Ch9. Tax Planning and Tax Saving Strategies — Legally Minimizing Your Tax Burden

Principles of Tax Planning

Tax Planning: Legally minimizing tax liability within the bounds of the IRC
Tax Evasion: Illegal failure to report or pay taxes → penalties, interest, criminal prosecution
Tax Avoidance (Abusive Shelters): Technically legal but contrary to congressional intent
→ IRS may recharacterize under substance-over-form or economic substance doctrines

Sound Tax Planning Principles:
① Income Shifting: Spread income across taxpayers and/or tax years
② Maximize Deductions and Credits: Utilize all available IRC deductions and credits
③ Timing: Accelerate deductions and defer income to optimize the tax year of recognition

Individual Tax-Saving Tools

Retirement Account Contributions

Traditional 401(k) / 403(b):
- 2024 employee contribution limit: $23,000 ($30,500 if age 50+)
- Contributions are pre-tax → reduce taxable income dollar-for-dollar
- Employer match is not included in employee limit
- Growth is tax-deferred; distributions taxed as ordinary income

Traditional IRA:
- 2024 contribution limit: $7,000 ($8,000 if age 50+)
- Deductibility phases out if covered by a workplace plan:
  Single: $77,000–$87,000 MAGI; MFJ (covered spouse): $123,000–$143,000
- Growth is tax-deferred; distributions taxed as ordinary income

Roth IRA:
- Same contribution limits as Traditional IRA
- Contributions are after-tax (no current deduction)
- Qualified distributions are completely tax-free
- Income limit: Single phase-out $146,000–$161,000; MFJ $230,000–$240,000

SEP-IRA (Self-Employed / Small Business):
- Up to 25% of net self-employment earnings, max $69,000 (2024)
- Fully deductible contribution for the employer/owner
- Tax-deferred growth; distributions taxed as ordinary income

Example:
Taxpayer earns $80,000; contributes $23,000 to 401(k) + $7,000 to Traditional IRA
Federal taxable income reduced by $30,000
At 22% marginal rate → approximately $6,600 in tax savings

Health Savings Account (HSA)

Eligibility: Must be enrolled in a High-Deductible Health Plan (HDHP)

2024 Contribution Limits:
- Self-only: $4,150
- Family: $8,300
- Age 55+ catch-up: additional $1,000

Triple Tax Advantage:
① Contributions are tax-deductible (above-the-line)
② Growth is tax-free
③ Withdrawals for qualified medical expenses are tax-free

Unlike FSAs, HSA funds roll over indefinitely — no "use it or lose it."
After age 65: can withdraw for any purpose (taxed as ordinary income, like a traditional IRA).

Mortgage Interest Deduction (IRC § 163(h)):
- Deductible on acquisition debt up to $750,000 ($375,000 MFS)
  (Pre-Dec. 16, 2017 debt: $1,000,000 limit grandfathered)
- Reported on Form 1098 from lender

State and Local Tax (SALT) Deduction (IRC § 164):
- Deductible property tax + either state income tax or state sales tax
- Currently capped at $10,000 ($5,000 MFS) through 2025

Qualified Residence Sale Exclusion (IRC § 121):
- Exclude up to $250,000 ($500,000 MFJ) of gain on sale of primary residence
- Must have owned and used as primary residence for 2 of the last 5 years

Real Estate Tax Planning

Capital Gains Strategies:
① Long-Term Holding: Assets held > 1 year taxed at preferential rates (0%, 15%, or 20%)
② Primary Residence Exclusion: Up to $500,000 gain excluded (MFJ, IRC § 121)
③ Document All Basis Improvements: Keep records of capital improvements to increase basis
   (Kitchen remodel, additions, new roof — not repairs/maintenance)

Like-Kind Exchange (IRC § 1031):
④ Defer gain by exchanging one investment/business property for another
   - Must be "like-kind" real property
   - Must use a qualified intermediary and meet strict timing rules
   (45-day identification; 180-day closing)
   - Gain deferred, not eliminated; carries over to replacement property

Depreciation Deductions:
⑤ Residential rental property: 27.5-year straight-line depreciation
⑥ Commercial real property: 39-year straight-line depreciation
⑦ Bonus depreciation / Section 179: Potentially immediate expensing of certain improvements

Gift and Estate Real Estate Planning:
⑧ Annual Exclusion Gifts ($18,000/recipient in 2024): Reduce taxable estate over time
⑨ Stepped-Up Basis at Death (IRC § 1014): Heirs receive FMV basis → eliminates built-in gain
⑩ Installment Sale (IRC § 453): Spread recognition of gain over multiple years of payments

Business and Corporate Tax Planning

Choice of Entity:
- Sole proprietor / single-member LLC: All income taxed on Schedule C at individual rates
- S Corporation: Pass-through entity; avoid double taxation
  Owner-employee must take "reasonable compensation" (subject to payroll taxes)
  Remaining distributions not subject to self-employment tax
- C Corporation: 21% flat rate (TCJA)
  May be beneficial at lower income levels; double taxation on dividends

Business Expense Deductions (IRC § 162):
- Ordinary and necessary business expenses
- Officer/owner salary (reasonable compensation)
- Vehicle expenses (actual cost or standard mileage rate)
- Home office deduction (regular and exclusive use)
- Employee benefit plans, health insurance premiums

Qualified Business Income (QBI) Deduction (IRC § 199A):
- Pass-through owners may deduct up to 20% of QBI
- Subject to W-2 wage limitations and income thresholds
- Phases in/out for Specified Service Trade or Business (SSTB)
  2024: Single $182,050–$232,050; MFJ $364,200–$464,200

Retirement Plan for Business:
- Defined Benefit Plan: Highest possible contribution for high-income owner near retirement
- Solo 401(k): Up to $69,000 (2024) — employee + employer contributions combined

401(k) + IRA Contribution Strategy ★★★★★ : Max out 401(k) first (especially to capture employer match), then contribute to IRA (Traditional or Roth depending on income level). Memory tip: Employer match = free money; always capture it first

HSA Triple Tax Advantage ★★★★★ : Contributions deductible, growth tax-free, qualified withdrawals tax-free. Only requires HDHP enrollment. Memory tip: HSA = the only account with all three tax benefits simultaneously

IRC § 1031 Like-Kind Exchange ★★★★☆ : Defer capital gain by exchanging investment property. Strict: 45-day ID rule, 180-day closing rule, qualified intermediary required. Memory tip: 45/180 — if you miss either deadline, the exchange fails and gain is recognized

Practice Quiz

Q. A single taxpayer with $75,000 in W-2 wages contributes$ 23,000 to a traditional 401(k). What is their approximate federal income tax reduction?

Taxable income is reduced by $23,000. At a 22% marginal rate, the tax savings is approximately$ 5,060. (Actual amount depends on the full tax computation including standard deduction, credits, etc.)

Q. Why is making tax-advantaged gifts to children at an early age a powerful estate planning strategy?

The annual exclusion ($18,000 per recipient in 2024) removes assets from the estate each year. Assets gifted early compound inside the child’s hands — any future appreciation is outside the estate. Consistent gifting over decades can transfer hundreds of thousands of dollars estate-tax-free. Additionally, the recipient may be in a lower tax bracket, reducing the overall family tax burden on investment income.