Tax Planning

For those of you who have wondered “What exactly is tax planning?” I’ve attached a few examples.

 

The first example demonstrates how to get more deductions by timing them carefully. You are entitled to deduct the greater of the standard deduction for your filing status (this example assumes Married Filing Joint) or itemized deductions. In Texas, real estate taxes are due by January 31, but most people pay them in December to take the deduction in the current year. By paying the 2014 taxes in January 2015, and paying the 2015 taxes in December 2015, you can reach the “better” plan, and by saving your contributions for 2014 until 2015, and then paying 2015 contributions in 2015, you get the “best” plan. So, economically, you are spending the exact same amount on real estate taxes and contributions, the only question is how much tax you can save by paying them in groups.

 

Timing your itemized deductions
Normal plan: 2014 2015 2 year total
Standard Deduction (Married filing joint)         12,400          12,600
or
Itemized Deductions
Mortgage Interest           6,500            6,500
Real Estate Taxes           4,000            4,000
Contributions           1,500            1,500
Total         12,000          12,000
Taken on return (larger of Std Deduction or Itemized)         12,400          12,600               25,000
Better plan:
2014 2015
Standard Deduction (Married filing joint)         12,400          12,600
or
Itemized Deductions
Mortgage Interest           6,500            6,500
Real Estate Taxes (pay in Jan 2015 and Dec 2015)                 –            8,000
Contributions           1,500            1,500
Total           8,000          16,000
Taken on return (larger of Std Deduction or Itemized)         12,400          16,000               28,400
Additional deductions (28,400-25,000)                 3,400
Tax savings at 28%                    952
Best plan:
2014 2015
Standard Deduction (Married filing joint)         12,400          12,600
or
Itemized Deductions
Mortgage Interest           6,500            6,500
Real Estate Taxes (pay in Jan 2015 and Dec 2015)                 –            8,000
Contributions (pay in Jan 2015 and Dec 2015)            3,000
Total           6,500          17,500
Taken on return (larger of Std Deduction or Itemized)         12,400          17,500               29,900
Additional deductions (29,900-25,000)                 4,900
Tax savings at 28%                 1,372

The next example is timing of capital gains and losses. When you take them (i.e., when you actually sell the stock) can make a world of difference.


Capital Gains Timing
Example:
Stock 1 Stock 2 Total Tax
Purchased stock November 2014  $     10,000  $     10,000  $     20,000
Current value December 2015  $       7,000  $     13,000  $     20,000
Potential Gain/(loss)  $     (3,000)  $       3,000  $            –
If you sell both in Dec 2015
Taxable gain  $            –
Tax  $        –
or
Sell Stock 1 in Dec 2015 and
Sell Stock 2 in Jan 2016
Loss in 2015  $     (3,000)
Tax savings at 28%  $         840  $      840
Gain in 2016  $       3,000
Taxed at capital gains rate of 15%  $        (450)  $    (450)
Net savings from splitting gains/losses over 2 years  $      390

 

 

And finally, this shows what can happen when you have depreciable assets. The tax code allows you to expense the amount (known as Section 179), or take bonus depreciation (this year it’s one-half of the amount spent), or elect to use neither option and depreciate the asset over its tax life (7 years in this example). This one is kind of hard to follow, (I suggest printing it out and marking it up) but it demonstrates that taking all depreciation now is not always a good idea.

Example: Schedule C and  depreciation
Choice 1 Choice 2 Choice 3
$50,000 Section 179 No Section 179, but bonus depreciation No Section 179 or bonus depreciation
Equipment placed in service in 2015, cost of          50,000          50,000          50,000
Taxpayer’s return before this decision looks like this:  Year 1
Gross Income        130,000        130,000        130,000
Expenses other than depreciation      (100,000)      (100,000)      (100,000)
Depreciation (including bonus and Sec 179)        (50,000)        (28,573)          (7,145)
Net income from self-employment        (20,000)           1,427          22,855
Spouse’s W2          20,000          20,000          20,000
Deduction for one-half of self employment tax                –             (101)          (1,615)
Standard deduction        (12,600)        (12,600)        (12,600)
Personal exemption          (8,000)          (8,000)          (8,000)
Taxable income        (20,600)              726          20,641
Income tax                –                73           2,174
Self employment tax                –              202           3,229
Total tax Year 1                –              275           5,403
We expect next year to be:  Year 2
Gross Income        130,000        130,000        130,000
Expenses other than depreciation      (100,000)      (100,000)      (100,000)
Depreciation (including bonus and Sec 179)          (6,123)        (12,245)
Net income from self-employment          30,000          23,877          17,755
Spouse’s W2          20,000          20,000          20,000
Deduction for one-half of self employment tax          (2,120)          (1,687)          (1,255)
Standard deduction        (12,600)        (12,600)        (12,600)
Personal exemption          (8,000)          (8,000)          (8,000)
Taxable income          27,281          21,590          15,901
Income tax           3,541           2,316           1,590
Self employment tax           4,239           3,374           2,509
Total tax Year 2           7,780           5,690           4,099
Total tax years 1 and 2           7,780           5,965           9,502
We expect next year to be:  Year 3
Gross Income        130,000        130,000        130,000
Expenses other than depreciation      (100,000)      (100,000)      (100,000)
Depreciation (including bonus and Sec 179)          (4,373)          (8,745)
Net income from self-employment          30,000          25,627          21,255
Spouse’s W2          20,000          20,000          20,000
Deduction for one-half of self employment tax          (2,120)          (1,811)          (1,502)
Standard deduction        (12,600)        (12,600)        (12,600)
Personal exemption          (8,000)          (8,000)          (8,000)
Taxable income          27,281          23,217          19,154
Income tax           3,170           2,560           1,951
Self employment tax           4,239           3,621           3,003
Total tax Year 3           7,409           6,181           4,954
Total tax years 1, 2, and 3          15,189          12,146          14,456
Ranking Worst Best Middle
Savings           3,043              733