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Tax Savings for Affluent Older Families

For tax savings, convert a vacation home to your principal residence, give an IRA to charity and double your family's estate-tax break with a by-pass trust.

Updated May 2014

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Upper-income older families should make these moves throughout the year to keep their bill low at tax time. Here are the areas where you should look for savings:

Tax Savings For: Work | Car and Home | Charitable Contributions | Estate Planning | Investments and Retirement Savings| Medical Expenses | Rental Property | Your Children

WORK

Give yourself a raise. If you got a big tax refund this year, it meant that you're having too much tax taken out of your paycheck every payday. Filing a new W-4 form with your employer (talk to your payroll office) will insure that you get more of your money when you earn it. If you're just average, you deserve about $225 a month extra. Try our easy withholding calculator now to see if you deserve more allowances.

Go for a health tax break. Be aggressive if your employer offers a medical reimbursement account — sometimes called a flex plan. These plans let you divert part of your salary to an account which you can then tap to pay medical bills. The advantage? You avoid both income and Social Security tax on the money, and that can save you 20% to 35% or more compared with spending after-tax money. The maximum you can contribute to a health care flex plan is $2,500.

Watch start-up costs. Generally, the costs of starting up a new business must be amortized, that is, deducted over years in the future. But you can deduct up to $5,000 of start-up costs in the year you incur them, when the tax savings could prove particularly helpful. Take our quiz on savvy start-up moves.

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Stash cash in a self-employed retirement account. If you have your own business, you have several choices of tax-favored retirement accounts, including Keogh plans, Simplified Employee Pensions (SEPs) and individual 401(k)s. Contributions cut your tax bill now while earnings grow tax-deferred for your retirement.

Pay tax sooner than later on restricted stock. If you receive restricted stock as a fringe benefit, consider making what's called an 83(b) election. That lets you pay tax immediately on the value of the stock rather than waiting until the restrictions disappear when the stock "vests." Why pay tax sooner rather than later? Because you pay tax on the value at the time you get the stock, which could be far less than the value at the time it vests. Tax on any appreciation that occurs in between then qualifies for favorable capital gains treatment. Don't dally: You only have 30 days after receiving the stock to make the election.

Pay back a 401(k) loan before leaving the job. Failing to do so means the loan amount will be considered a distribution that will be taxed in your top bracket and, if you're younger than 55, hit with a 10% penalty, too.

Cut compensation, boost dividends. Principals in closely held businesses may want to shift part of their compensation from salary (which is taxed in their top bracket) to dividends (which is taxed at a maximum 15% rate). This can pay off if the corporation is in a low tax bracket, so the loss of the deduction for dividends paid is more than offset by the owner's savings.

If you use part of your home regularly and exclusively for your business, you can qualify to deduct as home-office expenses some costs that are otherwise considered personal expenses, including part of your utility bills, insurance premiums and home maintenance costs. Some home-business operators steer away from these breaks for fear of an audit. But a new IRS rule makes it easier to claim this tax break. Instead of calculating individual expenses, you can claim a standard deduction of $5 for every square foot of office space, up to 300 square feet.

Time receipt of self-employment income. Those who run their own businesses have a lot of flexibility at year-end. To push the receipt of income into the following year, delay mailing bills to clients until late December so that payment is received after December 31. Or, pay business expenses before January 1 to lock in deductions.

Pay estimated taxes ... or not. If you receive significant income not subject to withholding — from self-employment or investments, for example — you probably need to make quarterly estimated tax payments to avoid an IRS penalty. But, if withholding will equal 100% of your 2014 income tax bill (or 110% if your income was over $150,000), you don't need to make estimated payments, no matter how much extra income you make this year.

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Tax Savings for Affluent Older Families

For tax savings, convert a vacation home to your principal residence, give an IRA to charity and double your family's estate-tax break with a by-pass trust.

Updated May 2014

Home

Make the most of tax-free home-sale profit. Up to $250,000 of home-sale profit is tax free ($500,000 if you are married and file a joint return) if you own and live in the house for two of the five years leading up to the sale. If you are bumping up on the limits, consider selling and buying a new home to start the tax-free clock ticking again. There is no limit on the number of times you can claim tax-free profit on the sale of a home.

That break that is restricted to the sale of a primary residence. But you can extend the it to cover part of the profit on a second home if you convert it to your primary residence at least two years before you sell. The portion of the profit that is tax-free is based on the ratio of time after 2008 that the house was a second home to the total time you owned it. Say you buy a vacation home this year, use it as a retreat for five years, and then move in and make it your principal residence. If you sell ten years later, two-thirds of the profit would be tax-free.

Don't underestimate the cost of home-equity debt. Generally, interest on up to $100,000 of debt secured by your home can be deducted, no matter what you use the money for. But if you are among the growing number of taxpayers subjected to the alternative minimum tax (AMT), home-equity debt is only deductible if the loan was used to buy or improve your home.

Use an installment sale of real estate to defer a tax bill. If the buyer pays you in installments, the IRS will let you pay the tax bill on your profit in installments, too. You must charge interest on the deal, and each payment you receive will have three parts: interest (taxable at your top rate), capital gain (taxed at a maximum of 20%) and return of your investment (tax-free).

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Charitable Donations

Tote up out-of-pocket costs of doing good. Keep track of what you spend while doing charitable work, from what you spend on stamps for a fundraiser, to the cost of ingredients for casseroles you make for the homeless, to the number of miles you drive your car for charity (at 14 cents a mile). Add such costs with your cash contributions when figuring your charitable contribution deduction.

Put away your checkbook. If you plan to make a significant gift to charity , consider giving appreciated stocks or mutual fund shares that you've owned for more than one year instead of cash. Doing so supercharges the saving power of your generosity. Your charitable contribution deduction is the fair market value of the securities on the date of the gift, and you never have to pay tax on the profit.

Give away an IRA. After age 70½, you must withdraw a minimum from your IRA each year, even if you don't need the money. You can meet that obligation by directing that up to $100,000 go directly to a charity. You don't get a deduction, but you don't have to pay taxes on the payout, either.

Be creative with your generosity. A charitable-remainder trust can avoid capital gains taxes on appreciated assets, allow you to receive income for life and receive a tax deduction now for a charitable contribution that will be made after your death. A charitable-lead trust can avoid taxes on appreciated assets, earn an immediate tax deduction and still provide an inheritance for your heirs later. A donor-advised fund can earn you a tax deduction for the full value of appreciated assets now, even though you don't have to determine the recipients of your generosity until later years.

Estate Planning

Protect your heirs. Be sure beneficiary designations for your IRAs and 401(k)s are up to date. If your IRA or 401(k) goes to your estate rather an a designated beneficiary, unfavorable withdrawal rules could cost your heirs dearly.

Death and taxes. Someone who is terminally ill may want to sell investments that show a paper loss. Otherwise, the "tax basis" of the property — the value from which the heir will figure gain or loss when he or she sells — will be "stepped-down" to date-of-death value, preventing anyone from claiming the loss. If you want to keep property, such as a vacation home, in the family, consider selling to a family member. You get no loss deduction, but it could save the buyer taxes later on.

Give it away. Money you give away during your lifetime won't be in your estate to be taxed at your death. That's one reason there's also a federal gift tax. The law allows you to give up to $14,000 to any number of people in 2014 without worrying about the gift tax. If your spouse agrees not to give anything to the same person, you can give $28,000 a year to each individual. If you have four married kids, for example, and you give $28,000 to all eight children and in-laws, you can shift $224,000 out of your estate gift-tax free each year.

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Tax Savings for Affluent Older Families

For tax savings, convert a vacation home to your principal residence, give an IRA to charity and double your family's estate-tax break with a by-pass trust.

Updated May 2014

Investments and Retirement Planning

Check the calendar before you sell. You must own an investment for more than one year for profit to qualify as a long-term gain and enjoy preferential tax rates. The "holding period" starts on the day after you buy a stock, mutual fund or other asset and ends on the day you sell it.

Don't buy a tax bill. Before you invest in a mutual fund near the end of the year, check to see when the fund will distribute dividends. On that day, the value of shares will fall by the amount paid. Buy just before the payout and the dividend will effectively rebate part of your purchase price, but you'll owe tax on the amount. Buy after the payout, and you'll get a lower price, and no tax bill.

Scour your portfolio for paper losses. Never make investment decisions solely for tax reasons (that’s called letting the tax tail wag the investment dog), but the prospect of realizing a money-saving tax loss might be the impetus you need to unload a loser. If you incur losses during the year, ask yourself if it’s time to take some money off the table by selling stocks or mutual funds that have enjoyed healthy run-ups in value. Offsetting losses could make your gains tax-free.

Tell your broker which shares to sell. Doing so gives you more control over the tax consequences when you sell stock. If you fail to specifically identify the shares to be sold, the tax law's FIFO (first-in-first-out) rule comes into play, and the shares you've owned the longest (and perhaps the ones with the biggest gain) are considered to be sold. With mutual funds, an "average basis" can be used when determining gain or loss; but that alternative isn't available for stocks. If you use an online brokerage, send an email directing which shares should be sold and ask for a response confirming receipt of your request.

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Ask your broker for a favor. The law allows investors to deduct a loss on a worthless security, but only if you can prove the stock is absolutely worthless. If you own stock you're sure isn't coming back, ask your broker to buy it from you for a nominal amount. You can then report the sale and claim your loss.

Consider tax-free bonds. It's easy to figure whether you'll come out ahead with taxable or tax-free bonds. Simply divide the tax-free yield by 1 minus your federal tax bracket to find the "taxable-equivalent yield." If you're in the 33% bracket, your divisor would be 0.67 (1 - 0.33). So, a tax-free bond paying 5% would be worth as much to you as a taxable bond paying 7.46% (5/0.67).

A bond swap may pay off. It's a fact of life: As market interest rates rise, bond values fall. If you have bonds that have lost value, consider a bond swap. You sell your losers, cash in the tax loss and invest the proceeds in higher-yielding bonds to maintain your income stream.

Think twice about selling stock for a profit if you're subject to the AMT. Although long-term capital gains benefit from the same 15% maximum rate under both the regular tax rules and the alternative minimum tax, a capital gain can effectively cost more than 20% in AMT-land. The special AMT exemption is phased out as income rises so, for example, a $1,000 capital gain can wipe out $250 of the exemption, effectively exposing $1,250 to tax. That means your tax bill rises by more than $150 for that $1,000 gain.

Keep a running tally of your basis. For assets you buy, your "tax basis" is basically how much you have invested. It's the amount from which gain or loss is figured when you sell. If you use dividends to purchase additional shares, each purchase adds to your basis. If a stock splits or you receive a return-of-capital distribution, your basis changes. Only by carefully tracking your basis can you protect yourself from overpaying taxes on your profits when you sell. If you're not sure what your basis is, ask your brokerage or mutual fund company for help. (Financial services firms must now report to investors the tax basis of shares redeemed during the year. For the sale of shares purchased in 2012 and later years, they must also report the basis to the IRS.)

Beware of Uncle Sam's interest in your divorce. Watch the tax basis — that is, the value from which gains or losses will be determined when property is sold — when working toward an equitable property settlement. One $100,000 asset might be worth a lot more — or a lot less — than another, after the IRS gets its share. Remember: Alimony is deductible by the payer and taxable income to the recipient; a property settlement is neither deductible nor taxable.

Time claiming Social Security benefits. If you stop working, you can claim benefits as early as age 62. But note that each year you delay — until age 70 — promises higher benefits for the rest of your life. And, delaying benefits means postponing the time you'll owe tax on them. Try Kiplinger's Social Security Solutions to find out your optimal solution.

Dodge a 50% tax penalty. Taxpayers older than 70½ are required to take minimum withdrawals from their IRAs each year. Failing to do so, subjects them to one of the toughest penalties in the tax law: the IRS claims 50% of the amount that should have come out of the account. Your IRA sponsor can help pinpoint the amount of the required payout. More on the ins and outs of the minimum withdrawals.

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Tax Savings for Affluent Older Families

For tax savings, convert a vacation home to your principal residence, give an IRA to charity and double your family's estate-tax break with a by-pass trust.

Updated May 2014

Medical Expenses

Keep careful records of the cost of medically necessary improvements. To the extent that such costs — for adding a wheelchair ramp, for example, lowering counters or widening a doorway or installing hand controls for a car — exceed any added value to your home or vehicle, that amount can be included in your deductible medical expenses.

Include travel expenses in medical deductions. In addition to the cost of getting to and from the doctor, you can deduct up to $50 a night for lodging if seeking medical care requires you to be away from home overnight. The $50 is per person, so if you travel with a sick child to get medical care, you can deduct $100 a day. You get a tax benefit only to the extent your expenses exceed 10% of adjusted gross income, or 7.5% if you're 65 or older.

Crank in the value of deducting long-term-care premiums. As you shop for long-term care insurance, remember that a portion of the cost is deductible. The older you are, the more you can write off. For employees, this is a medical expense which means it only saves money if your medical expenses exceed 10% of your adjusted gross income (7.5% if you're 65 or older.) If you're self-employed, you avoid the haircut and get this deduction even if you don't itemize.

Rental Property

Take advantage of tax-free rental income. You may not think of yourself as a landlord, but if you live in an area that hosts an event that draws a crowd (a Super Bowl, say, or the presidential inauguration), renting out your home temporarily could make you a bundle — tax free — while getting you out of town when tourists overrun the place. A special provision in the law lets you rent a home for up to 14 days a year without having to report a dime of the money you receive as income.

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Stay actively involved in rental real estate. Generally, anti-tax-shelter legislation prevents losses from real estate investments from being deducted against other kinds of income. But, if you are actively involved in a rental activity, you can deduct up to $25,000 of such losses, if your adjusted gross income is less than $100,000. You don't have to mow grass and unclog toilets to qualify as actively involved; but you should make sure you're involved in setting rents and approving tenants and management firms.

Use a tax-free exchange to acquire property. By trading one rental property for another, for example, you avoid the capital gains taxes you'd incur if you sold the first property, leaving you with more to invest in the second.

Your Children

Fund a Roth for you child or grandchild. As soon as a child has income from a job — such as babysitting, a paper route, working retail — he or she can have an IRA. The child's own money doesn't have to be used to fund the account (fat chance that it would). Instead, a generous parent or grandparent can provide the funds, or perhaps match the child's contributions dollar for dollar. Long-term, tax-free growth can be remarkable.

Help your children earn credit for retirement savings. This credit can be as much as $1,000, based on up to 50% of the first $2,000 contributed to an IRA or company retirement plan. It's available only to low-income taxpayers, though, who are often the least able to afford such contributions. Parents can help, however, by giving an adult child (who cannot be claimed as a dependent) the money to fund the retirement account contribution. The child not only saves on taxes but also saves for his or her retirement.

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