Different types of income have different tax rates. Shift income to exploit the lower tax rates. For example, income from investments such as qualified dividends are taxed at lower rates than ordinary income. Retirement accounts defer income from high tax bracket years to lower. Business structure affects the taxes you pay. Real estate investments offset income with depreciation expenses. Don't be a HENRY!
2. NOT ALL TAXES ARE THE SAME!
Ordinary income tax 10% - 39.6%
Self employment tax 15.3%
Capital gains tax 0%, 15%, 20%
Net investment income tax 3.8%
Corporate tax rates 15% - 38%
4. OVERALL STRATEGIES
Shift income into categories where tax rates are lower
Reduce/defer taxable income
Shelter income
5. Strategy 1:
Increase Income from Investments
Want to focus on qualified dividends and long term capital gains
Qualified dividends must be issued by a US corporation and must have been owned for a
specific holding period.
These are taxed at the lower capital gains tax rates of 0%/15%/20%
Can also invest in municipal bonds
These are tax exempt for federal tax purposes and tax exempt in the state they are issued
Different from regular interest, which is taxed as ordinary income
6. Strategy 2:
Defer income aka contribute to a retirement account
W-2 employees – contribute to your company’s 401k plan to reduce income taxable in the current
year
Business owners
Company contributions are deductions, which reduce net taxable income
Employee deferral contributions reduce taxable income in the current year
7. Strategy 3:
Change Your Business Structure
C-corporations
C-corps have very high tax rates
Withdrawing money is subject to double taxation
1. C-corp pays income tax on net income
2. Shareholders pay tax on dividend income also, thus double taxation
Make election to be s-corporation when possible
LLCs and partnerships
Member/partner’s share of net taxable income is subject to income AND self-employment
tax
Make the check-the-box election to be taxed as an S-corporation
8. Strategy 3 (Continued):
Change Your Business Structure
S-Corporation
S-corp is a “pass-through” entity, which means the net taxable income is passed through to
the owners.
S-corp net income is only subject to income tax, no self employment tax
Tax rates for individuals are lower than corporations
Take money out of the company tax free
This is a distribution, NOT a dividend
Owner needs to be on payroll but it can be a “reasonable” amount
9. Strategy 4:
Shelter Income with Real Estate Investments
Expenses, including mortgage interest, real estate taxes, management fees, etc, offset income
from rental properties
Income is also offset by depreciation, which is not tied to cash transactions
Actively manage the property to deduct real estate losses up to $25,000, subject to phase outs
10. How the IRS describes “Active Management”
"You actively participated in a rental real estate activity if you (and your spouse) owned at least
10% of the rental property and you made management decisions or arranged for others to
provide services (such as repairs) in a significant and bona fide sense. Management decisions that
may count as active participation include approving new tenants, deciding on rental terms,
approving expenditures, and other similar decisions.“
12. Strategy 5 (Continued):
Don’t be a HENRY
Income might be high but wealth is not. This is seen with many professionals, such as doctors
and lawyers.
Higher incomes mean paying higher taxes and hitting phase-outs on personal exemptions,
itemized deductions, tax credits, etc., or alternative minimum tax (AMT) increasing taxes further.
HENRYs often have highly leveraged, high-consumption life styles- expensive cars and homes,
child related costs, vacations, etc.
Reduce your cost of living to reduce the income necessary to support your life style to reduce
your tax bill.
