Legal Authorities 

     I want you to be totally confident about the tax strategies you’ll be learning about in this book to create your proactive tax plan. All tax reductions strategies are fully authorized by The Federal government, U.S. Courts, and the Internal Revenue Service. All tax strategies are legally based upon the Internal Revenue Code, U.S. Treasury Regulations, U.S. Tax Court published opinions, IRS Revenue Procedures, IRS Private Letter Rulings, IRS Publications, IRS Manuals, and IRS Tax Forms.    

Tax Preparation, Planning, Assessment

     The entire subject of taxes can be broken down into three basic areas:

(1) Tax Preparation

    Tax Preparation is what Accountants do for people each year around April 15th. Accountants take all the annual invoices and receipts people dump into their lap, and they enter the right numbers on the right lines on the right tax forms, and then delivers those tax forms to the U.S. Treasury Department.

(2) Tax Planning

     Tax Planning is what this book will do for you. This book will show you how to create a proactive tax plan that will put more of your hared earned money into your pocket each year. Rarely do accountants perform any tax planning. In fact, only 5 percent of the CPA state examinations taken by accountants even involve tax planning.

(3) Tax Assessment

     Tax Assessment is what the IRS does all year long, unless you have proper tax preparation and tax planning. There is a huge group of tax professionals who dedicate their lives and careers to helping individuals and businesses resolve tax assessments. They assist clients at IRS Tax Audits, the IRS Office of Appeals, the U.S. Court system, and with installment notes and offers of compromise. This book will show you how to avoid these tax assessments, and thus avoid having to hire these tax professionals.

ProActive Tax Plan

     Let’s start by reviewing the underlying tax goals which will be incorporated into all of your tax reduction strategies. I refer to these tax goals as “The Holy Grail.”

(1) Convert ordinary gross income into TAX-FREE, TAX-REDUCED, and TAX-DEFERRED INCOME;

(2) Lower ordinary gross income by maximizing ADJUSTMENTS, DEDUCTIONS, EXEMPTIONS, and CREDITS; and

(3) SHIFT ordinary gross income to other individuals and future tax years, while shifting future Deductions to the present tax year.

Tax-Free Income 

     The first goal of any tax reduction strategy involves finding ways to convert ordinary gross income into tax-free income.

     Tax-free income is just what it sounds like; income for which you pay zero taxes. Unlike ordinary gross income, you should always welcome tax-free income with open arms. The IRS cannot seize one penny of this very special category of income.

     The Federal government intended certain forms of income to escape taxation in order to promote economic and social policies. Don’t argue with the Federal government on this policy. Pursuing tax free income is perfectly legal, and perfectly smart.

      With proper tax planning, tax-free income includes: the sale of your home, rental income from a vacation home, a like-kind real estate exchange, gifts, child support, family member’s earned income, damage awards and settlements, divorce awards and settlements, public assistance, awards and prizes, employee fringe benefits, foreign income, work transportation, disability pensions, certain education and retirement accounts, scholarships, municipal bonds, U.S. savings bonds, social security benefits, life insurance, inheritance, money earned within family limited partnerships and family limited liability companies, and various types of trusts, such as a living trust, spendthrift trust, education trust, special needs trust, charitable trust, irrevocable life insurance trust, grantor retained trust, and qualified personal residence trust.

     The preceding list does not include every form of tax-free income. There are over fifty ways to receive tax-free income that we’ll examine during this study course. Take advantage of tax-free income whenever possible.

Tax-Reduced Income

     If you cannot find a way to convert ordinary gross income into tax-free income, your next tax goal is to convert ordinary gross income into tax-reduced income.

     Tax-reduced income includes long-term capital gains from the sale or disposition of a capital asset, such as personal property and real property. Tax-reduced income also includes legal tax shelters, as well as tax shifting strategies, such as shifting income from the present year to a future year; shifting income from an individual in a higher tax bracket to an individual in lower tax bracket; and shifting tax deductions from a future year to the present year.

Capital Gains

     Chapter 26 of the Internal Revenue Code at Section 1221 defines a “Capital Asset” to include the sale of real and personal property, such as real estate and securities. A capital asset also includes the sale of a copyright, literary, musical, or artistic composition, a letter or memorandum, accounts or notes receivable, a publication of the U.S. Government, a hedging transaction, and business supplies. A capital asset even involves the sale of a business.    

     When you sell a capital asset you owned for at least one year, you normally pay a substantially lower tax rate than the tax rate for your ordinary gross income. The amount of your tax liability therefore depends upon whether your gain is short-term or long-term. As you can see, the key factor is time.

     When you own a capital asset for “less than one year,” and you then sell the capital asset, any dollar gain you receive from the sale will be subject to the same tax rate as your ordinary gross income.  This is called “short term capital gains.” 

     When you own a capital asset for “more than one year,” and you then sell the capital asset, any dollar gain you receive from the sale will be blessed with a special tax rate that is normally much lower than the tax rate for your ordinary gross income.  This is called “long term capital gains.” 

     This marvelous tax strategy is not limited to self-employed individuals or business owners, or reserved for the Rich, Middle Class, or Poor. Anyone can take advantage of long-term capital gains.

Tax Shelters

     Many people believe tax shelters consist of illegal tax evasion that will send them straight to prison. Nothing could be further from the truth. Ask the Internal Revenue Service. A legal tax shelter syndicate once purchased an office building in New York City leased by the IRS!

     The Federal government addresses Tax Shelters in Section 6111 and 6112 of Chapter 26 of the Internal Revenue Code. These sections discuss the “disclosure of reportable transactions” by “material advisors.”

      The term “Tax Shelters” is not really any particular tax strategy, but is really only a generic phrase for any means of minimizing one’s tax liability. All Tax Shelters involve one or more of the following tax reduction strategies: leverage, deductions, depreciation, depreciation, credits, and conversion. 

     You most likely participated in one or more tax shelters without even realizing it. For example, if you ever purchased a rental home, you were involved in a Tax Shelter. You obtained leverage by means of a home mortgage loan. You received deductions for the home, land, and furnishings. You depreciated the home over an extending number of years. If your purchase involved a community development project, you received a tax credit. Finally, you converted ordinary gross income into long-term capital gains by selling the home more than one year after you purchased it.

    In a nutshell, the word “Tax Shelter” has gained a negative reputation during the past decade, but Tax Shelters are legal. In fact, the most widely used Tax Shelter in the U.S.A. today is a 401K employer sponsored retirement plan.     

Tax Shifting

     There exists a very simple but often unused tax reduction strategy known as “tax Shifting.” Tax Shifting involves three tax goals:

     (1) Present Year: You shift tax deductions from a future year to the present year. You use this tax strategy when you anticipate receiving more income in the present year than next year. Common examples include business expenses, taxes, mortgage interest, investments, credit cards, and gifts.

     (2) Family Members: You shift taxable income from yourself to another family member. You use this tax strategy when you’re in a higher tax bracket than a family member. Common examples include gifts, employment earnings, and co-ownership of a family limited partnership or limited liability company.

     (3) Future Year: You shift taxable income from the present year to a future year. You use this tax strategy when your receipt of ordinary gross income in the present year would be subject to a higher tax rate than if received in a future year.      Common examples involve wages and salary, business sales, investments, contracts, and retirement plans.

Tax-Deferred Income

     If you cannot find a way to convert ordinary gross income into tax-free income or tax-reduced income, your next tax goal is to convert ordinary gross income into tax-deferred income.

     Tax-deferred income involves ordinary gross income for which you pay zero taxes in the present year, because you elect to defer the payment of taxes until a future year.

     What happens with the ordinary gross income you elect to defer? First, you put the income into individual or employee retirement plans approved by the Federal government. Next, you invest the income in stocks, mutual funds, commodities, bonds, and real estate. Finally, you make withdraws from your plans during your retirement years.

     Besides paying zero current taxes on the ordinary gross income you put into a retirement plan, you also pay zero current taxes on any interest, investments gains, and appreciation generated by your income. In fact, you never pay any taxes whatsoever until the date you make a withdrawal from your retirement plan, at which time, you pay ordinary taxable income when you are most likely in a lower tax bracket.

Adjustments

     Another effective way to reduce your taxes is by means of Adjustments. Adjustments involve special types of tax deductions that are subtracted from your ordinary gross income to determine your adjusted gross income. The more Adjustments you have, the less taxable income you have, which means the less taxes you pay.

     Adjustments are authorized by the Federal Government in Section 62 of Chapter 26 of the Internal Revenue Code. Adjustments include payment of expenses associated with self-employment taxes, health savings accounts, education, retirement accounts, moving, and alimony.

     Adjustments are “above the line deductions.” What line? The adjusted gross income line. Above the line deductions involve Adjustments and business expenses, while “below the line deductions” involve other itemized deductions. There are two reasons why above the line Adjustments provide more valuable tax deductions than below the line itemized deductions.

     The first reason involves a tax concept known as “Phaseout.” Phaseout triggers a loss of below the line deductions when your annual adjusted gross income reaches a certain dollar amount. When Phaseout occurs, you can no longer benefit from below the line deductions. Adjustments can help remedy this situation. Adjustments can lower your annual adjusted gross income below the Phaseout amount, and thus enables you to enjoy additional below the line deductions.

     For example, let’s say your annual adjusted gross income totals $120,000, and your Phaseout amount begins at a $100,000. Under this scenario, you can no longer benefit from anymore below the line deductions because your $120,000 of income exceeds your $100,000 Phaseout. Now throw in $30,000 of Adjustments. These adjustments lower your income from $120,000 to $90,000. Since your income is now $10,000 below the $100,000 Phaseout, you can now enjoy an additional $10,000 in below the line deductions that were previously disallowed.

     The second reason why above the line Adjustments are more valuable than below the line itemized deductions involves a tax concept known as “Deductible.”  A Deductible causes a loss of below the line tax deductions because your tax deductions have not exceeded a certain percentage of your adjusted gross income. Examples of itemized deductions that include a deductible are medical bills, charitable contributions, and casualty losses. Adjustments can help remedy this situation. Adjustments can lower your adjusted gross income, which in turn, lowers the amount of your deductible, and thus enables you to enjoy additional below the line itemized deductions.

     For example, assume again your annual adjusted gross income totals $120,000, and there is a 7.5% deductible for your medical deductions, which equals $9,000 based upon your $120,000 income.  Now let’s say your medical bills total $8,000 for the year. Under this scenario, you cannot benefit from your $8,000 of medical deductions because they do not exceed your $9,000 deductible threshold. Now throw in $30,000 of Adjustments. These Adjustments lower your income from $120,000 to $90,000, and thus decrease your deductible from $9,000 to $6,750. You can now enjoy $2,250 of your $8,000 medical deductions that were previously disallowed.

Itemized Deductions

       Another effective way to reduce your taxes is by means of Itemized Deductions.  Itemized Deductions are subtracted from your adjustable taxable income, along with Exemptions, to determine your taxable income. The more Itemized Deductions you have, the less taxable income you have, which means the less taxes you pay.

     As discussed in the preceding section, “above the line” deductions involve adjustments and business expenses, while “below the line deductions” involve other Itemized Deductions.  Itemized Deductions are therefore similar to adjustments, but not as powerful as Adjustments, because Itemized Deductions are subject to income Phaseout and Deductibles.

     Itemized Deductions include the “Standard Deduction,” which is a statutory dollar deduction that everyone receives, even if they have not paid any deductible expenses. If an individual earns income below the Standard Deduction amount, the individual pays no income taxes. If an individual earns income above the Standard Deduction amount, the individual may or may not pay income taxes, depending upon his or her above the line deductions.

      When your annual Itemized Deductions exceed the Standard Deduction, you select your Itemized Deductions for your tax return instead of the Standard Deduction, because your Itemized Deductions will lower your taxable income more than your Standard Deduction. Itemized Deductions include unreimburseable employee expenses, along with home mortgage interest, points, taxes, health insurance, medical bills, dental bills, charitable contributions, casualty losses, gambling losses, and education.

Exemptions

     Exemptions provide another way to lower your taxes. Exemptions involve below the line deductions, and are therefore similar to itemized deductions. Exemptions are subtracted from your adjustable taxable income, along with your itemized deductions, to determine your taxable income. The more Exemptions you have, the less taxable income you have, which means the less taxes you pay.

     Exemptions come in two flavors:

(1) Filing Status

      Your Filing Status can be married filing jointly, married filing separately, head of household, qualifying widow or widower, or single. Each Filing Status provides a different tax advantage and disadvantage.

(2) Dependents

     You can claim any individual as a dependent if he or she is a member of your family whom you provide domestic and financial support during the year. There are no limitations to the number of dependents you can claim each year.

Credits

      Tax Credits lower your taxes dollar for dollar. In other words, every dollar of tax credit cuts your tax liability by one dollar. For example, $100 of tax credits lowers your tax liability by $100. Only tax-free income can match this amazing feat.

     Tax Credits include dependent children, dependent care, adoption costs, low earned income, certain education costs, elderly status, disability status, qualified rehabilitation building community development, residential energy, foreign taxes, certain retirement savings contributions, and an electric vehicle.