Understanding the Data Scorecard

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Measuring the right activities today can tell you where your business is going tomorrow

Being in the right place at the right time isn’t always a matter of luck. Organizations that adhere to the principles of the Entrepreneurial Operating System (EOS) use a powerful tool which allows them to take the pulse of their business and know exactly what’s going on right now, in order to make validated and proactive actions for the future.

The EOS data scorecard tracks the activity of five to 15 areas of your business. A single person reports on each area of activity, which creates considerable focus and accountability. It’s a one-page sheet that reports the health of your business.

Pattern detection

Weekly tracking of this activity creates a record of what his happening right now. You can use it to gain insight into what is about to happen based on the current activities of your business. With this data scorecard, you can engage in predictive analytics.

CIO defines predictive analytics as looking at current and historical data to detect trends and forecast what should occur. The data allows organizations to exploit the patterns and use them to detect both risks and opportunities. Your data scorecard allows you to move past analyzing what’s actually happening and detect future trends or upcoming behaviors.

Business reporting software creator Malartu points out that detecting patterns can only happen when you place a deep focus on this information. The purpose of your scorecard isn’t to collect the data, but to retain what it teaches you and act on it. They use the term “data disfluency” from author Charles Duhigg’s book Smarter, Better, Faster. Understanding data, Duhigg writes, requires us to transform it into experiments to testideas. Your scorecard provides the data. Now it’s time to analyze and predict.

Gino Wickman’s seven basic truths about the data scorecard

EOS Worldwide founder Gino Wickman observes that the data scorecard’s value as a tool works only if you put the effort into creating and maintaining it. Making it work, he says requires you to subscribe to seven basic truths:  

  1. What gets measured gets done.
  2. Managing metrics saves time.
  3. A scorecard gives you a pulse and the ability to predict.
  4. You must inspect what you expect.
  5. You can have accountability in a culture that ishigh-trust and healthy.
  6. A scorecard requires hard work, discipline, andconsistency to manage, but it’s worth it.
  7. One person must own it.

Wickman offers explanations for each basic truth in his post, with the preface that you’ll find it difficult to manage your data scorecard if you don’t believe in all of them.

Less is more

Blogger and EOS practitioner Brent Weaver says that implementing a scorecard with just five to 10 numbers on it has changed him as an entrepreneur. He says that it helps him see connections between one number and another, which pushes him deeper into the mechanics of the business.

Too much data, Weaver says, can be a disservice because it’s difficult to influence. He recommends that your scorecard feature what he calls “the essential few that if improved – could dramatically change your business for the better.”

Many organizations, observes ArrayFire CEO and co-founder John Melonakos, measure only things that tell you the trailing indication of the performance of an organization. Your data scorecard, he says lets you change the future. But what should those numbers be?

Melonakos recommends undertaking an exercise where you imagine you are cut off from all knowledge of your business except for the five to 15 numbers you select. What would you want those numbers to measure? Brent Weaver agrees, saying that your scorecard will be unique. He admits to discarding numbers he’s tracked, calling the selection an “evolutionary process.”

Dallas-based consultants Whittle & Partners moves it past selecting what to measure, saying that these numbers should answer a simple question: “Did my team have a damn good week last week?” An effective scorecard evaluates whether your organization actually did those critical few things you’ve all agreed to measure because they ultimately will lead to success.

Your data scorecard will require regular effort to maintain it. One person will own it, but everyone will contribute to it. And believe in it. As Gino Wickman puts it, the tenacity your data scorecard requires enables it to evolve over time into an incredibly valuable management tool.

Learn how we can help you with your EOS data scorecard.

Investments that Give You the Biggest Tax Breaks (Part One)

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Insurance products offer tax-deferred growth while hedging your financial risk

Investing is a wise way to build wealth for the future. But taxes can take a big bite of the money you earn if you don’t choose the right products.

Fortunately, advanced planning can put you in the driver’s seat, enabling you to make informed choices that maximize the tax efficiency of your portfolio and minimize the effect of taxes on your investments.

At the end of the day, there are two main ways to save on taxes: paying less and paying later. In this first installment of our two-part series on investments that give you the biggest tax breaks, let’s take a look at insurance products specifically designed to reap the rewards of those strategies.

Life insurance and annuities are two long-term investments with attractive tax benefits. Permanent life insurance policies can come with a cash-value component that grows over time like an investment account, and annuities typically act as a safety net that provide a steady income stream during retirement. Savings in these products are tax-deferred and create an opportunity for investors who want to hedge their financial risk.

There are several tax benefits all annuities share: the ability to control when to pay tax by timing distributions, tax-deferred growth that continues indefinitely because distributions don’t have to start at a certain age, and no contribution limits – enabling you to grow your wealth while avoiding taxes on the accumulating assets. But there are also pros and cons to each type of investment.

  • Immediate annuities. Immediate annuities are long-term, tax-deferred contracts sold by insurance companies that exchange a lump-sum investment for immediate regular payments. These payments are based on your age, gender, and the amount of your purchase, and can be guaranteed to last a lifetime. As people live longer and retirements lengthen, many investors are opting to annuitize assets into reliable income they can’t outlive.

Immediate annuities sometimes get a bad rap because payments can stretch so long that you don’t recoup all your principal. But there is plenty of upside in the significant tax breaks:

  • When you buy a non-qualified immediate annuity, the money you receive is divided between interest and principal. The interest is taxed as ordinary income, but the principal is tax-free because it’s a return on an initial investment made with after-tax funds. Distributions from most non-qualified annuity contracts are also subject to the 3.8 percent Medicare tax on investment income for those earning more than $200,000 a year ($250,000 for joint filers).
  • If you die before you recover your principal in full, your heirs can deduct your unrecovered cost on your final tax return as a miscellaneous itemized deduction not subject to the 2 percent floor.
  • Fixed annuities. A fixed annuity is an insurance contract that resembles a bank CD, but without the annual income tax that eats into your earnings. They are issued by life insurance companies to people who want guaranteed rates of return without any risk to their principal. They offer many similar benefits to immediate annuities, including lifetime income options and the ability to avoid probate delays and expense.

Another option is purchasing an equity index annuity (EIA), which is linked to a stock index. These mirror the fixed return and taxation of fixed annuities but add the chance to profit from increases in the index. Here’s the biggest tax break:

  • Fixed annuities offer a tax-deferred accumulation of earnings, building interest on the principal investment, the interest, and the tax savings. Since interest is not taxed until you make withdrawals or start taking regular distributions, this triple-compounding process keeps your money working hard for you instead of Uncle Sam.
  • Variable annuities. A variable annuity is a tax-deferred insurance contract that lets you choose from a selection of investments, and then pays you a level of income that’s based on their performance. In most cases there is no guaranteed return, but some new contracts offer “guaranteed withdrawal” benefits that let you draw a minimum amount without annuitizing – no matter how the market performs.

Variable annuities offer standard annuity benefits like unlimited contributions and tax-free death benefits. All gains are taxed as ordinary income, no matter how they’re earned. That means you can’t take advantage of lower tax rates on corporate dividends or long-term capital gains. But tax benefits include:

  • Earnings grow tax-deferred until you withdraw them from the contract. When you do, they are taxed entirely as income until all your gains are withdrawn. Withdrawals before age 59 ½ incur a 10 percent penalty.
  • You can transfer assets from one subaccount to another, tax-free. This enables you to rebalance your portfolio without paying the tax bill that would accompany similarly-styled investments, like mutual funds.
  • If you lose money in a variable annuity, you can surrender the contract and deduct your loss as a miscellaneous itemized deduction, subject to the 2 percent floor.
  • Permanent life insurance. If you’ve maxed out contributions to your retirement plan – and deductible retirement plans don’t fit your needs – life insurance policies that include cash value can supplement your savings with significant tax planning opportunities.

There are four main types of cash-value policies that fit different temperaments for investment:

  • whole life, similar to a bank CD with required premiums and strong guarantees;
  • universal life, similar to a bond with flexible premiums but the least strong guarantees;
  • variable life, which lets you invest cash values in a series of subaccounts that resemble mutual funds;
  • equity index policies, which guarantee a minimum fixed return with an option to profit from growth linked to a stock market index.

Participating cash-value policies pay dividends out of the insurance company’s surplus earnings that you can take in cash, leave with the insurer to earn interest, or invest in additional life insurance. No matter which option you choose, withdrawals less than or equal to what you’ve paid into the policy – known as the cash basis – are not taxable. Withdrawals greater than the cash basis are taxed as ordinary income.

There is a caveat: be careful not to stockpile too much cash into the policy in the first seven years or it will transition to a modified endowment contract (MEC), meaning it was funded with more money than is allowed under federal law. In that case, your withdrawals are taken from taxable gains before nontaxable contributions. You also incur a 10 percent penalty for withdrawals made before age 59 ½. But if you avoid triggering the MEC rule, significant tax benefits abound:

  • Gains in the cash value of a permanent life insurance policy are tax-deferred – they aren’t taxed unless you surrender the policy for a cash amount that’s more than you invested. If that happens, your taxable gain equals the cash value withdrawn minus premiums paid.
  • You can take cash from your policy tax-free by withdrawing your original premiums and borrowing against any remaining cash values. While you will pay non-deductible interest on the loan, you will earn it back on the cash value. That means if you pay $500,000 into your policy over the years and it grows to $1 million, you can take it all in the form of withdrawals and loans and never pay a dime in income tax as long as you maintain the policy. If you let the policy lapse, unpaid loans are taxable.
  • Life insurance proceeds don’t count toward the threshold that makes your Social Security benefits taxable. They also aren’t subject to the 3.8 percent Medicare tax.

Insurance products are investment options that can offer financial peace of mind during retirement with significant tax benefits. And while other factors such as your goals, financial situation, and risk tolerance should be considered before choosing to invest in one of them, the tax-deferred growth on the underlying assets is a key selling point.

In the next installment of our two-part series on tax-saving investments, we will explore other options that offer significant tax breaks.

Provident CPA & Business Advisors serves successful professionals, entrepreneurs, and investors who want to get more out of their business and work less, so they can make a positive impact in their lives and communities. Typically, our clients reduce their taxes by 20 percent or more and create tax-free wealth for life. Contact us for expert advice on tax planning, and to find out how we can help your business exceed your expectations.

How to Avoid Overpaying Tax on Stock Investments

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Make sure you’re not paying the IRS more than necessary on your stock investment gains

Even though stock investments can be risky, investors can realize pretty big returns. Most experts suggest creating a diverse portfolio of different kinds of stocks, and hanging on to them through various market fluctuations.

But keep in mind that there are certain strategies you can use to minimize the tax you pay on the returns you see. Here’s a look at how stocks earn you money and how small steps can help you avoid overpaying in taxes.

Stock basics: How you earn taxable rewards

When you own stock, you own a share or a piece of a company. Stock is then traded through a stock market exchange. You can then earn money on stock investments in the following ways:

  1. The price of a stock you own increases, and you sell it for more money than you paid for it
  2. Dividends, which are regular payments made to shareholders

Note that not all stocks pay dividends, and of course, not all stocks increase in value. But the proceeds made from rewards are taxable when they’re paid out. However, capital appreciation may be deferred until you sell, or stepped-up at your death.

Why stocks can be a tax-advantaged investment

Stocks are often considered to be tax-advantaged investments. The returns you receive on qualified corporate dividends have tax caps of 20%, which is a big benefit, considering income could otherwise be taxed at 39.6%. Qualified dividends are taxed at the capital gains tax rate, and most dividends from companies in the U.S. that operate under a standard corporate structure are considered qualified.

Long-term capital gains received from stock investments are also capped at 20%. These caps were implemented at the beginning 2013, when the “fiscal cliff” in the U.S. was narrowly avoided.

Keep in mind that if your income is greater than $200,000, or greater than $250,000 for people who file taxes jointly, you are subject to a 3.8% unearned income Medicare contribution on dividends and capital gains.

Stocks can be held in taxable or tax-deferred accounts, IRAs, or qualified plans. However, if you do keep these funds in tax-deferred accounts, qualified corporate dividends and capital gains are converted into income, which doesn’t see that cap of 20%. So, you may see a higher rate on that converted income. Plus, stepped-up gains at your death don’t apply in tax-deferred accounts.

Tax swaps

A tax swap is a strategy in which you sell a stock at a loss to receive the tax benefit on that loss, and then buy another stock that is similar, but not identical, to that stock. Losses in your investments are tax deductible, so often investors will take advantage of a loss this way. This strategy is also referred to as harvesting tax losses.

But, there are regulations to be aware of so you don’t make a detrimental mistake. The IRS prohibits what is called a “wash sale,” meaning you cannot sell your stock at a loss and then buy the same stock back right away (within 30 days before or after the sale). While it can be tricky to determine what the IRS considers to be an identical stock, risky moves could include:

  • Reinvesting in another fund in the same stock market index, like the S&P 500
  • Using an IRA, qualified plan, or trust and claiming the loss in the taxable account
  • Failing to keep an eye on accounts that have different managers

The first two examples above may appear too aggressive to the IRS.

Tax swapping, or harvesting tax losses, on the other hand, is not prohibited by the IRS, since you aren’t buying the exact same stock; only a similar stock that essentially keeps your portfolio the same as it was. You can swap with stocks, bonds, and mutual funds.

On your taxes, you can deduct up to $3,000 in capital losses against your ordinary taxable income, or $1,500 for married couples that file taxes separately. Any additional losses can then be carried forward to future years to offset income.

This is why tax-loss harvesting can be a good way to avoid overpaying tax on stock investments.

When you’re ready to take a look at your financial plan and create strategies that minimize tax and maximize returns, get in touch with our team at Provident CPA and Business Advisors. Our aim is to help you protect your assets and provide you with the advice you need to create the best portfolio for you.

How to Avoid Triggering the Dreaded Wash Sale Rule

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Don’t make this critical mistake that keeps you from harvesting losses on taxable investments

The silver lining to losing money in the stock market is getting a tax benefit. Recording a loss is as simple as selling the losing investment – and when your capital losses exceed your capital gains, you can take a tax deduction for the difference.

But there’s a critical misstep that can stop you from achieving the tax reward: triggering the wash sale rule. The wash sale rule impacts all stocks, bonds, mutual funds, and options – basically, any investment that can generate a taxed capital gain.

Congress enacted the wash sale rule to keep people from selling securities with the sole intention of lowering their taxable income. Previously, investors could unload a losing stock and then snap it up again a minute later, cleverly locking in a tax-reducing loss and retaining ownership at the same time.

What is a wash sale?

In the eyes of the IRS, a wash sale occurs when you sell a security at a loss and then purchase the same security or a “substantially identical” one within 61 days: 30 days before or after your sale date. The rule comes into play even if the transactions occur in different calendar years.

Buying a contract or option to buy the same or substantially identical securities won’t fool the IRS, nor will purchasing them for your individual retirement account. Selling an investment at a loss and then having your spouse or a corporation you control buy it back within the wash sale time frame will also trigger the rule.

When the wash sale rule is tipped, your loss is disallowed and added to the cost basis of the securities you rebought. Even investors who don’t mean to break this rule are often caught by it if they use an automatic investment strategy like reinvesting dividends.

Let’s be clear: it isn’t illegal to do a wash sale. But it’s illegal to claim an undeserved tax benefit.

Consider this example: You own 100 shares of XYZ stock that you purchased at $50 a share. The current market price is $25 – resulting in a $25 per share loss or $2,500. You have gains from other investments, and you know that if you book this loss in the calendar year it will offset them and reduce your tax burden.

You decide to sell the XYZ stock and record the $2,500 loss. To rightfully record this loss on your taxes, you can’t purchase XYZ stock within 30 days before or after your sale. If you do, it’s considered a “wash” and the capital loss is deferred until you sell the new, replacement shares.

If you continue to sell and replace these shares with “substantially identical” ones, the loss is carried forward with each transaction until the shares are liquidated for longer than the wash sale time period.

What does “substantially identical” mean?

There is much debate about what defines a “substantially identical” investment; the vague IRS warning to “consider all the facts and circumstances” leaves a lot of room for interpretation. Generally, stocks, preferred stocks, and options issued by one corporation aren’t considered substantially identical to those of another. That means if you sell Apple and buy Microsoft, you shouldn’t trigger the wash sale rule.

But the rules get murkier in other scenarios. Corporations can be considered substantially identical if they are a predecessor or successor corporation in a reorganization, so make sure you do your homework to ensure there is no connection. Most tax advisors would also urge you to shy away from replacing one S&P 500 index mutual fund with another. Even though they have different ticker symbols, expense ratios, and fund managers, their holdings could be similar enough to trigger the wash sale rule.

How to avoid a wash sale

The simplest way to avoid a wash sale is waiting until the 61 day wash sale period is over before repurchasing the same or a similar investment. If you really want to book the loss but remain invested in a similarly performing security, it’s critical that you use your best judgment to choose one that’s not “substantially identical” to the one you unloaded.

Are wash sales ever beneficial?

If your capital gains wind up being taxed at a 0 percent tax rate, you won’t get any tax benefits from claiming a capital loss. In that case, triggering the wash sale rule and deferring the loss to another year might help you take better advantage of potential tax savings.

Is there any upside to adding the loss to the cost basis of the replacement securities?

Like previously noted, your disallowed loss doesn’t simply disappear in a puff of smoke; it’s added to the cost basis of the new securities you purchase. When you sell those, the old loss will effectively reduce your gain or increase your loss on the transaction.

The holding period of the wash sale securities is also added to the holding period of the securities you replaced them with, increasing your odds of qualifying for the better tax rate of long-term capital gains. Tax rates are currently 0 percent, 15 percent, or 20 percent for gains on assets held for more than a year. If assets are held for less than a year, gains are taxed in the investor’s ordinary income tax bracket, where rates can reach as high as 37 percent.

Achieving a tax benefit on investment losses can alleviate some of the sting of paying taxes on gains or absorbing losses from investments that didn’t pan out. But it’s easy to make a mistake that triggers the wash sale rule when you try to reinvest the money you made on the sale of the losing securities. An experienced tax advisor can help you avoid the financial pain of unexpected wash sales by guiding you toward actions that won’t break the rule.

Provident CPA & Business Advisors serves successful professionals, entrepreneurs, and investors who want to get more out of their business and work less, so they can make a positive impact in their lives and communities. Typically, our clients reduce their taxes by 20 percent or more and create tax-free wealth for life. Contact us for expert advice on tax planning, and to find out how we can help your business exceed your expectations.

Don’t Let Fear of Getting Audited Stop You from Maximizing Your Tax Deductions

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Not only is an audit unlikely to happen – if it does, it’s rarely a huge deal

Few words inspire such fear in the hearts of Americans as “IRS audit.” In fact, 27 percent of Americans said they rather get an “IRS” tattoo than deal with the agency ever again, writes Money magazine. But one of the biggest mistakes that taxpayers make is letting fear of the Internal Revenue Service stop them from taking advantage of tax savings they deserve.

A tax audit might be a nuisance, but it’s usually not more than that – and chances are extremely high that it will never happen at all. That doesn’t mean it’s open season to cheat on your taxes; you should always be methodically honest. But since audit rates are historically low, many experts agree that it pays to be aggressive because most legitimate deductions are unlikely to raise red flags.

In other words, while it’s wise to respect the IRS, there is less reason to fear it.

Fear of IRS audits – which the IRS actually calls “examinations” – are fueled by speculation that the IRS feeds into by being evasive about its audit process. Read on for a few facts about tax audits that may help ease your fears.

  • You have a better chance of living to 100 than getting audited by the IRS. The average American faces a less than 1 percent chance – one in 160, to be exact – of experiencing an IRS audit. And those low odds may sink even lower, thanks to continuous budget cuts at the IRS that result in less personnel to perform audits. Only 0.6 percent of taxpayers were audited in 2017 – the lowest number in 15 years.
  • A tax audit doesn’t always mean you’re in trouble. While the IRS does audit people it suspects have done something wrong, your selection for an audit can also purely be a matter of chance. In fact, of the 1.1 million tax returns audited in 2017, about 34,000 actually resulted in refunds to the taxpayer.
  • You can lower your chances of an audit. A computerized scoring system called the Discriminant Index Function (DIF) helps the IRS choose which tax returns to audit. This system assigns a score to individual and corporate tax returns, and scoring above the national average ups your chances of triggering unwanted attention from the IRS.

Tax returns flagged by the DIF system are manually screened to determine if there is a cause for audit. Items that might increase your score include:

  • Income other than basic wages, such as contract payments.
  • Unreported income, such as investments.
  • Owning a small business – especially if it’s a sole proprietorship or in a cash industry like coin-operated laundromats, where it’s easier to hide income and skim profits.
  • Reporting losses from businesses that the IRS classifies as hobbies. For instance, if you train dogs and take a loss every year, the IRS may take a closer a look to determine if your business is really a hobby and doesn’t qualify for deductions.
  • Deductions and credits for unusual amounts. If you claim that you give a significant chunk of your income to charity as non-cash contributions, the IRS may pay attention. Another red flag is excessive home office deductions.
  • The new tax code made significant changes to the deductibility of business meals and entertainment starting this year, and it’s expected to be highly scrutinized by the IRS during tax season. In broad strokes, entertainment expenses are no longer deductible and most meals are now only 50 percent deductible – and only then if business is discussed.
  • You can only deduct losses not reimbursed by your insurance company. If you write off a large casualty loss, the IRS may take a closer look at the situation.
  • That said, go ahead and take a reasonable home office deduction. Too many people avoid taking certain credits and deductions – denying themselves savings to which they are legally entitled – because they’ve heard that taking them makes them more susceptible to an audit. Home office deductions are often the epicenter of audit fears, as the IRS has been known to scrutinize returns that include them to make sure taxpayers aren’t simply writing off personal expenses.

But here’s the thing: it’s always OK to claim legitimate expenses, no matter how long your list gets. It’s true that the IRS has established ranges for amounts of itemized deductions based on your income. The scanning system may flag deductions that exceed the statistical norm for your region and state – or just seem unlikely, such as charitable contributions that exceed your income.

But that doesn’t mean you shouldn’t take all the deductions you deserve. If you have valid backup documentation that you’re telling the truth, you have nothing to fear from the IRS – even in the unlikely event that you get the dreaded audit letter.

  • An audit is no reason for panic. Many times, an IRS audit isn’t what you expect – the IRS simply wants additional documentation or a response about a particular item. But even if you lose after a full-blown audit, you may only receive a “deficiency notice” – a simple bill for more tax.

The IRS can impose an accuracy-related penalty equal to 20 percent of any underpayment of federal tax that results from many types of misconduct, including disregard of rules and negligence. But even then, you may be able to avoid the penalty if you can show a “reasonable basis” for the position you took on your return.

It’s a crime to cheat on your taxes – it’s impossible to overstate the difference between legal tax avoidance and illegal tax evasion. But honest mistakes or even negligence aren’t likely to trigger a criminal investigation – meaning the average American shouldn’t worry about being charged with criminal tax fraud or evasion.

Of the 150 million returns the IRS processed in 2017, it launched 1,188 investigations into legal source tax crimes. Less than 600 people were sentenced to jail for tax fraud.

At the end of the day, the average American has little to fear from the IRS – and should never be afraid of taking a legitimate deduction. Refusing to claim money that’s rightfully yours is the same as simply gifting your hard-earned cash to the government.

An experienced certified public accountant will work diligently to help you uncover all the different tax savings you deserve. And if a CPA does recommend that you steer clear of a strategy that you think is valid, be sure to investigate further before giving into a vague threat that it will raise a red flag. While you can never guarantee that the IRS won’t audit your return, in today’s tax climate, the odds are ever in your favor.

Provident CPA & Business Advisors serves successful professionals, entrepreneurs, and investors who want to get more out of their business and work less, so they can make a positive impact in their lives and communities. Typically, our clients reduce their taxes by 20 percent or more and create tax-free wealth for life. Contact us for expert advice on tax planning, and to find out how we can help your business exceed your expectations.

Tax-Deferred Accounts are Valuable – If They aren’t Your Sole Savings Strategy

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Why diversification is critical for retirement accounts

It sounds like a no-brainer for tax planning: defer as much income as you can from a current high-tax bracket to a time you are likely to be in a lower tax bracket, such as retirement. Tax-deferred accounts can be a valuable vehicle for tax-efficient retirement savings, especially for high-income earners. But there are several reasons this strategy can backfire – and these should be carefully considered before you automatically sock all your money into these plans for your golden years.

What is a tax-deferred account?

The majority of tax-deferred accounts (TDA) offer immediate tax deductions on the full amount of your contributions and enable investment earnings – including interest, dividends, and capital gains – to accumulate tax-free. Future withdrawals are usually taxed at ordinary income rates.

Let’s break down what that means: Say your current taxable income is $100,000 and you contribute $5,000 to a TDA. You will only pay tax this year on $95,000. But once you retire, if your taxable income is $50,000 and you decide to withdraw $5,000 from your TDA, you will pay taxes on $55,000.

What are the different types?

Tax-deferred accounts can be qualified – meaning contributions are made on a pre-tax basis – or non-qualified, meaning contributions are made from post-tax income but earnings can still accumulate tax-free until they are withdrawn. While many qualified plans limit annual contributions, many non-qualified ones do not. Some examples include:

  • Permanent life insurance. Not only can cash grow tax-deferred inside the policy, but you can transfer your assets income-tax and estate tax-free to beneficiaries.
  • Deferred annuities. Tax is deferred on your gains until you withdraw them from the contract, and only the earnings are taxable.
  • Employer-sponsored retirement plans, including 401(k), 457, or 403(b)s. Employees allocate a percentage of their pre-tax salary to one or more investment accounts, where it accumulates tax-free. Distributions are taxed at ordinary income rates once you reach retirement age, and penalties are usually assessed to earlier withdrawals.
  • Traditional IRAs and Roth IRAs. Traditional IRAs function similarly to employer-sponsored retirement plans. Contributions to Roth IRAs are taxed but distributions are tax-free once you reach retirement age, including investment growth. You can also withdraw contributions at any time without a penalty.
  • Health Savings Accounts (HSAs). Besides providing tax-deferred growth of earnings, HSAs are also tax-free if withdrawals are used to pay for qualified medical expenses.

Until when is tax deferred?

Ideally, the income is not taxed until retirement, when your tax bracket is likely to be lower. But even if your bracket stays the same, you can still benefit from a tax-deferred account because it’s almost always better to pay taxes in the future and save and invest the money you earn now.

So what’s the down side?

  • Withdrawals can impact your tax bracket. Withdrawing money from tax-deferred accounts can bump you into a higher tax bracket in the year that you use it. This is especially true if your plan requires you to start taking minimum distributions at a certain age.

Consider this: $38,700 in income places single retirees in the 12 percent tax bracket in 2018. But earning a dollar more bumps you up to 22 percent. Too much saved in tax-deferred accounts can leave you with little flexibility and an unexpectedly big tax bill in retirement.

  • Withdrawals can impact Social Security taxation. There is a formula that determines how much of your Social Security is taxed, and a major factor is the amount of “other income” you receive. Withdrawals from TDAs can make more of your Social Security income subject to taxation. Medicare premiums can also go up because they are linked to income.
  • Taxable withdrawals are taxed at ordinary income rates. TDAs are best suited to your least tax-efficient holdings. For instance, they can prevent you from profiting off the lower tax rates that usually apply to qualified corporate dividends or long-term capital gains. For the 2018 year, you do not need to pay taxes on qualified dividends if your ordinary income is $38,600 or less. If your income falls between $38,600 and $425,800, you pay a tax rate of 15 percent.
  • There’s no step-up basis at death. Most assets qualify for step-up basis at death, which eliminates or minimizes capital gains tax by “stepping up” the value of an appreciated asset for tax purposes to its fair-market value at the time it’s inherited. This doesn’t apply to most TDAs, causing your beneficiary to pay ordinary income tax on any distributions at his or her regular tax rate.
  • Withdrawals can be subject to a penalty tax. If you need money before you retire, many tax-deferred accounts will force you to pay penalties and taxes on the withdrawal.

What does this mean for you?

Just like diversification is important for investments, spreading your money across diverse tax buckets is the best way to reduce your long-term tax bill. Rather than funneling all your funds into tax-deferred accounts, it’s also wise to build up after-tax accounts that you can withdraw from during retirement.

Even though you will sacrifice some deductions now, the financial flexibility you create will be invaluable in your golden years. A qualified certified public accountant can help you estimate your future tax bracket and determine the right balance of accounts to set you on the path toward a comfortable retirement.

Provident CPA & Business Advisors serves successful professionals, entrepreneurs, and investors who want to get more out of their business and work less, so they can make a positive impact in their lives and communities. Typically, our clients reduce their taxes by 20 percent or more and create tax-free wealth for life. Contact us for expert advice on tax planning, and to find out how we can help your business exceed your expectations.

Why You Can’t Overestimate the Importance of Tax Planning

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Failing to create a plan is the most expensive mistake taxpayers can make

Many people scramble to find ways to reduce their taxes as April 15 approaches – and then dive back into busy lives and don’t give them another thought until the following year.

But not making time for advance tax planning is one of the biggest and most expensive mistakes taxpayers can make. As you become successful, taxes will most likely serve as your single biggest expense over the long-term. That makes taking advantage of every applicable tax break a critical part of your financial and/or business plan.

Year-round tax planning is an essential way for people and businesses to guarantee that nasty tax bills don’t pop up unexpectedly. It’s the process of estimating your tax burden ahead of time, and analyzing your situation so you can strategize ways to lower your current or future liability.

Tax planning helps you make smarter business decisions and establish a clear direction for your company. It must be done every year; the government is constantly making changes to the tax code that might inspire action, whether you hope to reap the benefits of a law before it expires or delay a purchase until the following year to benefit from a new provision that’s taking effect.

Read this carefully: these options for avoiding or deferring taxes won’t be available if you don’t know about them until the last-minute: when it’s time to file your tax returns. Legally shifting income between individuals and companies can take months or longer, for instance, and the most tax-advantageous company retirement plans take time to implement and must be in place before Dec. 31.

The Tax Cuts and Jobs Act (TCJA) made federal tax rules more complicated than ever, and that makes the benefits of solid tax planning more important than ever as well. By proactively planning ahead, you can uncover a world of options that enable you to keep more of your hard-earned cash in your pocket instead of Uncle Sam’s – and even turn tax season into a financial boost, not a burden.

What’s the goal?

There are two powerful benefits that make successful tax planning stand out from other financial strategies. It’s key to a financial defense, which essentially means spending less so you have more money to save and invest. It also guarantees results in a way that can’t be relied upon from riskier, market-driven investments.

The most effective tax planning addresses these goals:

  • Lowering the amount of taxable income
  • Reducing the tax rate
  • Controlling when taxes are paid
  • Receiving every applicable tax credit and deduction
  • Taking charge of the Alternative Minimum Tax (AMT). The AMT was created to ensure that high-income households can’t use deductions to avoid paying their fair share of taxes. The TCJA made major changes to the AMT, significantly increasing exemption amounts and dramatically raising the phaseout thresholds for these exemptions.

Incidentally, while everyone benefits from tax planning, it’s particularly vital if any of these situations apply throughout the year:

  • You are self-employed or own a business
  • You have investments with unrealized gains or losses
  • You experienced a life-changing event – for instance, selling a home, marriage or divorce, retirement, or the birth of a child
  • Your income has gone significantly up or down, or you changed jobs
  • You moved, especially between states
  • You are sending a child to college for the first time
  • You purchase health insurance from the government health exchange, linking premiums to your income

9 smart and easy ways to reap the benefits of tax planning

  • Save for retirement. Deferring taxation from a current high bracket to a time you are likely to be in a lower bracket is a common tax strategy. Retirement plans are a popular way to achieve this goal. Contributing money to a traditional IRA reduces gross income up to $6,500, and the money saved grows tax-deferred until you retire. Employer-sponsored plans like 401(k)s are another way to defer income until retirement. Contribution limits for these plans are usually much higher than that of an IRA. In 2018, the employee contribution limit for a 401(k) was $18,500.
  • Harvest investment losses. Tax gain/loss harvesting uses your portfolio’s losses to offset overall capital gains that are subject to taxation. You can offset unlimited investment gains – and up to $3,000 of ordinary income each year – by selling investments that have suffered losses. If your losses exceed your gains and the $3,000 of ordinary income, you can carry them over with no expiration to be used in future tax years.
  • Consider 1099 contracting. Thanks to the new tax code and its pass-through deduction, self-employment – or 1099 contracting – is a better tax choice than collecting a salary in most cases. For the first time, individual taxpayers are allowed a deduction of 20 percent of qualified business income earned in a qualified trade or business. That means a 1099 contractor will pay considerably lower taxes on equal pay, as long as you qualify and stay under certain income limits. 
  • Structure your company wisely. An important decision many small business owners face in the wake of the new tax law is whether incorporating as an S-corporation or a C-corporation offers better tax benefits. There are advantages to both: tax rates for C-corps were slashed from 35 to 21 percent, although dividends are subject to double taxation because they are taxed again at the individual level. Many S-corp owners can benefit from the new 20 percent deduction of pass-through income, the biggest tax break for small business owners in decades. And in some cases, a multi-tiered structure that enables the entire business to enjoy the tax benefits of multiple entities is the right solution.
  • Provide for college education. The new tax code modified and eliminated some benefits for people who are saving for college or paying off student loans. But if you are paying exorbitant amounts for your children’s college education, there are several tax benefits you still can use.

The American Opportunity Credit, for instance, allows taxpayers to reduce their taxes by as much as $2,500 a year per student for qualified education expenses. If the credit brings the amount of tax they owe to zero, they can have 40 percent of any remaining amount of the credit refunded to them, up to $1,000.

A Section 529 plan investment account allows savings to grow tax-free, and distributions to a beneficiary are also tax-free if they are used to pay for qualified college costs. The new tax law also allows 529 plans to cover qualifying expenses for private, public, and religious schools from grades K-12 for the first time.

  • Make charitable gifts. If you itemize your tax deductions, charitable gifts can be a savvy way to lower your taxes. Donating appreciated assets is especially tax-efficient because it allows you to avoid paying capital gains on the appreciation.
  • Gift assets to your family. A simple way to slowly remove money from your estate is by giving it away. If your estate is larger than the normal exclusion amount, you can lower its value by giving away $15,000 per year to each of your heirs or anyone else you choose without triggering the gift tax. Your spouse can give away money as well, leading to a total gifting capability of $30,000 per year per recipient.
  • Invest in municipal bonds. Many people with high incomes now face a 3.8 percent Medicare surtax on investment income. Investing in municipal bonds can avoid this additional tax – and usually all federal and state income taxes.

Put simply, the tax equivalent yield (the yield an investor would require from a taxable bond to equal the yield of a comparable tax-free municipal bond) has increased for taxpayers in higher brackets, making tax-free municipal bonds more attractive. As a side note, the income threshold for trusts subject to the 3.8 percent surtax is only $12,500, making municipal bonds an attractive investment option for avoiding it there as well.

  • Don’t trigger the AMT. Schedule A of your tax return lists the deductions you took in 2017. If you become subject to the AMT, you will likely lose the benefit of some of these deductions. If that happens, it may be wise to accelerate or delay some income or deductions to avoid triggering the AMT.

Tax laws are constantly changing, and being proactive about tax planning ensures that you don’t miss out on opportunities to reap the benefits of favorable tax law provisions – or utilize all the deductions and credits that you deserve.

Tax planning is not a process that can be done effectively at the last minute. An experienced certified public accountant will spend time with you throughout the year to identify the right strategies that maximize your savings and accomplish your long-term financial goals.

Provident CPA & Business Advisors serves successful professionals, entrepreneurs, and investors who want to get more out of their business and work less, so they can make a positive impact in their lives and communities. Typically, our clients reduce their taxes by 20 percent or more and create tax-free wealth for life. Contact us for expert advice on tax planning, and to find out how we can help your business exceed your expectations.