Tax Guide: Strategies for High-Income, High-Net-Worth Individuals

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Chapter 3
20 Tips for High-Income,
High-Net-Worth Individuals
Tax Strategies for 1998

Take maximum
advantage of
company benefits.

Contribute directors' fees to retirement accounts. Earning compensation for serving on a company's board of directors may enable you to make a contribution to a tax-deferred self-employed retirement account and receive a current income tax deduction for the amount you contribute. It may be possible to do this even if you are also an employee of the company, if the compensation is sufficiently segregated from your wage income.

Make gifts to grandchildren or children to encourage contributions to individual retirement accounts (IRAs). Children and grandchildren with earned income can contribute up to $2,000 (and an additional $2,000 for a spouse) annually to a tax-deferred IRA. To encourage the child or grandchild to make the maximum contribution to a tax-deferred IRA, you may make a gift to the child or grandchild that is at least equal to the after-tax cost of the IRA contribution. Taxation of gifts is discussed in Chapter 8.

Important!

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Make pretax gifts to low-income parents and grandparents. Individuals in a 40% income tax bracket need income in excess of $16,666 to make a $10,000 gift to their parents or grandparents. If income could be shifted to the relative in need (for example, through the use of a trust), significantly less income would be required to fund the $10,000 gift after taxes. The ultimate savings will depend upon the relative's cur-rent income tax picture (including such factors as the relative's income tax bracket and whether deductions and exemptions are being wasted).

Contribute to flexible spending accounts. If your employer allows you to contribute pretax earnings to fund accounts for medical and child care expenses, you can obtain significant tax savings by contributing the projected annual out-of-pocket expenses (after insurance). Although you will lose whatever is not expended during the year (which should not occur if you are monitoring how much is available to you), the income tax savings generally make it advantageous to contribute

Select the right beneficiaries for qualified retirement plans. You can maximize the time over which your retirement plan distributions are paid (which results in more time for tax-deferred growth) by selecting the right beneficiaries for your retirement accounts. Consult with a specialist who can assist you to select the proper persons to designate as your primary and secondary beneficiaries. A specialist can also help you understand how the distribution amounts are calculated. Distributions from retirement plans are discussed in Chapter 6.

Weigh the tax effects of withdrawing retirement funds early. Large retirement account balances remaining in your name at death may be subject to both estate taxes and income taxes, which could significantly reduce the balance remaining for your heirs. Review whether it would be more advantageous to withdraw additional funds currently and benefit your heirs more in the long run through the use of gifts. Plan distributions are discussed in Chapter 6; lifetime gifts are discussed in Chapter 8.

Use gift tax exclusions, including paying certain medical and educational expenses. Each year, a donor may give $10,000 ($20,000 if a spouse joins in the gift) per donee without paying federal gift tax. Beginning in 1998, these amounts will be indexed for inflation. In addition, a donor can pay certain medical and educational expenses of the donee without any gift tax liability. Using these exclusions from gift tax to the maximum extent annually continues to be a good estate planning strategy. Gift tax is discussed in Chapter 8.

Use all or part of the unified credit for federal estate and gift taxes. For 1997, each individual can transfer, either during life or upon death, $600,000 ($1.2 million if the spouse joins in the gift) free of federal estate and gift taxes. If you can afford to use this exemption during life, you should consider doing so as early as possible. This strategy can save estate taxes on the appreciation on the gifted assets. The estate tax rates range up to 55%. The $600,000 amount, above, rises to $625,000 in 1998; it rises in later years until it reaches $1,000,000 in 2006.

Use all or part of the exemption from generation-skipping tax. Each individual can transfer, either during life or upon death, $1 million ($2 million if the spouse joins in the gift) free of the 55% federal generation-skipping transfer (GST) tax. Beginning in 1998, these amounts will be indexed for inflation. If you want to maximize the amount of wealth you transfer to future generations, you should consider using this exemption (and possibly leveraging this exemption through the use of life insurance) as early as you can afford to do so. With proper planning, millions of additional dollars can be made available for future generations. You may have to file gift tax returns to allocate part of the GST exemption, even if the gifts you make fall under the annual exclusion. The gift tax annual exclusion is discussed in Chapter 8.

Make taxable gifts to pay less in taxes. Although the federal estate and gift tax rates are based on the same tax rate schedule, the computation of the tax liability is very different. The federal gift tax is computed using the net amount gifted to the donee, while the federal estate tax is computed using the gross amount. For example, assume a donor with a 50% federal estate and gift tax rate has $1.5 million. The donor could make a gift of $1 million (and pay $500,000 in federal gift tax). If the donor dies with the $1.5 million, only $750,000 would be available for heirs after paying the $750,000 federal estate tax.

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