Let the tax code be your guide

Finding your purpose of life can be one of those topics related to philosophical discussions with deep thinkers. However, I believe it can be much easier and certainly more meaningful.

The unfortunate reality is that many people never discover their purpose in life, and it can lead to being unhappy and full of future regret.

One quote from Jim Rohn summed it up best for me, “The goal of this grand human adventure is productivity, pursuing the full development of all your potential. To see all that you can become with all you’ve been given.”

If we all could live to our maximum potential, imagine how much greater the world could be. This requires we take full responsibility to use our potential for its highest use in all areas of our lives.

This absolutely applies to our wealth as money is just a tool to help us live our best lives. Many factors cause our wealth to erode so we cannot reach our maximum potential with the biggest loss in the form of taxes. Recapture losses from unnecessarily overpaying taxes, and you can significantly increase your chances to reaching your full potential financially and gain the control you desire.

Key Takeaways
Most experts expect tax rates to be higher in the future.
Many of your retirement accounts and other retirement saving vehicles are “tax deferred” not tax exempt. That means you’ll eventually have to pay tax in your golden years.
Below I share six tax strategies for keeping your tax hit in check in an era of rising rates. Consider ways to pay some tax now while rates are still historically low.

Regardless of which party wins the November election, most people expect their taxes to go up in 2021 and beyond. Given Every CPA and tax accountant I know tells me taxes are going up due to COVID relief, rising national debt, unfunded liabilities related to social programs and growing wealth inequality.

It’s like preparing for a big storm. We don’t know exactly when it will hit, or how severe it will be, but we want to take as many precautions as possible– hope it’s not as bad as projected.

When most people hear the word “taxes,” their knee-jerk reaction is to run and hide–or at least defer to a later date. But kicking the tax can down the road just delays the inevitable—it’s like seeing the dentist or having that coloscopy you’ve been avoiding. It’s not pleasant, but if you don’t deal with it soon, there will be even more painful consequences down the road. Eventually you’ll have to pay the piper.

But there’s another reason to think broader than just deferring taxes to a later date–It will keep you from enjoying more of your wealth in retirement. Tax rates are historically very low right now. Why put the bulk of your assets into tax-deferred accounts now (i.e. IRA or 401k) that may be exposed to even higher tax rates in the future? That’s especially painful when you’ll have to take requirement minimum distributions in retirement from those tax deferred accounts. For people who have significant assets in retirement accounts, they may have to reduce the amount they get to enjoy as they won’t want to incur the tax hit.

Yes, having some assets in tax-deferred is good as you could withdraw an amount to take advantage of the standard deduction. But, did you know that taking too much taxable income in retirement can cause you to have up to 85 percent of your Social Security taxed?

Weren’t our paychecks already taxed to fund Social Security in the first place? Welcome to the “tax torpedo.”

Also, what about all those deductions you had earlier in life: Mortgage interest, retirement account deductions, child exemptions, student loan interest, flex accounts? Those valuable deductions mostly disappear when you’re retired.

Beyond the impact of taxes on your retirement income, much of your wealth is taken in taxes right now. The typical advice is to defer the taxes and contribute to a qualified plan such as a 401(k) or IRA. Again, that’s just kicking the can down the road. How about finding ways to reduce taxes right now (and permanently) rather than just deferring them? It’s simpler than you might think:

6 tax strategies you can implement today

1. Roth IRA/Roth 401(k)s. Unlike a traditional IRA or 401(k) in which your contributions are tax-deferred (meaning you’ll eventually pay tax), with a Roth, you contribute after-tax dollars—up to $6,000 a year ($7,000 if over age 50). Your money grows tax-free, and you can generally make tax- and penalty-free withdrawals after age 59½. A Roth 401(k) is generally used for higher earners whose income disqualifies them from doing a Roth IRA—generally married couples filing jointly, who have over $206,000 in adjusted gross income. The Roth 401(k) allows you to contribute up $19,500 in after-tax dollars ($26,000 if over age 50). Again, with either type of Roth, you essentially pay the tax up front, so you don’t have to pay tax on your distributions in retirement. If you believe taxes are going up in the future, the Roth approach becomes even more attractive.

2. Cash value whole life insurance. What I like about cash value is that unlike a Roth, there’s no limit to how much you can contribute to the policy. For starters, the earnings within a whole-life policy are tax-deferred and you can avoid the tax hit forever if you take those earning via a loan from the life insurance company. The loan provision can be used throughout the life of your policy without tax implications. In retirement, you can take income tax-free from the policy up to the amount you contributed. Once you hit that point, you can take out loans tax-free for the earnings.

Upon death, the death benefit (which will likely be substantially larger than the cash value) is distributed to your beneficiaries tax-free. If there is an outstanding loan at the time of death, the benefit would pay off the loan the rest of the proceeds go tax-free to beneficiaries.

3. Direct real estate investments. If you own a building you get to depreciate that investment for 27 years and all the expenses related to it. In terms of depreciation it’s 27.5 years for residential and 39 for commercial and only applies to the building/improvements and not the land.

All the expenses (e.g. mortgage interest, taxes, maintenance, property management etc..) can be deducted from rental income. Lastly, just like other investments the capital gains are not realized unless you sell the property. Current law allows for a step in basis if you pass which allows your heirs to not have to pay taxes on the gain.

4. Real Estate syndications. Instead of owning a building, apartment complex or residential invest property directly, you can also invest in a portfolio of such properties without being responsible for upkeep or tenant issues. around. The tax benefits of syndications are the same as direct real estate investments.

The first thing to understand is that an equity investor in a syndication is actually a limited partner in the partnership. Investments in syndications will generally be considered “passive” activities and each investor gets to share in these deductions based on their proportional ownership interest in the overall limited partnership which make investing in commercial real estate assets very tax efficient.

5. Oil & Gas (O&G). Most people invest in O&G partnerships, rather than directly in oil fields. Either way, almost all of your initial investment can be deducted from your active income in the year you invest. The tax code really wants people to invest in oil and gas. Say you invest $50,000 into an oil and gas partnership. You can get up to $50,000 deducted from your income that year—and it never has to be paid back. Plus, you receive additional tax benefits from the income you generate from the O&G partnership.

Here are three powerful ways that investing in oil and gas can help you mitigate your tax bite:

a) Intangible Drilling Cost (IDC) Tax Deduction. The intangible expenditures of drilling (labor, chemicals, mud, grease, etc.) are usually about 65-to-80 percent of the cost of a well. These expenditures are considered an IDC, which is 100 percent deductible during the first year.

b) Tangible Drilling Cost (TDC) Tax Deduction. The total amount of the investment allocated to the equipment “Tangible Drilling Costs (TDC)” is 100-percent tax deductible.

c) Small Producers Tax Exemption. This exemption allows 15 percent of the Gross Income (not Net Income) from an oil and gas producing property to be tax-free.

6. Business Ownership. Starting and running a business is not easy, but there are tremendous tax benefits to doing so. You can deduct so many more things that a W-2 wage earner cannot—part of your mortgage, utilities, your car, etc. You can also sock away so much more of your income into tax-advantaged retirement plans than a W-2 wage earner can.

If you think about it, the U.S. tax code was not set up to make people’s lives miserable; it’s actually a set of incentives put forth by the government. The tax code wants you to start a business, invest in energy or real estate and to give generously to charity. Follow the code and it will tell you where to find your tax savings.