Monday, July 15, 2013

TAX SAVINGS, THE LONG RANGE PICTURE

Most of us will agree that we do not want to pay more taxes than we have to.  But making this year’s tax the lowest that is possible is not always the best idea.  We need to look at the long term picture to see if we might be better off paying a little more this year in order to facilitate paying less in the future.  Let me give you an example:  a couple of years ago one of my clients and I discussed converting his Traditional IRA to a Roth IRA.  The IRA was about $2,500,000 and the resulting tax would be about $900,000.  “Why would you want to accelerate the tax bill on that IRA”, you might ask.  There were several reasons we decided to make the conversion.   As a traditional IRA there was a required minimum distribution each year of over $300,000. This income kept the taxpayers in the highest tax bracket and we expected the highest bracket to go higher in the future.  We also knew that the “Medicare Surtax” was going into effect in 2013.  The taxpayers also had to pay a higher Medicare insurance premium because of their high income each year, and they often had capital gains that would be taxed at a higher rate beginning in 2013.  By converting the IRA to a Roth with no more taxable distributions they were able to lower their tax rate from the highest rate to the lowest rate, avoid the Medicare Surtax, reduce their Medicare insurance premium, and pay a lower tax rate on their capital gains.  An additional plus is that the Roth IRA has no required minimum distribution so the taxpayers could let the IRA accumulate and pass it along to their heirs if they did not need to use it during their lifetimes.

There are other, less dramatic ways that we can save taxes by paying more now.  When putting new depreciable assets into use we often have a choice about using one of the rapid depreciation methods or using a slower depreciation method.  Before making that choice we need to look at the long range picture.  If the year the new asset goes into use happens to be a low income year, it could be better to not use a rapid depreciation method so that more depreciation will be saved for years when the income is expected to be higher.  There are many times when taking a bigger depreciation deduction causes the income to be so low that a person’s itemized deductions are not as effective that year, and since itemized deductions cannot be carried over to the next year, the effect of the added depreciation is lost.

Sometimes a decision has to be made as to whether an expenditure is currently deductible or should be capitalized and depreciated over time.  Theoretically, an expenditure either is or is not currently deductible.  However, as a practical matter, there are lots of times when the facts can be viewed different ways and a decision made as to which way to handle the tax treatment.  In these cases it is important to look at the long term and see when the deduction would be most beneficial.

These are just a few of the kinds of tax choices that you can make.  There are many times that we can make decisions that affect long range tax issues and it is important that we communicate with you face-to-face so that the best decisions can be made.  The better we know you and your plans and expectations, the better those choices will be.
 
Loren L McCann, CPA, MS (Tax)

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