Five Strategies Of The Rich During Tough Economic Times
The current recession being the worst since the great depression has affected Americans in many ways. Going forward we are forced to be more cautious on our spending and borrowing habits but be aware that tax policy will be more aggressive during these times. The United States government has implemented plans to boost tax revenues by going after tax evaders in the Swiss banks, eliminating the provision for allowing overseas business income to be tax exempt and by being more aggressive on those that aren’t current in their taxes amongst other things.
As a tax advisor, I have come up 5 ways to limit your tax liabilities in these tough times. Some of the suggestions, you might have already heard of but if one takes advantages of all these suggestions, you might be surprised that you could reduce your tax liabilities by almost 30% on a yearly basis.
Municipal Bonds (often called munis)- These are bonds that are sold to state municipalities such as schools, governmental agencies, local infrastructure such as airports, seaports etc These types of bonds are more attractive than corporate bonds because their interest payments are tax exempt. No federal income tax and no state or local taxes in most states. There are a few that are taxed which are called private activity bonds but there is no need to have those in your portfolio if you can purchase ones that are completely tax exempt. All bonds will disclose if they are taxed or exempt so it makes sense to go for the ones that are exempt. The default rates on municipal bonds are a lot less than corporate bonds. Although not completely risk free it is unlikely that states will default on a bond. You can find municipal bonds from your broker. As states are cash strapped from less tax revenues, there has been increased demand for these types of bonds as it allows states to raise money much easier.
Government Credits- To revive the economy, the government is providing plenty of credits and subsidies to businesses and consumers to increase spending. The current savings rate is about 4% (total income minus total spending divided by total income). In 2006 it was negative; we were spending more than we were bringing in. Some of the current credits include first time home buyers credit, home energy improvement credits, cash for clunkers, alternative motor vehicle credit, health coverage credit for seniors, adoption credits for expenses involved in adopting a child, earned income credit for low income tax payers, American opportunity credit often called Hope credit for college related expenses, retirement contribution credits etc. As you can see, there are plenty of credits available and it is important to note that these credits are not tax deductions which means that you actually get money in your pocket for taking advantage of the credit rather than just a tax deduction. For more information on these credits.
Unrealized gains- This is a gain that is on paper and has not been exercised. For example, if your stock has appreciated by $1,000 on the stock market, it is not a realized gain until you sell the stock and take the gain. How can this be advantageous? If you know that your tax bracket in this year will be higher than next year, it will make sense to not realize your gain until next year. If you sold it in this year, you will be paying more taxes than if you held unto it and sold it next year. You can find current tax brackets on the internet and by planning you are able to take the gain and pay less tax. Gains are not only realized in the stock market, you can have gains in your home and any other assets that you own.
Treasury Inflation Protected Securities (often called TIPS)- These are bonds sold by the United States federal government and are indexed to compensate for inflation risk. In other words, your interest receipts are structured in a way that if inflation went up by 10%, your coupon payment will be increased by 10% respectively. (Inflation is based on the consumer price index) This is your safest bet on any bond. As a result, the interest payments on these bonds are very low but it is still income. These bonds are becoming more popular as most economists are predicting high inflation in the years to come.
Interest Payment Deductions- If you are a business owner, you can generally deduct as a business expense, all interest you pay or accrue during the year. If you had the chance to pay off a loan remember that loan payments are NOT tax deductible. The interest and the items that you purchased with the loan is generally deductible. You can determine the tax benefit from debt financing by multiplying the cost of debt by 1-tax rate. Keep in mind that you don’t have to be a business owner to take advantage of this provision, even interest on student loan payments are above the line adjustments which generously reduces your tax liability. There are requirements to these deductions so do your research to ensure that you will be qualified to take the deduction. Personal loans are always not deductible.