1998 Tax Guide: More Tips for High-Income Individuals

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Chapter 3
More Tips
for High-Income Individuals
Tax Strategies for 1999

1998 Tax Guide

Make taxable
gifts, and
maximize your
contributions to
retirement
accounts.

Make taxable gifts to pay less in taxes. Although the federal estate and gift tax rates are based on the same tax rate

Important!

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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-percent 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.

Change your residence. Moving to another state may save not only income tax, but also other taxes (such as estate, property, and sales taxes). The states that do not have an income tax are Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. Bear in mind, how-ever, that low income tax rates may be counter-balanced by high estate taxes or personal property taxes.

Withdraw IRA funds for 60 days. Rather than borrow short-term funds from a third party, consider using your IRA funds for up to sixty days. To avoid tax, you must follow proper procedures. Consult with an expert before withdrawing funds.

Avoid ancillary probate in another state. Real estate and tangible personal property owned by a deceased individual but located in another state are subject to probate proceedings in that state. To avoid having to have more than one probate, consider transferring any out-of-state property, such as real estate, into a revocable living trust or into joint tenancy.

Maximize contributions to retirement plans. Verify that you are contributing the maximum amount possible to employer-sponsored retirement plans and to any plans that have been established for self-employment income.

Weigh the effectiveness of a defective grantor trust. This type of trust is effective for estate-planning purposes. It is only "defective" for income tax purposes, which means that you, the person establishing the trust, will continue to pay the tax on the income earned by the trust. Although the value of the trust is increased by the amount of the tax paid, this payment is currently not treated as an additional taxable gift to the beneficiaries of the trust.

Consider the use of trusts for charitable giving. Charitable remainder trusts and charitable lead trusts are split-interest accounts. In a remainder trust, the income interest is payable for a term of years (maximum of 20) or for life to a noncharitable beneficiary, with the remainder going to qualified charities at the end of the income term. In the year the trust is funded, the donor has an income tax charitable deduction equal to the present value of the charity’s remainder interest. A charitable lead trust provides an income stream to qualified charities and the remainder passes to noncharitable beneficiaries chosen by the donor. Whether the donor receives a charitable deduction depends on how the trust is structured. Gift tax consequences must also be considered for both types of trusts.

Verify that estimated income taxes cover trust income that may be taxable to you. Have you established any trusts for the benefit of your family, with the income still taxable to you (that is, established a defective grantor trust)? Alternatively, have you established any trusts that provide you with certain rights that cause you to pay tax on all or a portion of the trust’s income? If so, make sure your 1998 income tax projections include this income for purposes of paying the correct amount of estimated income tax.

Consider renting to college-age children. Most college expenses have continued to rise annually at a faster pace than the consumer price index. Rather than renting a place for your child to live while he or she is attending college, consider purchasing property that you could rent to your child.

Weigh ordinary income taxation on retirement-plan distributions against capital gain rates on other investments. In some cases, it may be more advantageous for individuals approaching retirement to invest in equities outside of their retirement accounts so they can obtain the favorable capital gains rate when they "cash in" their investment. Retirement plan distributions are generally taxed at ordinary income tax rates, which can be in excess of 39.6 percent.

Consider limitations in deducting mortgage interest on primary and secondary residences. For residential mortgages dated after October 14, 1987, you can’t deduct all of the interest if the total indebtedness exceeds $1.1 million ($100,000 on any new indebtedness -- such as a home-equity loan -- that was not used to acquire, construct, or substantially improve a personal residence). If interest is attributable to debt that is greater than these dollar limits, it is not deductible.

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