Did you know there are 74,608 pages in the federal tax code?
That is 58.24 times the length of the Bible.
It would take the average person 2,486.9 hours to read the entire tax code.
Don't worry... we read it so you don't have to. Below are three income tax reduction strategies you could potentially be taking advantage of.
#1 Defined Benefits Plan
For 2016, the maximum employee elective deferral for a 401(k) is $18,000 (an additional $6,000 for those aged 50 and up). Alternatively, by using a Profit Sharing Plan instead, the overall limit on annual contributions is $53,000 (an additional $6,000 for those age 50 and up). The bottom line is those who earn 6 figure salaries can't maintain their lifestyle using the savings from a 401(k) plan or Profit Sharing Plan alone.
Enter the Defined Benefit Pension Plan. This is a type of pension plan in which an employer/sponsor promises a specified monthly benefit on retirement. The amount is based on a formula that takes an employee's earning history, years of service and age into account. It may increase your retirement savings exponentially. It is possible for an owner to set up a DBPP for himself or herself. It's not unusual to have annual contributions of $250,000 or more- again, depending on your particular situation.
Due to the complicated nature of IRS rules, there are more set up and annual maintenance expenses with a DBPP than a 401(k) / Profit Sharing Plan. For this to make economic sense, you need to have significantly more free cash flow than what you would put in a 401(k)/Profit Sharing Plan
#2 Cash Rich Whole Life Insurance
One of the most popular plans for retirement is a Roth IRA. A married couple filing jointly cannot put any money away in a Roth if their taxable income is over $194,000. Under that taxable income amount, the maximum contribution is $5,500 as of 2016 or if you are age 50 or over you can put $6,500. Moreover, the annual contribution of $5,500 begins to phase out at incomes starting at $184,001 for married filers until the contribution finally reaches $0 for incomes above $194,000. For single tax payers the thresholds are even lower. In the long term, the amounts are simply not enough to significantly benefit affluent families who want to maintain their lifestyle and live comfortably in retirement.
So, what would be another way of accomplishing a more practical result? Many corporations have been using whole life insurance policies to put money away after tax. After enjoying stable and consistent tax-deferred cash value growth, they can take it out in a tax efficient way like a Roth IRA but without the IRS limits. In other words, your policy builds guaranteed cash value over time which increases each year and will never decline in value due to changes in market conditions. The only caveat is: the money has to stay in the life insurance policy as specified by the IRS. If this policy is placed with one of the prominent mutual life insurance companies, it's possible to get between a 4% and 6% tax deferred rate of return, depending upon the age and health of the individual. In today's environment, this would be considered a very favorable outcome.
#3 Charitable Lead Trust
After you pass away, who do you want to get your money? Most people believe they can funnel their money to their family. Unfortunately, the funnel has leaks in it, namely, the IRS and taxing authority of some states. Recently, the federal gift tax exemption allowed a single individual to pass over $5 million ($10 million for a couple) tax free to heirs. But, some states have a much lower threshold, starting as low as $675,000 in NJ. NY passed legislation as of April 1, 2014 that more than doubles the estate tax exemption ($2,062,500) and increases annually till it matches the Federal exemption in 2019 (Projected to be $5.9 million in 2019). However, most people have some form of retirement plan, such as IRA's, 401(k)'s, etc., all of which produce a significant income tax liability for family since the taxes on these assets have not been paid yet.
If families do not include charity in their planning, the IRS and the states could take a significant amount of wealth through taxes, and will likely use that money for a goal that does not align with their values. Allowing the government and state to use your tax money to promote their interpretation of "social good" would make you an involuntary philanthropist. With the proper planning, you can be a voluntary philanthropist and direct those assets to a social good you care about, while helping your family in the process. A charitable lead trust, for example, will allow you to leverage generosity to simultaneously benefit a favorite charity and family, producing tax savings as well. A CLT basically functions in the following manner: A charity receives an agreed upon stream of income for an agreed upon term, which can be for a number of years, lifetime of you (the donor), life of you and your spouse. At the end of the term, the remaining income on the CLT can revert back to the donor or pass onto the other beneficiaries named in the trust.
These are a few of the many strategies that can be used to potentially reduce your tax burden.