No one likes to hear the heavy tread of the tax man, so it’s incumbent on you, your financial planner and your tax specialist to take advantage of the many available tools that keep predatory taxes from cutting into your wealth. The following presentation offers you 10 Top Tax Planning Opportunities you may be able to use to your benefit.

Top Tax Tip #1: Bracket Management

Everyone fits into a tax bracket so Uncle Sam can assess the percentage of taxes you have to pay on your income. However, it is very likely you can manage your taxable placement and reduce your taxes.

Brief Review:

The 2017 Tax Cuts and Jobs Act created seven ordinary income tax brackets as follows: 10%, 12%, 22%, 24%, 32%, 35%, and 37%, in addition, the Act established three capital gains tax brackets: 0%, 15%, and 20%. (There are also two additional tax brackets for special income.)

To add to the mix, even more tax brackets are possible with the new 3.8% net investment income tax (NIIT) that creates a 40.8% tax rate on ordinary income for high income taxpayers and a 23.8% tax rate applied to long-term capital gains.

Because of the variety of tax brackets that could apply to your particular financial situation and because you might be in a position to save tax expenses by careful planning, the strategies of tax deferral and “income smoothing” could give you a strong tax advantage.

The First Step

A properly considered tax strategy begins with estimating how much taxable income you’re expecting to receive over the next 5 to 15 years. Once this amount is estimated as accurately as possible, discovering ways to avoid the higher tax brackets and the NIIT can be initiated.

Multiple Potential Choices

Your tax strategy might include one or more of the following:

1. Harvest losses in high income years

2. Harvest gains in low income years

3. Contribute to traditional IRAs in high income years

4. Contribute to Roth IRAs in low income years

5. Invest in tax-deferred annuities

6. Create charitable remainder or lead trusts

7. Engage in life insurance strategies

8. Implement Roth IRA conversions

9. Create family trusts

Whichever of these possibilities are most profitable for you and your tax circumstances, the concept is basic: use income smoothing to achieve the best tax-advantage benefit for you.

Income Smoothing

Income smoothing typically means one of these two choices:

1. Reducing your taxable income during high income years by increasing your deductions and shifting your income to years with lower income, and/or

2. Increasing your taxable income during low income years by deferring your deductions and decreasing your taxable income to fit into the lower tax brackets.

Another key strategy is to keep your taxable income under the 3.8% NIIT threshold level so you don’t bear the burden of additional higher income tax. Should this strategy not apply, the focus then becomes keeping taxable income under the 37% tax bracket.

Remember, poor bracket management is likely to result in your being responsible for paying taxes you might otherwise not have to pay. A little planning now can go a long way to helping you retain more of your wealth.

As with the other strategies mentioned in this report, this is only the tip of the iceberg of the many permutations available to you with bracket management. Other issues include whether or not you are single or married, and whether you are currently in your early accumulation years, core accumulation years, or enjoying retirement.

Tax deferral can be a very powerful tool, and when used expertly, it can result in significant wealth protection.

Top Tax Tip #2: Roth IRA Conversions

Roth IRAs differentiate from traditional IRAs in several important ways:

  1. Over the long-term, they can lower your overall taxable income

  2. They offer tax-free growth, not tax-deferred growth.

  3. Required minimum distributions (RMDs) are not required at age 70½

  4. Your beneficiaries can withdraw the funds tax-free.

  5. Roth IRAs provide more effective funding of your bypass trust

  6. They are a good instrument for working with the NIIT, and facilitate in come smoothing

Of course, whether or not a Roth conversion is particularly favorable depends upon the taxpayer’s larger financial situation. Only a careful analysis can determine the value of conducting a Roth IRA conversion.

If the taxpayer’s tax rate is low at the time of conversion, the taxpayer will obviously enjoy a positive financial result by converting. The reverse is true if the taxpayer’s tax rate is too high. However, if the tax rate is slightly to moderately high, there are factors that may make a Roth IRA conversion advantageous.

Here are some factors of particular interest:

  • If the taxpayer is able to pay the Roth conversion tax with funds other than the Roth IRA, more financial value will be retained by the IRA, favoring continued growth of the asset.
  • If a taxpayer has such favorable tax capabilities as investment tax credits, net operating losses, charitable deductions, etc., these may diminish the taxable conversion amount.
  • If the taxpayer does not need to receive the minimum distribution at age 70½, the Roth IRA fund can continue to grow for the benefit of the taxpayer’s heirs.
  • When a taxpayer makes a Roth IRA election during their lifetime, they reduce the overall value of the estate and thus potentially decrease the cost of higher estate tax rates.
  • When making a Ross IRA election, taxpayers benefit by paying income tax before paying estate tax…compared with the income tax deduction of a traditional IRA that is subject to estate tax.
  • If a taxpayer is married, there is the possibility that the conversion tax of a married couple filing joint returns could be less.
  • Distributions to the surviving spouse are tax-free.
  • Distributions to surviving beneficiaries are tax-free.
  • Roth IRA distributions are not calculated in the 3.8% NIIT net investment income or MAGI (Modified Adjusted Growth Income).
  • Roth IRA distributions also will not increase 199A taxable income, but might increase the deduction under certain conditions.

When it comes to preserving wealth, Roth IRA conversions fall into one of four factors:

1. Strategic conversions: Conversions in this category seek to take advantage of a client’s long-term wealth transfer goals.

2. Tactical conversions: These provide short-term income tax relief for attributes that will soon expire such as tax rates, tax credits, current year ordinary losses, etc.

3. Opportunistic conversions: This allows taxpayers to take advantage of short-term volatility in the stock market and such things as sector rotation and asset class rotation.

4. Hedging conversions: These conversions allow the taxpayer to be in position to take advantage of potential future events that could cause the taxpayer to be in higher tax rates in the future.

Avoiding the 3.8% NIIT is desirable. A Roth IRA conversion assists with income smoothing so more wealth could potentially be retained. A traditional IRA’s distributions are not NII but they do contribute to MAGI, and that could result in an increase in the taxpayer’s NIIT. For this reason, a taxpayer could choose to use a Roth IRA conversion as a way to keep future income out of the higher tax bracket categories and eliminate NIIT taxation on IRA distributions.

If it’s your goal to pay less taxes in your later years, a Roth IRA conversion could be a very useful tool for retaining your estate’s wealth. Depending on your particular financial circumstances, employing a Roth IRA to limit the tax-man’s bite could be a good solution for you.

We hope this first article about two strategies you can use to save money n your taxes in FY 2019 was insightful. We welcome a discussion with you on how Synergy Financial Management can facilitate your tax savings this year. Thank you!

Joseph M. Maas, CFA, CVA, ABAR, CM&AA, CFP®, ChFC, CLU®, MSFS, CCIM

Synergy Financial Management, LLC

13231 SE 36th Street, Suite 215

Bellevue, WA 98006

ph: 206.386.5455

fx: 206.386-5452

www.sfmadvisors.com