notes_investment_issues - 1 TAX 6845 Tax Planning...

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1 TAX 6845 – Tax Planning & Consulting (September 6) Topic: Investment issues & the loss limiters updated: September 7, 2011 I. What is a tax shelter? It depends… A. Some take the view that a tax shelter is any investment or transaction that helps reduce how much tax you pay the federal government by reducing your taxable income. Tax shelters typically: (1) defer, or avoid, the recognition of income or (2) create tax deductions for the taxpayer. While the IRS generally reserves the term for “abusive” or “overly aggressive” tax strategies that may be questionable or even illegal. B. Although the term – tax shelter – sounds like a tool for the very rich to exploit “loopholes” in the tax law, many tax shelters are available for regular taxpayers. C. When you use a legal, legitimate tax shelter, you are avoiding taxes, which should not be confused with evading taxes. Many legal tax shelters are actually created by the government to encourage certain behaviors (long-term savings) or to help the economy. D. The IRS considers the abuse of tax shelters a form of tax evasion, which is illegal. If your investment has no economic substance and is made solely for avoiding or evading taxes you may be liable for additional taxes, interest and penalties. Civil fraud can include a penalty of up to 75% of the underpayment of tax. E. Some common (legal) tax shelters available to individual taxpayers include: 1. Retirement accounts – such as pensions, 401(k) and 403(b) plans, and Individual Retirement Accounts (IRAs). Taxpayer’s make pretax contributions to the plan and are taxed when amounts are withdrawn. You defer payment of income taxes until your retirement years. 2. Life insurance and annuities – Once again your money will grow tax free and you will have to pay taxes on whatever you start drawing out. (For example, the cash surrender vale of whole life insurance policies.) The face value of the policy payable to the beneficiary upon the death of the insured is excluded from gross income. 3. Charitable contributions – Donations to qualified charities are tax deductible (an itemized deduction). The tax benefit is even greater when you contribute appreciated assets held for more than one year. 4. Home ownership – If you itemize you can deduct home mortgage interest and property taxes, and exclude up to $250,000 profit ($500,000 MFJ) from the sale.
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2 5. Rental real estate – Allows you to use leverage to buy property, with the rents helping to cover your mortgage interest, property taxes and other expenses. Plus, you get to depreciation the property so you often will show a paper loss when the property is appreciating (hopefully) in value. 6. Run your “hobby” as a business – If you can show you are attempting to
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notes_investment_issues - 1 TAX 6845 Tax Planning...

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