How We Can Help Reduce Your Tax Bill Through Planning

Understanding your total tax bill and making accurate tax projections is a complex process. The following information will give you a detailed breakdown of the various taxes by type and how the projections are done.

Income and Payroll Tax:

For wage earners, total wages are subject first to payroll taxes, which include Medicare and Social Security. Those taxes are as follows:

Medicare

Social Security

Next come federal income taxes:

       Federal Income Taxes

Payroll taxes on self-employed income are different still., First of all, as you can see below, if you are self employed, with income of $127,200 or less, you will pay 12.4% Social Security tax and 2.9% Medicare tax for a total of 15.3%. Then, depending on income, you will pay an additional 2.9% Medicare tax for incomes greater than $127,200 and no more than $250,000. Finally, for incomes above $250,000 the additional Medicare tax goes up to 3.8%. This information is summarized in the following table::

   Taxes for Self Employed

Taxes are also levied by states, and by some local jurisdictions as well. Further, if you earn an income over a certain amount, there is a possible additional tax of 3.8% tied to the Affordable Care Act.

This is just the tax collection side, it doesn’t even begin to get into the tax filing side with exemptions, deductions, and credits that are available to some or all and may be phased out at various income levels.

Taxes During Retirement:

Standard income for retirees is taxed differently. Social Security income is generally taxable and 50% or 85% of the benefits are subject to income taxes depending on your income. Medicare premiums also change at various levels of income.

Pension income is considered regular income, and is subject to regular income tax. There are no Social Security or Medicare taxes, but federal and state taxes will be collected.

Taxes on Investment Income:

First off, taxes are paid on dividend and interest income.. Dividends are tax free if the taxpayer is in either the 10% or 15% tax bracket. They are taxed at 15% in tax brackets from 25% through 35% and they are taxed at 20% for taxpayers who fall into the highest tax bracket of 39.6%.

Capital gains are positive returns from the sale of investments. Returns from investments held for less than one year are treated as ordinary income and are subject to regular income tax rates. Capital gains from investments held longer than one year are taxed like dividends; either tax free, taxed at 15%, or taxed at 20%. The first $250,000 of capital gains on a primary residence is tax free ($500,000 for married filing jointly).

So now that you are either thoroughly bored or confused or a bit of both, let me explain why I went into so much detail. It is to explain how being proactive and collaborating with us on your tax planning can really help your total tax picture. We are able to make investment decisions and allocate capital to different account types in a way that helps reduce your total tax bill. So, for instance, if you had a year in which you sold a private investment for a large gain and have two or three investments in your portfolio that are currently at a loss, it may make sense to sell those investments in order to recognize it for the tax year and thereby offset some of your gains. Or, in a year that you received an unexpectedly large bonus, it may make sense to contribute more to tax qualified accounts, shifting the taxes down the road to future years.

So, keep us up to date and/or empower your CPA to collaborate with us during their planning period as well. The more notice we have and the better view we have of your total income and tax picture, the better we can be as your advisory team!

We recently participated in a case study that illustrates the power of effective tax planning:

Suppose you had an offer from an investor group to purchase investment real estate that you had owned for many years with significant capital gains on the property.

As part of the negotiations, you were offered the opportunity to become the financing agent over five years. This would create an installment purchase of the investment, which would spread out the capital gain over five years. To our surprise, when strategizing the taxes we discovered that even though the gains would be spread over years, the actual tax costs were HIGHER than if all the gains were taken in one year. This seems counter-intuitive, but it is nonetheless true.

Spreading out the capital gain over five years means four extra years of higher capital gains on all other capital transactions. It also means four additional years of itemized deductions reductions, four additional years of alternative minimum taxes, and four extra years of increased Medicare premiums as well as four extra years of higher dividend taxes. When doing the total exercise, we discovered that it was better to take the entire gain all in one year, and then tax manage the other four years to obtain the best rates possible. The installment note strategy would lock the seller into five high tax years in a row. The improved strategy results in one high tax year and four modest ones.

Strategies like this can result in substantial tax savings!

Not a client of Destiny Capital? We’d love to hear from you.

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