? The title is “The United States Tax Code”.? ??This doesn’t include the additional 75,000 pages of rules and regulations.?? Fortunately, others have gone before you.? I, for one, have done the heavy lifting.? It took me over thirty years, but my pain is your gain.?

The Two Systems

Many believe that two systems mean one for the rich and one for everyone else.? This is not true.? Everyone must play by the same rules, but there is one system for the “informed” and one for the “uninformed”.?? Which system are you participating in?? The informed group recognizes that we pay two types of taxes: Voluntary and involuntary.? What is the difference?? Simple, if you have a job you must pay income tax.? Income on wages is involuntary.?? If you invest in growth stocks, you may or may not have to pay taxes.? You can sell the stock (voluntarily) and pay capital gains taxes, which are lower than the taxes on wages (if held 365 days or longer).? You are not forced to sell the stock, and if you die, your heirs get a new cost basis and can sell the stock tax-free.? These are two very simple examples.? But now you understand the fundamental difference between the two tax systems.? Enter the forward-looking, strategic tax advisor.?

The Deceptiveness of 401ks

I think one of the damaging beliefs is that people should “max out” their 401k contributions.? When companies offer a match, it is hard not to take advantage it.? While a 401k can be a great savings tool, one must be aware of the downsides – and there are many.? When 401ks were first offered in 1978, tax rates were much higher than they are today, and the top bracket was 70%.? Back then, the average person believed that tax rates would be much lower when they retired and began taking distributions from these plans at a lower tax rate.? But now, the reality is that most people retiring today are in the SAME bracket as they were during their working years, thus they are not saving on their taxes by contributing to their 401k. They are simply putting off paying the taxes they would have paid anyway. ?Not only that, but the government is also now charging a success penalty by taxing social security, increasing Medicare premiums, and increasing capital gains tax rates based on AGI (Retirement plan distributions raise AGI).? The other problem with retirement accounts is the mandatory distributions.? Even if you don’t need the money, you are forced to start taking distributions at age 72 (or 73 or 75).? Why?? Because the IRS wants their money.? If you have $100,000 in a traditional IRA, at least 25% of that money is NOT yours.?It never was. ?You can’t get it, your spouse can’t get it and your kids can’t get it.? This tax time bomb is money you never paid in taxes and, therefore, belongs to Uncle Sam.? You get the privilege of managing this money for a few years, but that’s all.?

So, how is investing in a 401k with a match paying voluntary taxes?? Because you could have re-routed those dollars into a private retirement plan that has a 0% tax rate!? Roth, back door Roth, life insurance, and real estate equity all can provide tax-free income.?

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Beginning in 1984, certain couples with incomes greater than $32,000 had to add a portion of their social security to their taxable income.? This $32,000 threshold is still in place.? How is it fair that some people have to pay tax on their social security when the money was already taxed once?? Because only half was taxed, the other half, paid by your employer was never taxed to you.? So, if a couple over age 72 has an IRA but doesn’t need the money, they still have to withdraw an amount based on IRS tables, which could potentially mean they would hit the Social Security Tax Threshold.? It gets worse!? Paying taxes on Social Security may seem like a raw deal but it is not that much money.? The other penalty for saving and investing is the Medicare surcharge.? In 2024, a single person will pay $174.70 per month for part B of Medicare.? However, if a single person earns over $103,000 but less than $129,000, their premium is $69.90 per month higher.? In fact, part B can go as high as $594/mo.? Capital gains taxes are also based on your AGI. ?

The bottom line:? Think carefully about your retirement and keep in mind that tax deferral is just that – deferral.? In the next installment, we will cover Roth 401k, Roth IRA, Roth conversions, and back-door Roths.? In addition, we will discuss other tax-free income strategies.? The 0% bracket is my favorite!? For more information, contact David Disraeli at [email protected] or 512-464-1110.?