Safe Tax Planning For High-Net-Worth Filers

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Safe Tax Planning For High-Net-Worth Filers

When the rich discuss tax preparation, they do it quietly, looking over their shoulders as if they are defrauding the government. However, regardless of income level, the Internal Revenue Service (IRS) has no prejudice against any taxpayer who uses authorized tax reduction strategies.

Unfortunately, because of their high income levels, many of the most prevalent tax benefits have been phased out for the rich. That doesn’t imply there aren’t lawful tax planning alternatives for the wealthy. People in higher tax brackets may save more on taxes than the typical American makes each year with a little knowledge, ingenuity, and planning.

Key Takeaways

  • Small companies provide several tax sheltering alternatives, such as retirement plans, health care plans, and employee benefit programs, among others.
  • In contrast to the IRS’ default first-in, first-out procedure, tax lot matching enables investors to designate which stock or mutual fund shares are sold.
  • Before making any offshore investments, investors should consult with a financial advisor.

Legal Strategies for Sheltering Employment Income

Thomas Stanley highlighted in his eye-opening book “The Millionaire Next Door” that at the time, two-thirds of millionaires in the United States were self-employed or small-business entrepreneurs. Even more of those persons worked for outside corporations while also running tiny home enterprises. There are several tax-planning alternatives available to small company owners that are not subject to the typical income constraints.

The usage of small company retirement plans is one of the most effective tax-cutting strategies. Previously, the IRS did not consider money donated to these programs in the earnings of a company owner or self-employed person under prior legislation. Taxation on such money may be avoided if a rich person can postpone excessive expenditure until retirement.

Another approach is to maximize the utilization of small company health care and employee benefit programs to protect revenue. Expenses that would have exceeded the deduction thresholds for individual taxpayers may be paid on a pre-tax basis via the company by establishing health savings accounts (HSAs), health reimbursement agreements, and Section 125 programs.

  Tax Liability: Definition, Meaning, Calculation, and Example

Another lawful income-protection strategy is to place children on a company’s payroll. If the kid is a juvenile, FICA and federal unemployment taxes may not be required, and the child may be eligible to contribute to an individual retirement account (IRA) with earned income. Using a spouse produces comparable outcomes. Because there is an annual restriction on how much FICA a person must pay, one spouse may be rewarded much more than the maximum. This may result in one spouse paying less into the Social Security system, but it also allows a couple to invest privately rather than placing it in the hands of the Social Security system.

Strategies for Sheltering Investment Income

The Roth IRA is one of the most exciting tax-saving prospects in decades. Unfortunately, many wealthy investors are barred from using them because their adjusted gross incomes (AGIs) are too high. These investors should consider contributing to a non-deductible conventional IRA. While these IRAs do not provide upfront deductions or tax-free withdrawals, the gains may build tax-deferred over time.

Another neglected tax-cutting strategy is “tax lot matching.” In contrast to the normal IRS practice of first-in, first-out, this methodology enables an investor to designate which individual shares of a company or mutual fund are sold (FIFO).When shares of a stock with little or no gain, or even a loss, are sold instead of shares from long-term investments with big profits, tax lot matching may give significant savings.

Affluent investors with children have more options for shielding investment income and profits from the IRS. Since the advent of 529 plans, one of the most popular, the universal transfer gift to minors (UTMA) custodial account, has faded from view. While these accounts are no longer the greatest way to save for college, they do provide a unique opportunity. A parent who holds highly valued stock may “gift” it to a kid, have the youngster sell it, and then report a part of the earnings at the child’s much lower tax rate.

  Disclosure of Tax Avoidance Schemes (DOTAS)

Affluent parents and grandparents have a unique chance to utilize Section 529 plans to move money out of their estates and shelter considerable sums from future income taxes if used for any family member’s education expenditures. The Internal Revenue Code (IRC) allows any donor to contribute up to five times their yearly gift exclusion limit to a Section 529 account for a child, as long as repeated contributions to the same individual are not made over the next five years.

Finally, wealthy investors with a philanthropic bent should avoid contributing cash as much as possible. The IRS permits investors to transfer significantly valued stocks to charitable organizations and claim a complete write-off. This spares investors the bother of having to sell the assets themselves, pay capital gains tax, and make smaller payments to charity. In a nutshell, gift the shares while keeping the cash.

You may avoid paying capital gains taxes by giving stocks rather than cash to charity organizations.

Questionable Strategies to Avoid

As previously stated, the IRS has no objections to wealthy investors avoiding as much taxes as is legally permissible. Nonetheless, no essay on rich tax-planning methods would be complete without a warning about the activities that might get you in trouble. Even if you overhear someone gloating about these tactics at cocktail parties, be warned: they may result in penalties and even prison time.

Offshore asset trusts are the most common abusive tax strategy that is heavily prosecuted by the IRS. While having a Swiss or Cayman Islands bank account may seem to be quite upper-crust, these accounts are unlawful when used to evade US income taxes. Furthermore, several post-9/11 legislation place tight restrictions on how much money may be moved overseas and for what objectives. If you are advised to use one of these trusts, you should get second and third views from independent tax specialists.

  What Is a Tax Return and How Long Must You Keep Them?

The IRS also frowns on wealthy investors engaging in “non-arm’s-length” transactions in order to evade taxes. In summary, all transactions between related parties should be handled as if they were between strangers. For example, parents who sell appreciated real estate to their children for half the market value (in order to avoid paying capital gains tax) would not likely do so with a total stranger. Affluent tax schemes that are not carried out in a professional manner are liable to IRS action.

Finally, family limited partnerships (FLP) have become a popular alternative for parents to transfer assets to the next generation while keeping ownership and evading gift tax laws. While such partnerships may be appropriately established in certain cases, they are exploited to the point that the IRS becomes involved. Using an FLP will very certainly place you and all of your other tax methods under scrutiny.

The Bottom Line

Warren Buffett, one of the world’s wealthiest men, is said to pay less in taxes than his secretary. Whether or not that is entirely correct, it is not impossible for someone earning hundreds of thousands of dollars to pay almost the same amount of taxes as someone earning a fraction of that. The secret is to use lawful rich tax planning tactics well in advance of your tax-filing date. This ensures that the ultimate benefactors of your hard work are you and your family members, not the IRS.

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