Because of the graduated income tax system, taxes are a major expense for high-income families. Fortunately, many tax breaks are available to those who understand the tax code. If you take full advantage of these tax breaks, you may end significantly reducing your tax bill.
The Internal Revenue Service levies a tax on estates whose value exceeds a certain exemption amount. While the exemption amount varies according to the year you die, in 2012 it was $5,120,000. Any amount above the exemption was taxed at 35 percent in 2012. An effective way to avoid the estate tax is to establish an irrevocable living trust, in which you instruct a trustee to distribute your assets to your beneficiaries before and after you die. While you lose legal ownership of trust assets, these assets do not go through probate when you die and are not included in the value of your estate for estate tax purposes.
You realize a capital gain when you make a profit from the sale of a capital asset (most types of property) that you hold for investment purposes. If you hold the asset for more than a year before you sell it, this profit is taxed at special capital gains tax rates. As of 2012, capital gains tax rates were 15 percent for high-income taxpayers. For this reason, it might make sense to arrange your finances so that most of your income comes from capital gains rather than ordinary income. If you are an owner-employee in an S corporation, however, the IRS requires that you be paid at least a "reasonable salary." Even if you incur capital losses, you can deduct them from your taxable income.
Deferring Capital Gains
You don't pay capital gains tax until you actually sell a capital asset. One way to delay capital gains tax liability and raise money at the same time is to hold on to corporate stock and use it as collateral to borrow money. Another way is to sell investment property and invest the proceeds into another property that qualifies as "like kind" under Section 1031 of the Internal Revenue Code. In some cases, you can delay a 1031 exchange for as long as 180 days without incurring capital gains tax liability.
You can deduct up to 50 percent of your adjusted gross income for donations to IRS-approved nonprofit organizations. Public charities, churches, universities and hospitals typically qualify. Even though you part with the value of your donation, you could still come out ahead by putting yourself into a lower tax bracket. For example, if you are married filing jointly and your 2012 taxable income was $218,000, a $1,000 donation to a qualified nonprofit would reduce your tax rate from 33 percent to 28 percent. This would save you over $10,000 in income taxes.
- Internal Revenue Service: Limits on Deductions
- Vickstrom Law: Irrevocable Trusts & the Current Federal Estate Tax (IRC 1022), Friend or Foe?
- Internal Revenue Service: Topic 409 - Capital Gains and Losses
- Internal Revenue Service: Publication 950: Introductory Material
- Internal Revenue Service: Like-Kind Exchanges Under IRC Code Section 1031
David Carnes has been a full-time writer since 1998 and has published two full-length novels. He spends much of his time in various Asian countries and is fluent in Mandarin Chinese. He earned a Juris Doctorate from the University of Kentucky College of Law.