Managing the amount of taxable income annually

Doug Horn

Every year most of us have to file our annual tax return and pay unto Caesar what is Caesar’s as the saying goes. While we each look for every valid deduction to make sure the amount of the net taxable income is as low as possible, there may be other ways to lower the income tax due.

For small businesses that file a separate return or the Schedule C, to lower the impact on the taxes due again is making sure all of the deductions or business expenses have been included. For individuals, it is making sure the Schedule A is complete which again includes a number of deductions. Thus, we are all trained to look for additional deductions as a way to lower the income taxes that might be due. But, what about the income reported on page one of the return? It could be asked if this income can be reduced and as such lower the income taxes?

The answer is ‘yes’, and the first thing an individual can do is to participate their company 401-k plan or contribute to an IRA provided they have earned income. But, this once again is dealing more with the deductions than the reported income.

Some of the income reported on page one just has to be accepted and nothing can be done to reduce the taxable amount. This would include wages once the retirement deduction has been considered. The same would be of pension income. Both wages and pensions generally must be taken and cannot be deferred to a later year. However, with additional planning or management, some of the other income can be altered or delayed which may reduce the annual income tax bill.

Interest income is the first opportunity. With interest rates so low, the tax paid on the income is not significant but the type of interest income could be changed to municipal interest by purchasing municipal bonds or municipal bond mutual funds. The amount of interest earned may actually be very similar, but now it is not subject to Federal income tax, thus lowering the tax bill.

Capital gain distributions can also add to the taxable income and are reported outside of the investor’s control. This income could be offset though by evaluating all of the taxable investments and “harvest” tax losses. This would be done by selling any investment whose current value is less than the tax basis of the holding. By doing so, the loss on the investment would offset a portion or all of the capital gains that may be reported by other holdings. With the number of mutual funds available, selling out of one and moving the funds to a new fund, perhaps one with a slightly better rating will solve two problems; provide a loss to offset reported gains and improve the quality of the investments within the portfolio.

For those who are living off of interest from CDs, annuities, or taking distributions from annuities, it may be advantageous to restructure this income. As an example, someone with $200,000 earning 3% or $6,000 per year could restructure this income and reduce their taxable income. It may be possible to purchase an immediate annuity for slightly less than $28,000 and have it pay $500 per month over five years. The cash flow is the same but now the taxable income is far less since a portion of the current distributions represents the initial investment. The balance of the portfolio, around $172,000 could be invested into a deferred or variable annuity and its earnings for the next five years would be deferred. If the new annuity earned the same 3%, at the end of five years the portfolio would once again be worth $200,000. Thus, even though part of the investment was consumed from the immediate annuity, the new deferred annuity could recover what was consumed.

For those taxpayers who are receiving Social Security and have to pay income tax on part of this income, should review to see if their taxable income could be reduced. Taking some of the above steps may reduce the amount of taxable income and as an additional benefit it may also reduce the amount of Social Security income subject to taxation.

Just remember, it is not only the deductions that can provide lower income taxes, managing the income can provide the some benefit.

For assistance with insurance, estate planning, and managing investments, contact me at Quality Financial Concepts or one of the other Certified Financial Planners in our area. To continue a personal quest for education, you can also view our learning center on our website, There you will find articles on a variety of topics, on-line seminars, calculators, as well as a host of other free tools.

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