The best income to receive tax wise is tax free. And while it may seem surprising there are many kinds of tax free income available. Here are a dozen kinds of income on which you need never to pay tax….
1. New tax free capital gains and dividends. Starting in 2008 capital gains and qualified dividends are tax free to people in the 10% and 15% tax brackets, which cover taxable incomes up to $65,150 on a joint return and $32,550 on a single return. Total income can be larger when taking personal exemptions and standard or itemized deductions into account.
The Alternative: If your income is too high for you to qualify to take such income tax free, consider making gifts of capital gains and dividend paying assets to lower bracket family members who do qualify.
2. Roth IRA and Roth 401(k) earnings. Contributions to these retirement savings accounts are not deductible, but all investment returns earned in them and distributions from them can qualify to be totally tax free.
Long term planning: There is a real risk that tax rates will increase in coming years due to large looming budget shortfalls and surging costs of Medicare and Social Security. If tax rates do rise, tax free income from Roth IRAs and Roth 401(k) will become even more valuable compared with retirement income taxed at ordinary rates when received from traditional IRAs and other kinds of retirement plans.
3. Interest free loans. A parent might want to make a loan to a child. Loan proceeds are tax free to the recipient, and loans given on interest free terms effectively provide fax free income to the recipient by saving the interest cost that would normally be owed when taking out a bank loan or such an amount.
No adverse tax consequences result from an interest free loan if all such loans made by the lender to the recipient do not exceed
A. $10,000 and the recipient does not invest the loan amount in income producing assets
B. $100,000 and the recipient’s net investment income does not exceed $1,000 in one year.
The recipient can obtain a valuable return from the loan proceeds by using them to start a business or buy a home or other asset, pay for education, etc.
Caution: For loans larger than the above amounts and when the rules are not met for loans of the above sizes, interest may be “imputed” on a loan, meaning that tax wise, the loan is treated as if interest is paid on it even though none actually is. The tax consequence: The lender has taxable interest income.
4. Children’s earned income. As a dependent child can receive up to $5,450 of income earned from a job tax free in 2008, protected from tax by the child’s standard deduction. Even better….
A. If the child places a like amount in a Roth IRA, they can earn compounding tax free investment income on it for life.
B. If the child’s salary is paid by a parent’s business, the business can deduct the salary, making that much of its income tax free to the family. If the child is under age 18 and the parent’s business is unincorporated, no Social Security tax is due on the child’s wages.
5. Children’s investment income. The so called “kiddie tax” applies generally to the investment income of children under age 19, and dependent children under age 254 who are full time students, which is taxed at their parent’s tax rate.
But the first $900 of a child’s investment income is exempt from any tax in 2008, and the next $900 will be taxed to the child at the child’s rate. Therefore, you can investment up to $30,000 in the child’s name ; earn the $900 interest and pay no tax on the interest.
6. Perpetually tax deferred gain. Capital gains tax on appreciated properties, such as investment of business real estate, can be delivered by swapping one property for a replacement in a “like-kind exchange” instead of selling the property for case. Taxable gain is deferred until the replacement property is sole, but that property also can be swapped in a tax deferred exchange, and so on, indefinitely. In the meantime, the tax free cash can be obtained from the appreciating properties by borrowing against them.
The requirements to make a like-king exchange are technical, so for the details call your accountant or our office for guidance.
7. Education savings. Contributions to a state sponsored “Section 529” college savings plan and or to a Coverdell Education Savings Account can earn investment returns that are tax free, when used to pay education costs. Also, up to $5,250 received from an employer’s qualified education assistance plan can be taken tax free when used to pay for the employee’s education
8. Home sales. Up to $250,000 of gain can be taken tax free on the sale of a home when you have owned it and used it as a primary residence for two of the prior five years. The income exclusion limit is $500,000 if you file a joint return.
9. Municipal bond interest. This is generally tax exempt from federal income tax, and may be exempt from state and local income tax as well.
Caution: Certain municipal bonds, known as “private activity bonds”, because they finance nongovernmental functions such as construction of sports stadiums, pay interest that is taxable under the alternative minimum tax (AMT). If you may be subject to the AMT, consult your advisor.
10. Gifts. These are tax free to recipients. Gift makers incur no tax cost on gifts up to $12,000 per recipient each year. In addition, gift makers have a $2million lifetime gift tax exemption amount. Gifts can reduce income tax by shifting income producing assets to family members in lower tax brackets, and reduce future estate tax by shifting assets out of an estate.
11. Bequests. These are tax free to recipients, and all taxable gain on bequeathed assets is eliminated at the owner’s death through “stepped up basis”. This resets the basis of inherited property as its market value as of the date of the owner’s death.
Example: A parent owns appreciated investment real estate that would product a $1 million taxable gain if he sold it. If he instead bequeaths the property to his children, they can sell it tax free for its value at the date of his death.
12. Employer provided tax free fringe benefits and “perks”. Employers can provide a wide range of tax free fringe benefits that effectively provide employees with tax free income.
Example: Employer matching contributions to 401(k) savings, group term life insurance coverage, disability insurance, flexible spending accounts into which employees can deposit a pretax portion of salary to pay for medical or dependent care coasts, employee discounts on products or services, free parking worth up to $220 per month and transit passes worth up to $115 per month. Check with your employer’s benefits manager to be sure that you are not missing out on any tax free pay.
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This publication is issued as a service to our clients and friends. This intellectual capital is of general nature and should not be acted upon without professional guidance. So if you know someone that is looking for a way to save taxes and avoid the IRS, call me at (702) 642-8953 or write me at isueirs@aol.com. No Exceptions. No Conditions. No Time limit. No IRS.
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