Elliott, Patrica C.

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Woman C.P.A. Volume 35 Issue 3 Article 3 7-1973 How to Avoid Income Taxes Without Evading Them Patrica C. Elliott Follow this and additional works at: https://egrove.olemiss.edu/wcpa  Part of the Accounting Commons, Taxation Commons, and the Women's Studies Commons Recommended Citation Elliott, Patrica C. (1973) "How to Avoid Income Taxes Without Evading Them," Woman C.P.A.: Vol. 35 : Iss. 3 , Article 3. Available at: https://egrove.olemiss.edu/wcpa/vol35/iss3/3 This Article is brought to you for free and open access by the Archival Digital Accounting Collection at eGrove. It has been accepted for inclusion in Woman C.P.A. by an authorized editor of eGrove. For more information, please contact egrove@olemiss.edu. HOW TO ADVOID INCOME TAXES WITHOUTEVADING THEMThe author gives many helpful hints on how total tax bill.a professional woman can reduce herDr. Patrica C. Elliott, CPA Arlington, TexasIt is too late to minimize one’s 1972 in­come tax bill but the time is perfect for proper planning for 1973 and future years. There are many simple and legal techniques for one to pay only her fair share of taxes; i.e., the least amount legally possible. A few of these tech­niques are discussed and illustrated below.Tax Planning Toward Adjusted Gross IncomeA self-employed person has more oppor­tunity than a salaried individual to properly plan the lowest possible adjusted gross income. A salaried person is allowed very few deduc­tions toward adjusted gross income (such as certain employee expenses and moving ex­penses) which are usually beyond her plan­ning control. Therefore, three areas of plan­ning for self-employed persons will be dis­cussed.Postponing Income and Accelerating ExpensesA self-employed individual who reports on the cash basis may lower her adjusted gross income by not collecting fees earned in De­cember (assuming a calendar year) until Jan­uary or by paying all current expenses and actually prepaying certain expenses in Decem­ber. Of course, any deductions taken in De­cember are not deductible in the following year, and fees collected in January are taxable the following year. In some instances, this deferral of income and/or prepayment of ex­penses each December will result in the same taxable income each year, since the previous year’s decrease will be offset by this year’s increase. However, if the income of the busi­ness is continually rising (which, hopefully, it is), the tax benefit (together with the time value of money) can be derived perpetually.The converse may be utilized to minimize taxes in certain cases. If, in one year the earnings are high and, for some reason, the following year’s earnings are low (or vice versa), the taxpayer should time her fee col­lections and expense payments in such a way as to be in the same tax bracket each year. This situation may actually result in fast collection plans and deferral of expense payments. Each self-employed woman should examine her own particular circumstances before year-end, pro­ject the following year’s events, and act ac­cordingly in order to minimize her total tax bill.Keogh PlansThe Keogh Plan (commonly called HR-10, but more properly referred to as the Self- Employed Individuals Tax Retirement Act of 1962) is a useful device for the self-employed person to “tax shelter” part of her earnings. If the self-employed individual’s plan meets cer­tain qualifications (the most important one being no discrimination in favor of the self­employed individual) she can deduct 10% of her earnings up to $2,500 per year. This maxi­mum of $2,500 must be invested in an ap­proved retirement plan. Approved methods are as follows:A. If the contributions are invested in stock of an “open-end” regulated investment com­pany or in policies issued by an insurance company, the plan may be lodged with a bank as trustee or custodian.1DR. PATRICA C. ELLIOTT, CPA, has been Assistant Professor of Accounting at the Univer­sity of Texas at Arlington since 1969. She will move to the University of Washington in Seattle, Washington, this September as Associate Professor of Accounting.Dr. Elliott has a B.S.B.A. from Eastern New Mexico University, an M.B.A. from the University of Denver, and a D.B.A. from the University of Colorado. She has contributed articles and book reviews to The Woman CPA and has been published in Taxation for Accountants. She is a frequent speaker at tax seminars and at meetings of professional societies.Dr. Elliott is a member of the Dallas Chapter of ASWA.9B. Contributions may be invested in non- transferable annuities or face-amount certifi­cates.2C. Contributions may be invested in a spe­cial series of U.S. Bonds authorized for this purpose.3When the self-employed individual retires (at no less than 59½ years of age) or is dis­abled, the payments received are taxed as ordinary income. (There is a 5-year averaging provision for lump-sum distributions.) Pre­sumably, the individual’s tax bracket is lower after retirement than when she was working.The tax benefit of a Keogh Plan for a per­son in a 36% bracket is $900 annually (assum­ing the maximum contribution is made) so it costs only $1,600 for her to contribute $2,500 toward her retirement. A side benefit is that a Keogh Plan forces one to set aside money for retirement. This can be most beneficial to persons who find it difficult to save.The Use of TrustsA self-employed individual can reduce her income tax bill and provide funds for her child’s education at the same time through the use of a trust. Briefly, it works like this: The mother sets up an irrevocable trust for the benefit of her child. She gives all her business assets (building, machinery, equipment, etc.) to the trust. She then leases the business prop­erty from the trust at a fair rental value. The funds she pays to the trust are deductible as business rental expenses (which exceed the depreciation she could have taken on the assets). The trust has rental income which can be partially offset by the depreciation ex­pense. The net income is taxable to the trust and/or child, who are both in a much lower bracket and who both have exemptions. The total family tax is reduced since income has been shifted from a high bracket taxpayer (mother) to a lower bracket taxpayer (the trust and/or child). Mother is, in effect, ac­cumulating funds for child with after-tax dol­lars, since the payments are deductible to her. The higher her bracket, the “cheaper” these after-tax dollars become.Tax Planning from Adjusted Gross IncomeThe major question for every working woman, whether self-employed or salaried, is whether to itemize her deductions or take the standard deduction. Since the standard deduc­tion has been increased to 15% of adjusted gross income to a maximum of $2,000 per year, many women will discover that it is cheaper to take the standard deduction, and there is not much planning one can do in that case. However, with proper planning, she may discover that by alternating between the standard deduction and itemizing, she can lower her total tax bill.Timing of DeductionsMany of the expenditures which result in itemized deductions can be made earlier or later than usual and can result in substantial tax savings. One such area for proper timing is medical expenses. If a woman making $20,- 000 per year typically had medical expenses averaging $600 per year, she would get no deduction because of the 3%-of-AGI reduction of medical expenses. If she could “bunch up” two years’ medical expenses in one year, the $1,200 total would be offset by $600 (3% of $20,000) and she would have created a de­duction of $600. It is true that some medical expenses cannot be deferred or accelerated (such as an automobile accident) but others can. For example, she could have the expensive" dental work done in the same year that she has a baby; her husband could buy new glasses that year; daughter’s tonsillectomy could just as well be done in November as January; son’s new corrective shoes can be purchased a month early; the whole family’s annual check-ups could be done in January and December of the same year; and so on. This type of plan­ning may be contrary to a family’s cash bud­get, but money can be borrowed and repaid and the interest could be less than the tax savings. (And, of course, the interest is de­ductible, too.)There are many opportunities for bunching up deductions in one year. A numerical ex­ample may serve to illustrate the savings a family could realize. Suppose John and Mary have an annual average of $2,500 in itemized deductions. If they are in a 30% bracket, these itemized deductions save them $150 per year over the standard deduction of $2,000. In 1973 and 1974, John and Mary plan to mini­mize their taxes. In 1973 they accelerate their medical expenses (as explained above); they make their 1974 contribution to the church in December, 1973; they pay their property taxes for 1973 in March and the 1974 property taxes in December; they prepay interest on several loans; John pays part of 1974’s alimony to a former wife in December; Mary pays two years’ professional dues in 1973; etc. They had to borrow some money to do this. Now they have $4,000 in itemized deductions for 1973 and $1,000 for 1974 (the same $5,000 total for two years). In 1973 they itemize their deductions of $4,000; in 1974, they use the standard deduction of $2,000. The total for two years is now $6,000 as opposed to $5,000.(Continued on page 14)10grove income. In 1969 Congress became con­cerned with over-production of almonds and citrus and enacted Section 278, requiring that the cost of planting, cultivating, and maintain­ing trees planted after 1969 be capitalized for four years and recovered through depreciation. This provision has effectively removed the tax shelter advantage.5. VineyardsAlthough the Tax Reform Act has just about nullified the sheltering effect of citrus groves, there is another farming operation that present­ly offers favorable tax treatment. The increase in domestic wine consumption has drawn the investor’s attention to California vineyards as a source of tax shelter. As with any growing crop, there is a certain risk in this type of investment due to price fluctuations and un­certain weather conditions, but the potential for profit as well as tax shelter benefits is excellent. For economic reasons, participation in these ventures will probably be in partner­ship form as a sizeable investment is necessary to produce a profitable vineyard, and Section 1251 rules governing annual deductions above $25,000.00 will apply.A new vineyard takes four to six years to reach income productivity. As in the case of citrus groves, the initial investment for clearing and preparing land, planting vines, and install­ing irrigation and drainage systems must gen­erally be capitalized. These expenditures are depreciable on either the straight-line or ac­celerated basis and will usually qualify for investment credit. The developmental costs during the years the vines are maturing may be expensed currently, and, accordingly, the in­vestor will have tax shelter available against his other income. The deductions, of course, are limited to the cash equity investment, plus, in the case of non-recourse borrowing, the pro­portionate share of the underlying real estate mortgage on the land. Capital gain will be realized in full if the vineyard is sold before depreciation begins. However, since vineyards like citrus groves are 1245 property, full re­capture is possible to the extent depreciation has been taken and there is an excess deduc­tion account.Assuming optimum conditions, vineyards can accomplish three basic concepts involved in tax shelter: deferral of tax, conversion of current deductions into future capital gains, and special statutory incentives for investment in the form of tax investment credits.This is a brief, rather general discussion of investing in tax shelters and does not cover the specific problems an investor may encounter when the investment is made through a limited partnership or when there are non-recourse loans. There are several related code provisions which have a direct affect on tax shelters. In addition, the Internal Revenue Service is cur­rently attacking certain aspects of sheltering; and, as a result, Congress is presently consid­ering new legislation in this area. Therefore, a taxpayer should approach a tax shelter venture as an investment rather than only as a means of tax savings.HOW TO AVOID INCOME TAXES . . .(Continued from page 10)In a 30% bracket the $1,000 in deductions they have created will save them $300. If they had borrowed $1,000 at 8% for six months to ac­complish this, the interest expense is $40. There is still an after-tax savings of $260. If John and Mary do this consistently, their sav­ings over several years will be substantial. For persons in a higher bracket, the savings will be even greater.Filing Status and ExemptionsMany women can reduce their tax bill by taking advantage of the head-of-household rates. One notable example is the divorced (or widowed) woman with children. She is en­titled to use the favorable head-of-household rates if she maintains a home for the children. She need not be able to claim them as depen­dents in order to qualify as a head-of-house- hold; the only requirement is that she maintain a home for them. This occurs commonly in cases where the father is supporting the chil­dren through child support payments.Retired parents offer another opportunity for filing as a head-of-household. The parents need not live in the taxpayer’s home for her to qualify. She must be able to claim them as dependents (i.e., furnish more than one-half their support), they cannot have income of over $750 each, and they cannot file a joint return. However, any social security payments received by the parents do not count as “in­come” for the $750 income test. Therefore, a retired parent living on social security can still be a dependent and the taxpayer can still qualify as a head-of-household, providing she provides more than one-half of the support. (Social Security benefits are taken into account in the support test, however.) If a woman has a rental property, she might save tax dollars 14by not renting it and letting her parents live in it. The fair market value of the rent is added to any money she gives the parents to de­termine “support,” which may be enough to amount to over 50%. She then gets $1,500 in exemptions plus the favorable Head-of-House­hold tax rates. This may result in tax savings in excess of the rental income she was receiv­ing.The partial support of parents does not re­sult in head-of-household benefits, but a multi­ple support agreement among the supporting children can result in an occasional exemption deduction. Anyone contributing to the support of parents should investigate this possibility.Married college-student children can also be claimed as dependents, providing the parents provide over one-half the support of their child and that child does not file a joint return with his or her spouse.A widow with dependent children for whom she maintains a household can qualify for the most favorable tax rates: those of married indi­viduals filing jointly. She qualifies for these rates for the year in which her husband died and for the two succeeding years provided she remains unmarried. After that, she will proba­bly qualify for the head-of-household rates.There are many ways one may claim a de­pendent; any woman who is contributing to the support of another person should investi­gate all the possibilities.ConclusionIt is hoped that this article has pointed out a few areas of tax planning to the reader. There are many other areas for possible sav­ings, such as the new child care deduction provisions. Each woman should investigate the new (and old, but overlooked) provisions and plan her tax affairs as carefully as she plans her other financial affairs. After all, after-tax dollars are what she can spend or invest.NOTES1. Code Section 401 (d)(1); Regulation 1.401- 12(c).2. Code Section 401 (g); Regulation 1.401-9.3. Code Section 405; Regulation 1.405-1.REVIEWS(Continued from page 20)The Income Tax and Business Decisions, Second Edition, William L. Raby, Prentice- Hall, Inc., Englewood Cliffs, N.J., 1972, 496 pages, $11.95 (cloth-cover).While this book is interesting, well written and occasionally amusing, it is not a book most readers of The Woman CPA would want in their libraries. It is neither a technical nor a specific-topic book. It is, rather, an elementary and general discussion of taxation.The book is organized into four parts. The first chapter presents a broad overview by dis­cussing the various concepts of income; Chap­ter Two is a hodgepodge of the legislative pro­cess, the judicial system, ADP, tax experts and tax practice. The second part looks at the vari­ous taxpaying entities and makes extensive use of filled-in tax forms for illustrations. Part three consists of ten chapters on specific areas of taxation such as depreciation, capital gains, and corporate reorganizations. The final part consists of a five-chapter concentration on tax practice.Dr. Raby appears to have fallen into the trap of being unable to decide toward whom the book is aimed. If it is aimed at the busi­nessman (who is ignorant of taxation and has no intention of becoming an expert) pictures of filled-in forms are of no benefit. Of what use (to a businessman) is the section on tax prac­tice? If, on the other hand, the book is aimed at tax practitioners, a more legalistic approach is necessary.Despite these deficiencies, the book is the best on the market for use in a tax course de­signed for non-accounting majors (or account­ing majors not planning a career in public practice). There are several specific sugges­tions for improving this book for use in a col­lege course: Part One should have some background history of taxation in the U.S.; the law-making process and judicial system could be expanded; more attention should be given to why certain laws were passed (an historical perspective would help); the section on tax practice could be eliminated; and, finally, more emphasis should be placed upon teaching the future businessman how to recognize problem areas so he will consult his C.P.A. prior to disastrous actions.This second edition is so much better than the first edition (1964) that one hopes it will not be another six years before the third edition is available.Dr. Patrica C. Elliott, CPA University of Texas at Arlington15

How to Avoid Income Taxes Without Evading Them

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