Discussion:Tax Planning Question

I'm not sure I can help them... I'd like your thoughts.

Client is married couple, only one spouse works, w2 income about $150k, 401(k) is max'd. There is income from positive cash flow rental real estate of ~$35k. Client owns own personal residence and deducts mortgage interest and property tax on Sch A. No other significant deductions.

Husband wonders what else they can do to save on taxes.

Their financial planner (a cfp) suggests they seek tax counsel from a tax specialist.

The husband's "idea": to put the residential rental properties in a corporation, owned solely by the wife, who doesn't work. It's not clear to me how this will help. Any ideas on this?

What other "tax planning" advice might you offer them?

Thanks,

The New Tax Guy

That is, in essence, what I tell clients like this.

150K, W2..... not much you can do.

Counsel them on withholding, how real estate income works etc....

They should basically rejoice that they're doing well, but I'd be thinking about some shelters along the lines of tax credited kind of stuff, low income housing, and oil and gas, about the only two left.

But it apparently bears repeating, NEVER EVER NO NOT EVER PUT REAL ESTATE INTO A CORP. And don't let your friends do it either.

I've been told before (and I've intuitively believed) that you shouldn't put real estate into a corporation. I admit, thought that ive never understood WHY.

Can you help me understand?

Thanks, TNTG

Again, out of my league here..Reminds me of the quote about keeping your mouth shut and make everyone THINK you are stupid rather than opening your mouth and letting people KNOW you are stupid.

"When everyone else is losing their head, it's important to keep yours."

Seriously, because of the way New Jersey taxes flow through entities, there can be an argument to put rentals into an S Corp if there is another buiness S Corp that flows profits but to do so might mean holding the property until death. I've yet to have the cojones to suggest this.

But hey, that might just be Marie Antoinette who put that thought into my mind.

Establish an LLC that will manage the property. LLC Hires spouse and pays reasonable salary (I don’t know like 25K or something). Establish profit sharing plan to match 25% or 401K (15.5K+employer match). Elect S Corp for pass through p&l. Sound like an idea? You do need to do some # crunching to see if this scenario would make sense. Consider, payroll tax-15.2%, workers comp in some states, SUI, retirement plan fees $250-$500, accounting fee $500-$1,000, etc. But if the client is in 30% combined Fed/St tax rate and you eliminate that 35K through salary/retirement plan, that would put extra 10K in his pocket. (Witch of course should be invested and not spent on plasma tvs or mid-winter vacation ;-)), not bad!?

Sorry, your head cannot be saved.

If their marriage is solid, why pay double Social Security with ideas like payrolling the wife? Sure you create a pension but you give much of the savings away by paying FICA.

What we should do is make another automatic malpractice category of maxing out a 401(k).

Increase payments to pay off the mortgage.

TexCPA 00:03, 17 September 2009 (CDT)

Let's consider the Roth: you can take money out in a pinch, you can take money out to buy your first home (which works out to be about ever three years, lol), and you can take money out for Junior's education.

And of course, that's what everbody does, and they're broke when they retire.

Just kidding. I know the client is looking only for "tax savings", wealth is an afterthought.

A good portion of the advice given above becomes complex, and in theory won't save much and is not cost effective.

I usually tell a client...OK, you have 35K of income with NO withholding. If you had a 35K job, what would you bring home? they say 25K. I say OK, where did the 10K go?

They start to understand and they start to respect you as an advisor as well as a tax prodessional.

Muni's , ROTH's etc... won;t do enough to satisfy these people if they are like most clients.

-Social Security is not just a retirement benefit, it is also a source of disability income. In really disastrous situations such as developing multiple sclerosis, Social Security can be the best source of lifetime income available anywhere, especially if there are dependent children; -it is a profoundly bad idea to leave one spouse utterly financially dependent upon the other spouse regardless of how well their marriage is going. Stuff happens, things like head traumas and young secretaries. -Having one's own resources, however modest, allay fears of abandonment and accompanying suspicion. In my experience of divorce (personal and professional) a degree of financial security actually adds to the stability of a marriage because those fears are absent or at least less pronounced.

And listen, people: Social Security isn't going anywhere. I agree that proper investment of the money MIGHT generate a better, even a much better, return than Social Security will, especially if you die young. But all the risk in private investment is on the investor. we've seen where that can lead!

You mean like two or three professors I have in the early sixties who have to put off retirement to build their 403(b)s back?

I think you must add the caveat to have advisors who have your interest foremost, not the commission they make or their own egos.

To get serious, the disability covereage can be very important. When CHF, followed by off and on dementia, left my late wife unable to be left alone for more than 30 minutes, social workers suggested disability but we found she hadn't workd enough quarters to qualify.

But in the current discussion, I cannot see artificially splitting this rental income into two: salary and rental income.

Several of the clients were recent med school graduates. They were not "full-blown" docs raking in the cash yet. Some even in a 10% bracket. Yet the former CPA had them all max'ing out IRA, 401(k), etc... So they deferred taxes while they were in the lowest bracket (most likely) of their life.

I must have known the same smart man as AAS. If after spending the net of 70 cents on that equipment you can get a suitable return on your investment, then absolutely buy it. Over the last several years, the other firm had several companies buying lots and lots of equipment with lots and lots of debt. They had strong cash flow and with the 179 deduction, very little taxes. Life was good!

Except in 2008 & 2009, revenues are way down. But since limited depreciation, they have a fair amount of taxable income...and resulting tax. They have lots of debt service. No cash. And several pieces of equipment that they really did not need at the time and are now sitting idle. But hey, they saved taxes!

The clients should also look at state tax credits. In the two states I practice, they can be startlingly good. Kansas, for example, has some astonishing credits for investment in certain business sectors in KS, and also for putting $$ in 529 plans (for example). Charitable donations to certain organizations may qualify as credits in Missouri (this takes advance planning and application).