The IRS's 1 Tax Trick That They Hate

By Bill Jackson March 22, 2024 8 mins read 77 Views

By Dr. Jim Dahle, WCI Founder

How's that for a click-baity title? Yet this is a common thing you will see on TikTok, YouTube, and countless blog posts all over the internet. People think there are tax secrets the IRS doesn't want you to know. The problem is that there are people out there who believe they exist, and they just keep looking until they either end up engaging in tax evasion or they buy some product designed to be sold, not bought, because it promises to lower their taxes.

Let me give you an example. Not too long ago, a WCIer went looking for that “one weird tax trick” and posted on the WCI forum. After getting some good suggestions but finding out these tax secrets didn't really exist, he decided to try somewhere else—the Bogleheads forum—where the response was essentially the same. Here's that post:

“Next year will be the year to start putting a strategy in place to reduce my tax bill if at all possible. I'm wondering if there are others who may provide advice on strategies to help reduce my tax bill. Here are the high level details:

All income is derived from an S-Corp. 100% active income. I have $0 in passive income.

1 employee which is me

Solo 401(k) is maxed out each year

R+D tax credit was used in 2019. No activities would allow for the R+D tax credit to be used this year

Max contributions to 529

No assets in the business like real estate that can provide depreciation.

I'm not really interested in starting another job where I become a landlord that may require large chunks of my time.

I have spoken with local CPAs and accountants, but most ideas are very small results that don't move the needle. Here are some examples:

Buy a car for the business. This will require keeping a log book and I probably couldn't meet the 50% business use requirement.

Buy a commercial building

Put children on payroll

I feel like there is a lot of talk about tax strategies, but when you dive into the details most strategies fizzle out.

I'm looking for some big ideas from people with real experience.”

See what I mean? He's looking for that “one weird tax trick” that doesn't require him to change how he lives his financial life. But he somehow wants to file his taxes differently with the right accountant, so he can somehow dramatically reduce his $700,000 income tax bill.

The Truth About That 1 Weird Tax Trick

There actually are some examples of that “one weird tax trick,” but they mostly apply to estate taxes. For example, you can put rapidly appreciating assets/businesses into an Intentionally Defective Grantor Trust/Spousal Lifetime Access Trust and get them out of your estate. The earlier in your life and business career you do this, the lower your estate tax bill is likely to be. It's entirely possible to pass tens of millions or even hundreds of millions of dollars of assets to your kids' estate tax-free by doing this. There are downsides, including costs and complexity and the loss of the step up in basis at death (i.e., increasing income taxes in order to reduce estate taxes), but it can be worth it for lots of wealthy people.

But these sorts of things don't really exist when it comes to income taxes. For the most part, if you want a lower tax bill, you need to live your financial life differently. If someone is promising something that doesn't require you to significantly change how you live your financial life, you had better get a second opinion and make sure you're not engaging in tax evasion. A high tax bill sucks, but it beats jail.

More information here:

What Are Frivolous Tax Arguments?

Tax Avoidance vs. Tax Evasion — What’s the Difference?

Paying a Big Tax Bill Is a Real Rich Person Problem

Most people would actually love to swap situations with someone with a really high tax bill. The reason your taxes are high is because you make a lot of money, and most people would love to make a lot of money. From that perspective, you should be grateful to have a big tax bill. It's the ultimate humble brag. “Man, I hate the IRS. I had to pay $2 million in taxes last year!”

Best Tax-Saving Techniques for High-Income Professionals and Small Business Owners

tax secrets irs

Although there isn't one technique out there that “the IRS hates,” it's still worth learning about taxes and seeing if you want to live your financial life a little differently. Here are some of them that can make a big difference.

#1 Grow Your Family

If you get married, especially to a non-earner or a low earner, you now get to use the Married Filing Jointly tax brackets, which are much more lenient than the single ones. Obviously, there are benefits to marrying another high earner, but reducing your tax bill isn't one of them. For many, having some kids can lower your tax bill as well due to the child tax credit, but lots of high-income professionals are phased out of those sorts of things. Kids also bring plenty of expenses like child care, college savings, a need for a bigger house with a bigger tax-deductible mortgage and property tax bill, and similar expenses. Like a business expense, these can bring you deductions and credits, but you'll end up spending more than you're getting back on your taxes.

#2 Give More to Charity

There are lots of ways to give to charity—including giving directly, Donor Advised Funds, Charitable Trusts, charitable foundations, and giving appreciated shares owned for at least one year instead of cash. However, like a business expense, you will give more than you will get back from the Tax Man. Still, this has been one of our largest deductions for many years.

#3 Retirement and Other Tax-Advantaged Accounts

Putting money into a 401(k), Roth IRA, 529, or HSA allows those investments to grow in a tax-protected manner, reducing your investment-related taxable income and taxes. While each account works differently, they all help save on taxes compared to investing in a taxable account.

#4 Big Tax-Deferred Contributions

Tax-deferred accounts are often the largest deduction for high-income professionals like doctors. These include 401(k)s with profit-sharing plans ($69,000 contribution limit for those under 50 in 2024), 403(b)s, 457(b)s, SEP-IRAs, and even HSAs. Do you have multiple employers or one employer plus some moonlighting? You can get a second 401(k). Perhaps the biggest tax break in this area is a cash balance plan. Six-figure tax-deferred contributions to these accounts are entirely possible, especially for those in their 50s and 60s. That's pretty close to being a “one weird tax trick,” but I've never heard the IRS say it hates them.

#5 The 199A Deduction

While this one doesn't always work for high-income professionals, it's pretty awesome when the 199A deduction does work. It's only scheduled to last through 2025, but it has rivaled charitable contributions for our biggest deduction for each of the last few years. It was originally designed to put partnerships and S Corporations on equal footing with C Corporations after the Tax Cuts and Jobs Act that went into effect in 2018. Whether it did that, I don't know, but if there were anything in the tax code that would qualify as that “one weird trick,” this would be it.

#6 REPS Plus Bonus Depreciation

While bonus depreciation is starting to phase out, acquiring Real Estate Professional Status (REPS) can allow passive losses to offset earned income, and those passive losses can be enlarged by doing cost segregation studies for bonus depreciation. A doctor married to a real estate professional can potentially pay nothing in federal income tax. It's a lot of work to get this one, though—at least 750 hours a year. If you're interested in running a short-term rental business, you don't even have to put in 750 hours to deduct passive losses against earned income.

#7 Business Expenses

Running things through your business can generate significant savings. Whatever expense you run through your business, however, must 1) be a justifiable business expense and 2) be something you want to buy anyway. But perhaps that annual $250,000 NetJets expense could at least be bought with pre-tax dollars. That could save you six figures in taxes.

#8a PTET

Many states objected to a provision of the TCJA of 2018 that limited the ability to deduct state income taxes on your federal tax return, so they put in place a Pass Through Entity Tax (PTET) that allows business owners to still deduct their state income taxes. This can be a substantial deduction if you have a big state income tax bill.

#8b Move to Puerto Rico

There are some pretty unique tax breaks available if you move your business to Puerto Rico. They could add up to be quite large for the right person. While we're talking about more exotic options, you might consider a captive insurance company or charitable conservation easements. But be aware that those sorts of things can be complex and expensive, and they are often abused and quickly turn into tax evasion.

#9 Adding up the Little Things

There are lots of other tax deductions out there that may be worth the hassle to get. Forming an S Corp can reduce your Medicare tax. Buying a car for your business or logging business miles can save a few bucks. You can rent your house to your business 14 days a year at the going rate and pay no taxes on the income. You can do tax-loss harvesting for $3,000 a year against your ordinary income, plus unlimited amounts against capital gains. Investing intelligently in taxable accounts can ensure the taxes you do pay are at qualified dividend and long-term capital gains rates. You can start 529s for nieces and nephews and deduct those contributions from your state income taxes in many states.

More information here:

Tax Deductions for a Home Office

3 Big Tax Deductions for Doctors

While I like to reduce my taxes as much as the next guy, I'm also aware there isn't “one weird tax trick out there that the IRS hates”—no matter how often that line shows up in my Facebook feed.

What do you think? What's your favorite tax break? What's your biggest tax break? Do you think there's something else you can or should be finding? Comment below!

The post The 1 (Weird) Tax Trick the IRS Hates appeared first on The White Coat Investor - Investing & Personal Finance for Doctors.

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By: The White Coat Investor
Title: The 1 (Weird) Tax Trick the IRS Hates
Sourced From: www.whitecoatinvestor.com/tax-secrets/
Published Date: Mon, 18 Mar 2024 06:30:02 +0000

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