As a Gonzaga University alum (class of 2000), I find it quite fitting and timely to share a tax strategy we refer to as bracket management. Yes, the NCAA tournament is approaching and my ten key cadence is a bit slower than normal due to having my fingers crossed that this year’s teams get the opportunity to share their talents and acumen with the spectating world at large…even if it will be viewed from our remote offices.
The U.S. currently has seven, yes 7, federal income tax brackets to apply to an individual’s taxable income. Until Congress revises the rates, they currently start at 10% and ratchet up to a top rate of 37% (this does not include the Additional Medicare Tax or other applicable taxes for gifts above the annual exclusion amount or those imposed by other jurisdictions, like states).
Depending on your filing status, the taxable income amounts subject to each of these seven marginal rates varies. You do not simply take your total income, find the applicable rate, multiply for the result, then cut the check. The applicable rate by bracket is incrementally applied to your taxable income. Calculating your taxable income is beyond the scope of this post, but rest assured, the calculation is within your control; possibly more than you may currently think.
As a self-employed business owner, the determination of income on which you are taxed is within your control. The decisions you make about how you generate and receive cash and income will determine how much tax you pay. Utilizing proactive tax planning allows you to effectively choose which tax bracket you are willing to accept as your highest tier. I believe this is best demonstrated through examples, but that may be the Jesuit based secondary education shining through.
If you are placed well (seeded) into a particular bracket, like the Gonzaga Bulldogs projected to go deep into the NCAA tournament ( they have held the top spot on my tournament bracket since 1998), then you may be wise to follow strategies for current income deferral and reduce your current income with additional deductions in order to remain in your current tax bracket or drop into a lower marginal rate’s bracket. Moving between the 24% and 22% brackets may not seem like much but stepping down one bracket from the 32% rate to the 24% bracket sure feels good. Similarly, a single bracket step from the 22% bracket to the 12% rate can be meaningful.
A simple time value of money calculator can show how a dollar saved today is worth more in the future. That said, depending on your specific circumstances and the anticipated changes coming from the proposed tax reform of the new administration, choosing to pay tax at today’s rates may be beneficial over the long-term.
When has a question been too expensive to ask? Do not be afraid to run the numbers to see for yourself whether deferring income is in your best interest or the government’s.
On the flip side, if you are like many individuals who have seen their personal income decline due to the current pandemic, you may find yourself in a lower than “normal” tax bracket. In this case, you may want to consider accelerating income into the current year to take advantage of taxing income at a lower rate, currently, so that you may invest those funds in an after tax arrangement that provides security in future periods. For example, in a down year, you may have $50,000 remaining in your current tax bracket before you bump up from the 24% rate and into the 32% applicable rate bracket. That provides room to consider completing a Roth IRA conversion up to the amount that keeps you in the 24% bracket, without subjecting yourself to a personally unacceptable level of tax.
Roth IRA conversions are just one option for an after-tax investment structure, but other choices could be considered based on your circumstances. Another option may include permanent life insurance to supplement as a retirement plan through a cash value leverage strategy. This strategy uses a specifically structured traditional investment product (i.e. life insurance) for a non-traditional purpose (i.e. retirement funding) and may result in providing tax-free cash flow during retirement, while funding your heirs to assist with life’s transition.
Please choose your investments wisely. Okay, that may be my prior position as Community Bank CFO and investment of “other people’s money” experience speaking. Nonetheless, emotions are very persistent negotiators when allowed to influence your decision making. Remaining objective can be difficult at times, even for the most disciplined investor.
If your current tax forecast projects your tax liability to be beyond your comfort level or moves into a higher marginal tax bracket, investigate strategies that:
- shift income to others in a lower tax bracket,
- move expenses or income to a different time period,
- make use of the Internal Revenue Code to your advantage,
- enlist the use of tax-efficient products
In my professional career, I hear and read the word bracket often and I am thankful the word still triggers great personal memories. While I attended Gonzaga University, through common coursework, living arrangements, or mutual friend relationships, I had the privileged and sparse opportunity to play 21 tip-in at the old Martin Centre (Center) main court with Richie Frahm, Matt Santangelo, Mark Spink, Ryan Floyd, Mike Nilson and some of the other great leaders that attended during my four years at Gonzaga. Admittedly, I grew up playing premier soccer and never played a minute of organized competitive basketball in my life. Those gentlemen took it easy on me by taking their free shots from three feet beyond the three-point line, while showing me grace at the charity stripe. I would like to think defensively I held my own (I had a chance with foot work and anticipation as a lifelong mid-fielder on the pitch), but I believe just about all of them would contest that claim just as they did every opportunity I thought I had an open look.
Attending from 1996-2000, I frequently saw Coach Few in the old weight room, although it looked much different back then, with the old stretched vinyl mirror tint on the walls of the space next to the practice courts. Coach Few was always approachable, humble and encouraging as I recall, no matter the hour we were there. Axel Dench, the Australian center at that time, shared a common wall with my single dorm room on the second floor in DeSmet Hall and would walk to Jepson Center, School of Business, to attend class at the same time as I did. It looked as you would imagine Me and Mini-Me going to class. At just over 6 feet tall, I might as well have stood as an end table for the off-the-court gentle giant. So long as my memories remain intact, they will be referenced each year as we assist taxpayers with managing their own brackets. It was a special time in my life, one in which the community grew and I wish to share the benefits of that prosperity with those whom we encounter today. Go Zags!
To get help with an IRS tax problem, or learn more legal, tax-saving strategies for business owners, contact me at (360) 474-5892 or e-mail me at tate@ensigncpa.com.
Tate Ensign, CPA
T.S. Ensign, CPA & Company, Inc.
P.O. Box 956
Ravensdale, WA 98051
(360) 474-5892
Fax (360) 474-5825
Comments(0)