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  • 5 Tips for the Tax Long Game




  • 5 Tips for the Tax Long Game

    By: Daniel Abrams, CPA

    It's a tradition as American as baseball and apple pie: Tax Day is approaching, you are staring at a tax balance due, and you are searching for write offs to limit the damage. Here's a counter-intuitive question to consider: Is saving on taxes now really the best strategy? What about 5 years from now?

    Like all tax questions, it depends on your individual circumstances and nobody can predict future tax law changes. What we do know for sure is that tax rates are at historic lows, and that creates opportunities for longer term tax planning. Here's a few ideas for those who want to play the long game:

    1. Contribute to a Roth IRA

    A Roth IRA is a type of retirement account. Unlike Traditional IRAs, you do not get a tax deduction for contributing to a Roth IRA. However, Roth IRAs are a tax favored retirement account, so you do not pay tax on any investment income within the Roth IRA as it grows. As long as you wait until retirement to make withdrawals, all distributions from the Roth IRA will be tax-free, both earnings and principal. You can contribute to a Roth IRA as long as your earnings are under the limit, which is $122k for single filers and $193k for joint filers in 2019. What's more, you can access the principal portion of your Roth IRA before retirement if needed tax-free.

    When it makes sense:

    -Younger taxpayers with a longer time horizon

    -Years when your income and tax rate are abnormally lower than a typical year

    Bonus tip: If you make too much to contribute to a Roth IRA, check out the details of your employer's 401k plan. Often, employer sponsored retirement plans contain a Roth provision that will allow you to make Roth contributions to the plan.

    2. Open and fund a Health Savings Account

    A Health Savings Account (HSA) is a special type of savings account for those covered by a High Deductible Health Plan (HDHP). Most health insurance plans will tell you if your plan is HSA compatible. You must have a HDHP to qualify for HSA contributions.

    HSAs offer a triple tax advantage: you get a deduction for contributing to the account, your money grows tax-free, and as long as you use the proceeds for qualified medical expenses the distributions are tax-free as well. What also distinguishes an HSA is that, unlike Flexible Spending Accounts, you do not have to 'use it or lose it' each year. Your balance can grow in the HSA indefinitely. Most HSA accounts offer an investment option, so usually you can choose from a selection of mutual funds instead of leaving your entire balance in cash. For 2019, the HSA contribution limit is $3,500 for taxpayers with individual health coverage, and $7,000 for taxpayers with family coverage.

    When it makes sense:

    -All taxpayers with high deductible health plans

    -Taxpayers who expect to start a family

    -Taxpayers approaching retirement

    -Taxpayers who anticipate substantial future healthcare costs

    3. Consider a two-tiered approach to college savings

    Have kids or grandkids? Want to put a few dollars toward their college education? 529 college savings accounts are a tax-efficient and popular vehicle. Some states even offer a state tax deduction for making contributions. Much like retirement accounts, 529s grow on a tax-free basis. As long as distributions are used for qualified education expenses, there is no tax on distributions either. Funds can be transferred between beneficiaries if you have more than one child.

    As you might expect, 'qualified education expenses' is the catch here. This generally includes tuition and fees, books, required technology, and room and board. College can often come with ancillary costs, such as study abroad, fraternity or sorority dues, eating out, clothing, and more. Moreover, if there are funds leftover in the 529 account without education expenses to pay, non-qualified distributions of earnings are subject to both tax and a 10% penalty.

    This is why a 'two-tiered' approach might make sense. Consider funding both a 529 account and a custodial account, such as an UTMA account (Uniform Transfer to Minors Act).

    Custodial accounts are taxable brokerage accounts. Depending on your home state, the account becomes the property of the beneficiary when they reach age 18 or 21. The difference is, the funds in a taxable brokerage account can be used for anything, including all those 'extra' college expenses. It offers flexibility that a 529 account does not. However, it is a taxable account, so it's best to be mindful of the tax efficiency of investment choices in this account while it's open.

    When it makes sense:

    -Taxpayers with anticipated future college costs

    4. Hold that condo!

    So, you are finally moving out of your first home. Maybe it was a bachelor pad or a starter home in a hip neighborhood. Before rushing to put it on the market, it might make sense to think about holding the property for rental instead. Perhaps being a landlord wasn't your life dream, but it might be worth crunching the numbers. If market rents will cover your monthly cash costs, you get to build equity for free. And you might be in for a pleasant surprise on your tax return too. That's because residential rental real estate is depreciated over a 27.5 year life. Meaning, you get to write off the cost of your property over 27.5 years, and, depending on your income and level of involvement managing the property, losses from rental activities may be fully deductible.

    This obviously isn't for everyone, but moving to a new place doesn't necessarily have to mean selling your old place.

    When it makes sense:

    -Taxpayers who own real estate

    5. Pay off your student loans

    Ok, we get it: You would probably like to be done with your student loans too. Here's an extra incentive: The tax deduction for student loan interest is capped at $2,500 no matter how much interest you pay. For 2019, the deduction is phased out entirely if your modified adjusted gross income exceeds $85,000 for single filers and $170,000 for joint filers. If you needed another reason to pay down your student loans aggressively, here it is: there's not much of a tax break for having student loan debt.

    When it makes sense:

    -Taxpayers with student loans

    If you want to learn more about how the tax long game might apply to you, please reach out to us at (612) 840 – 4080 or via email at danny@abramstaxco.com


    05/29/2019



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