Nibletz Staff
Federal income and capital gains taxes are a hit or miss game. You might think that the amount you earn might will determine how much you pay but actually it’s much more complicated than that and you can reduce your tax bill with some careful planning and a better understanding of the financial services available to you. There are many things that can affect the percentage of tax you are liable to pay including the financial accounts you invest in and how you choose to manage any money that you make. There are investment programs and tax-efficient accounts specifically set up to encourage economic growth and free up taxable income for property, stock and business investment. For a startup entrepreneur, managing the amount of tax payable can mean the difference between new business success or failure so it is important to get it right. There are three main options for managing your federal and capital gains tax bills, these are:
- Using tax-advantage accounts and investments to not only save on the contributions on your current taxable income but also reduce tax on any investment growth in future years. Options such as 401(k)s, 403(b)s, IRAs, and health saving accounts allow you to defer your tax burden and potentially offer tax-free contributions, deposits and withdrawals.
- Utilizing strategic asset location and mutual fund distribution to manage your federal and capital gains tax. This includes offsetting charitable gifts, capital loss deductions and other tax deductable programmes such as 1031 exchange to manage income made from property investment.
- Reduce taxes by exploiting municipal bond income, Roth IRA or 529 college savings options. These not only reduce your overall tax bill but encourage good saving habits that offer huge growth benefits.
Let’s take a look at a few of these options in a little more detail. For instance let’s review how these options can help you to create a sound tax strategy that will look after your money so that you can get on with building your startup business as well as supporting your personal financial future through property and stock market investment.
Saving using a tax-deferred account is a positive choice not only to defer your tax bill but also to support high-growth savings that can be used towards your retirement. In fact this is positively encouraged. You will see your savings grow faster in a tax-deferred account and it has the dual benefit of planning for your financial future. In fact retirement savings is an important part of your strategic tax planning because you are protecting your money both now and in the future.
Tax deferment is only part of the puzzle though when it comes to good tax planning, choosing wise investment options is also fundamental. Choosing investment opportunities that actually reduce or deduct tax is key. That doesn’t mean you should only choose an investment based on its tax benefit, there are many reasons to choose a particular investment option which will depend on your personal financial goals and return requirements – but tax is important to consider when weighing up your choices.
One such investment opportunity that can reduce your tax burden is real estate, particularly if you use 1031 exchange rules to potentially avoid capital gains tax altogether. 1031 exchange legislation allows you to ‘swap’ property without having to worry about capital gains tax which means you are free to build your portfolio without worry about a tax bill until you wish to ‘cash out’. You can get more information online by checking out investment advisors such as this 1031 exchange company
Your next option is asset location placement, which might sound complicated to the layperson but it is simply working out which of your investments or personal income will demand the highest rate of tax and then placing that in the most tax-efficient account or program such as municipal bonds, stock index-linked ETFs or growth stocks. A general rule of thumb – the more tax rich an asset is the more you want to protect it using a tax-advantaged account.
It’s not just where you place your investments and savings that make good tax planning but also good timing. If you take an investment into a mutual fund for instance, you will want to see when the distribution of income and net capital gains is due because no matter how long you have held that account- from one day to one year – you will be reliable for the full amount, which could be up to a equal distribution of 90% of 98% of the total fund held. It is therefore worth doing a bit of research into the history as well as the tax benefits of the accounts you are placing your money in.
Selling your investment close to distribution might seem like the solution for avoiding this potential distribution issue but it isn’t always advisable because if it generates you a large profit by avoiding the distribution of income and capital gains you are likely to incur a large capital gains charge on the sale profits. How long you hold your investment is also a considered part of your portfolio planning because if you sell a fund or security after the short term you could then be liable for short-term capital gains rate. You qualify for lower levels of tax if you hold on to your investment for at least a year so timing really is everything in successful tax planning.
This might all seem very complicated but it is just an extension of the fiscal strategy and planning you have applied to your business long-term goals. Although paying tax is inevitable and you should never take steps to defraud the tax department, by taking professional advice and making smart investment decisions you can pay tax to your advantage, enabling you to free up monies to grow your business, increase your property portfolio or indeed invest in a new startup and encourage the future generation of entrepreneurs. Tax strategy planning then is as inevitable as paying taxes – but perhaps not quite as painful.
