A personal CPA Houston can help you plan for taxes by keeping you in compliance and consulting you in how to reduce taxes over your lifetime. Being in compliance means following the tax law and filing required reports by their statutory deadline and tax planning means applying the tax law in a way that helps mitigates tax exposure. When both of these happen, you can avoid penalties and over-paying in taxes. This post will provide some examples of tax strategies to obtain an understanding of how a personal CPA can consult you based on my experience as CPA. Furthermore, I’ll mention some specific examples of how a CPA can keep you in compliance.

The Landscape of Tax Strategy From a Personal CPA in Houston

We can categorize tax planning into three primary buckets. Those buckets include changing the character of income (ordinary; capital; business income), changing the timing of income and deductions, and optimizing available tax credits and deductions. Whether it be determining the best organizational structure for a business or estate planning, you can be assured that the planning tools being assessed will fall into one of the three categories mentioned above. Consider the following examples to illustrate this point.

Example 1: Real Estate Investment Consider an individual who invests in real estate. By holding onto a property for more than a year before selling, the income from the sale is treated as long-term capital gains rather than ordinary income. This is an example of changing the character of income, as capital gains often have a lower tax rate than ordinary income. Additionally, the investor can strategically time the sale of the property to a year when they expect a lower overall income, thereby changing the timing of income to potentially fall into a lower tax bracket.

Example 2: Charitable Contributions Another common tax strategy involves charitable contributions. An individual might decide to “bunch” several years’ worth of charitable donations into a single year, allowing them to itemize their deductions and surpass the standard deduction amount. This is an example of changing the timing of deductions. Furthermore, by donating appreciated stocks or assets, the individual can also avoid capital gains tax on the appreciation, optimizing available tax credits and deductions.

Example 3: Starting a Home-Based Business

Imagine an individual, Sarah, who starts a home-based graphic design business. By doing so, she can change the character of her income. Instead of just earning a salary (ordinary income) from her day job, she now also earns business income. This allows her to deduct business expenses such as a portion of her home’s utilities, office supplies, and even a part of her rent or mortgage as a home office deduction.

Furthermore, Sarah can decide when to bill her clients or when to make significant business-related purchases, thereby changing the timing of her income and deductions. For instance, if she anticipates a higher income next year, she might delay billing some clients until the beginning of that year.

These examples illustrate the categories of tax strategy. Now that you have a better understanding of the tax planning landscape, I will discuss some high leverage areas of concern when it comes to this topic – areas that yield the most significant value and impact.

Personal CPA Houston: Maximizing Deductions For Individuals

For an individual with no business, the first step in maximizing deductions is to obtain an understanding of what you are spending. Then once you obtain an understanding of how much you are spending to consider whether there are any tax benefits for those types of expenses. Here are three types of deductions that the tax code favors:

Medical Expenses:  You can deduct medical expenses that exceed 7.5% of your adjusted gross income (AGI). This includes a range of costs, from doctor’s visits and surgeries to prescription medications. If you have significant medical expenses planned, such as an elective surgery, consider timing it in a year when you’re bunching deductions.

Charitable Contributions: Donating to charity is tax deductible. Keep detailed records of all charitable donations, whether they’re cash contributions, donated goods, or even mileage driven for charitable purposes.

Retirement Savings: Allocating funds to retirement vehicles such as 401(k)s and IRAs serves a twofold purpose. On one hand, it’s a step towards ensuring a stable financial horizon post-retirement. On the other, these contributions are generally made before taxes, effectively lowering your annual taxable income. As of 2023, the contribution limits stand at $19,500 for 401(k)s and $6,000 for traditional IRAs, with an extra provision of $1,000 for individuals aged 50 and above. Additionally, for those enrolled in high-deductible health schemes, Health Savings Accounts (HSAs) present an opportunity for contributions made pre-tax, coupled with the advantage of tax-exempt growth.

The Bunching Strategy: An advanced approach to deductions is the bunching strategy. This involves accumulating or “bunching” deductions in a specific year to exceed the standard deduction threshold, allowing you to itemize that year and then take the standard deduction in the subsequent year. For instance, if you’re on the brink of the itemized deduction limit, you might choose to make two years’ worth of charitable contributions in one year, pushing you well above the standard deduction. Similarly, if you’re planning a significant medical procedure, timing it in the same year as your increased charitable donations can further amplify your itemized deductions. This strategic bunching can lead to substantial tax savings over a two-year period.

Personal CPA Houston: Maximizing Tax Credits For Individuals

Unlike deductions, which reduce the amount of income subject to tax, credits directly reduce the amount of tax you owe, dollar for dollar. For individuals without a business, there are still numerous tax credits available that can significantly reduce tax liability. Here’s is a list of some of the most impactful:

Earned Income Tax Credit (EITC): This is designed for low- to moderate-income earners. The amount of the credit varies based on income, filing status, and the number of dependent children. It’s refundable, meaning if the credit exceeds the amount of tax owed, you can receive the excess as a refund.

Child Tax Credit: For parents or guardians of children under 17, this credit can provide significant relief. The amount is subject to income limitations and can be partially refundable under certain conditions.

Child and Dependent Care Credit: If you pay for childcare or care for a dependent adult so you can work or look for work, you might qualify for this credit. It’s based on a percentage of the care expenses you incur.

American Opportunity Credit and Lifetime Learning Credit: These are for individuals pursuing higher education. The American Opportunity Credit is available for the first four years of post-secondary education, while the Lifetime Learning Credit is available for any post-secondary education or courses to acquire or improve job skills.

Retirement Savings Contributions Credit (Saver’s Credit): If you contribute to a retirement account like an IRA or 401(k) and meet income requirements, you might be eligible for this credit. It’s designed to encourage retirement savings among low- and moderate-income individuals.

Premium Tax Credit: For those who purchase health insurance through the Marketplace and meet certain income requirements, this credit can help offset the cost of premiums.

Residential Energy Credits: If you make energy-efficient improvements to your home, such as installing solar panels or energy-efficient windows, you might qualify for this credit.

Elderly and Disabled Credit: For those over 65 or retired on permanent and total disability and meet income requirements, this credit is designed to provide some financial relief.

Adoption Credit: If you’ve incurred expenses related to the adoption of a child, this credit can help offset those costs.

Changing the Character of Your Income: Personal CPA Houston Tax Strategies

The nature or “character” of your income can significantly impact the amount of tax you owe. By understanding and strategically altering the character of your income, you can potentially reduce your tax liability. Here’s a closer look at this concept and some strategies individuals can employ:

What Does “Character of Income” Mean?

The “character” of income refers to the classification of income for tax purposes. Different types of income are taxed at different rates. For instance, ordinary income (like wages or interest income) might be taxed at a higher rate than long-term capital gains.

Why Change the Character of Income?

By shifting income from a higher-taxed category to a lower-taxed category, you can achieve significant tax savings. This doesn’t mean evading taxes but rather making informed decisions that align with tax laws.

Examples of Changing the Character of Income:

a. Investment Holding Periods:

• Ordinary Income: Profits from selling an asset (like stocks) held for less than a year are considered short-term capital gains and are taxed as ordinary income.
• Strategy: By holding onto investments for more than a year, profits become long-term capital gains, which are typically taxed at a lower rate than ordinary income.

b. Convert Traditional IRA to Roth IRA:

• Ordinary Income: Withdrawals from a traditional IRA in retirement are taxed as ordinary income.
• Strategy: By converting a traditional IRA to a Roth IRA, you pay taxes upfront. However, future withdrawals in retirement are tax-free, changing the character from taxable to tax-free income.

c. Real Estate Investments:

• Ordinary Income: Rental income is typically considered ordinary income.
• Strategy: By investing in real estate, you can benefit from depreciation, which can offset rental income, effectively reducing your taxable income. Additionally, when you sell the property, you might benefit from long-term capital gains rates if held for more than a year.

d. Dividend Income:

• Ordinary Income: Some dividends are classified as ordinary dividends and are taxed at your regular tax rate.
• Strategy: By investing in stocks that pay “qualified dividends,” these dividends are taxed at the lower capital gains rate.

Things to Consider:

While changing the character of your income can offer tax advantages, it’s essential to consider the broader financial implications. For instance, while Roth conversions can be beneficial, they might not be suitable for everyone, especially if you expect to be in a lower tax bracket in retirement. Understanding and strategically altering the character of your income can lead to substantial tax savings. However, it’s crucial to approach these strategies with a comprehensive understanding of your financial situation and goals.

Personal CPA Houston: Ensuring Compliance

A personal CPA does more than just prepare annual tax returns. They offer guidance on tax planning, financial decision-making, and, crucially, ensuring that you remain compliant with all relevant regulations. Here are some real-world examples of what that looks like:

Deduction Validation: John, a freelance graphic designer, believed he could deduct his entire home internet bill since he worked from home. As a CPA, I would help clarify portion of the internet used exclusively for work could be deducted, preventing a potential audit trigger.

Retirement Plan Contributions: Sarah, nearing retirement, was contributing to her IRA. As a personal CPA, I would let her know that she was exceeding the annual contribution limit, which could have led to penalties. The CPA advised her on the correct amounts and explored other retirement saving options.

Reasonable Compensation: Lisa and Raj, as shareholder-employees of ABC Co,, drew salaries from the company. However, they initially set their salaries below market rate to reinvest more profits back into the business. I would warn them that the IRS expects shareholder-employees of S Corps to receive “reasonable compensation” for their services. Underpaying themselves could be seen as an attempt to avoid payroll taxes.

Conclusion and Next Steps

Having a personal CPA can help provide you with more tools for managing your taxes and staying in compliance. If you’re looking to better your tax situation, then feel free to schedule a call with us at JAG CPA & Co.

About The Author

Joe is  a Certified Public Accountant (C.P.A.) and a Certified Valuation Analyst (C.V.A.). Joe’s professional career in public accounting began in 2012 with one of the “Big 4” international accounting firms. Since 2012, the focus of his professional engagements has been primarily in the area of business tax planning, cash flow planning and management, business valuations, and small business financial consulting.