| 3/2004
Don't overpay taxes on income that's protected by the U.S. tax code.
Here are the major categories to watch, including five types of raises
that don't add a dime to your taxable income.
Want to keep the tax man away from your money? It's easier than you
think. There are lots of ways to increase your wealth without having a
chunk gobbled up by the IRS.
It's not that the agency doesn't want your money. It's just that the tax
law prohibits the IRS from touching it. And with a bit of planning, you
can start to cut your current tax bill and put money in your pocket now.
Let's look at a few examples.
Tax-free interest
Interest earned on bonds issued by a state, territory, municipality or
any political subdivision is free from federal taxes. These are
generically called municipal bonds, and their tax benefit increases in
value as your marginal tax rate goes higher. (In other words, the bonds
are worth more to you as your overall income rises.)Need more time?
File for an extension
online at H&R Block.
Assume you're in the 35% bracket, the top rate for 2003 and 2004. A 5%
tax-free rate becomes the equivalent of a taxable rate of 7.69%. In the
15% bracket, the taxable equivalent is only 5.88%. If you check out
investinginbonds.com, you can compare taxable and tax-free yields. (See
link at left.) Compare the after-tax rates on alternative investments of
equivalent risk.
Some bonds may not only be tax-free at the federal level, they may also
escape state and local taxes. If you're in the top brackets and live in
New York City, this is one investment you definitely want to consider
for your portfolio.
Carpool receipts
Commuting to work? Bring a friend -- and his wallet. If you form a
carpool to carry passengers to and from work, any dollars received from
these passengers aren't included in your income.
Commuting costs are generally not deductible. But if you establish a
carpool and you're reimbursed in amounts sufficient to cover the cost of
your repairs, gas and similar items used in connection with operating
your car to and from work, then you've converted personal nondeductible
expenses into excludable income.
Assume you're in the 25% bracket (down from 27% in 2002). You have to
earn $133 per month to cover a $100 monthly commuting expense. If you
have a carpool arrangement with expenses being reimbursed, you've got no
additional income. But you do have an additional $133 per month in
wealth!
Sell your house
Under a tax law enacted in 1997, if your house was your principal
residence for two of the last five years, you can exclude as much as
$250,000 in gain ($500,000 on a joint return) when you sell it.
You don't have to reinvest the money, and you can claim the exclusion
every two years. (If you've got $500,000 in gain every two years, I want
to meet your real estate agent and go shopping!)
If you don't meet the two-year rule, you can get a partial exclusion
based on the time of use and ownership. Assume you sold after only one
year and had a $50,000 profit. Your exclusion is half the $250,000, not
half the $50,000 profit. In this case, you'd pay zero tax on the sale.
But this partial exclusion is only if the sale is required because of
either a change in place of employment, health reasons or unforeseen
circumstances. I haven't yet seen final regulations defining "unforeseen
circumstances." My understanding is that the IRS is going to be flexible
here.
Tax-free compensation
When you're due for a raise, ask your company to get creative in your
compensation. There are numerous ways to receive non-taxable
compensation. Let's look at some of the best alternatives to taxable
earned income.
Use your health coverage. Health and hospitalization
insurance premiums
paid by your current or former employer are tax-free -- a huge benefit.
Let's say your Health Insurance premiums come to $280 a month or $3,360
a year (for an HMO policy for a family of four with a $1,500
deductible). If you're in the 25% tax bracket and have to pick up the
bill, the real cost to you would be $4,480. That's $3,360 for the
premiums and $1,120 for additional income taxes because you'll be paying
for the coverage in after-tax dollars. Having your company pick up the
cost helps both of you. It doesn't have to pay the salary necessary to
get you even. It gets to write off the full cost of the coverage. Plus,
neither of you has to pay the 7.65% payroll taxes on the premiums. And
you, of course, boost your disposable income substantially.
Cover your life . Group term life
insurance coverage of $50,000 or less
paid for by your company isn't taxed to you. You pick the beneficiary;
your company pays the premiums. Your company deducts the expense; you
walk away with additional tax-free income.
Send yourself to school. Get educated. The courses don't even have to be
job-related. But they can't be for any education involving sports,
games, or hobbies. Your company can pay, and deduct, as much as $5,250
per year in educational assistance paid for either undergraduate or
graduate courses. Again, that assistance comes to you tax-free.
Get you there…and parked. Your company can give you discount fare cards,
passes or tokens to take public transportation to work. As long as it's
not worth more than $100 per month, your company can deduct it, but you,
as an employee, receive it tax-free as a de minimus tax benefit. You're
taxed only on any excess over the $100. If you drive and have to pay for
parking, your company can provide free parking, up to a maximum value of
$180 per month, to you tax-free.
Cafeteria plans. These are sometimes called Flexible Spending Accounts.
Your company makes deductible contributions under a written plan, which
allows you to select between taxable and non-taxable benefits. To the
extent you chose non-taxable benefits, you have no additional income.
Available non-taxable benefits may include group life
insurance,
disability benefits, dependent care and/or accident and health benefits.
Your individual plan details the options. You make your choices among
the items on the cafeteria menu.
You get the idea. Any time you can convert taxable income into
non-taxable income, you've given yourself a raise. And when both you and
your company save money, it's a win-win for everybody.
Get creative…in most cases you're paying for the items anyway, and on an
after-tax basis. It's really relatively simple.
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