Tax Strategies

When engaging in tax planning, you may be able to reduce your overall tax burden by employing specific strategies to generate tax-free income, shelter earned income from taxes, and defer taxes. However, other tax-advantaged strategies exist as well. You might wish to create passive income to take advantage of passive losses, and you might wish to engage in year-end tax planning. Additionally, it may be wise to consider the tax benefits of generating capital gains, investing in real estate, and receiving annuitized payments. We believe everyone should pay their “fair share”, but enough is enough. So if there is a way to legally, ethically and morally reduce your taxes we want to find ways in which to do this. That is why we ask you to bring in your last two years tax returns. We want to review these with you and have the option to work with your CPA or legal tax advisor to look for ways to help you save.

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Why should you create passive income to take advantage of passive losses?

A passive activity involves the conduct of any trade or business in which you do not materially participate. For example, if you have an interest in a limited partnership and the partnership generates income, it is likely that your share of partnership income will be classified as passive. In addition, real estate rental activities are generally considered passive activities.

Caution: There are special rules if you actively participate in a passive real estate rental activity.

Generally, a loss from a passive activity cannot simply be deducted outright on your personal income tax return; rather, a passive loss can only be used to offset passive income. Accordingly, if you have passive activity losses, you may be able to take advantage of the offset provisions by creating passive income. In effect, you will have created tax-free income, because your passive income will be offset by otherwise unusable passive losses. Generally, unused passive losses can be carried over to offset passive income in subsequent years, and unused passive activity loss carryforwards are allowed to be used in full when you dispose of your entire interest in the activity generating the passive losses in a fully taxable transaction.

Why should you engage in year-end tax planning?

Year-end tax planning may often result in substantial tax savings. Tax planning primarily concerns controlling the timing and the method by which your income is reported and your deductions and credits claimed. The basic strategy for year-end tax planning is to time your income so that it will be taxed at a lower rate and time your deductible expenses so that they may be claimed in years when you are in a higher tax bracket. In a nutshell, you should try to:

  • Recognize income when your tax bracket is low
  • Pay deductible expenses when your tax bracket is high
  • Postpone tax whenever possible

By using these methods, you may be able to lower your overall tax liability.

Why is it useful to generate capital gains?

If you can generate net capital gains (instead of ordinary income), you may save considerably on your taxes. This is because the top capital gains rate is substantially lower than the marginal rate applicable to ordinary income. You generate capital gains by selling capital assets. Another advantage to investing in capital assets involves the timing of income. You usually have the flexibility to control when you recognize the income or loss because, in most cases, you determine when to sell your assets.

How is investing in real estate beneficial, from a tax standpoint?

One big advantage of investing in real estate is that any appreciation in value is a tax-deferred gain that will not be recognized until the real estate is sold at a future point. Moreover, if the real estate you invest in is used as your personal residence, it may be possible for you to exclude all or a portion of the capital gain income when you sell the residence (if certain conditions are met).

If, on the other hand, you purchase real estate for investment purposes only, you may be able to take advantage of depreciation and other deductions.

What is the tax advantage to receiving annuitized payments?

When you receive income in the form of periodic annuity payments, you could pay a smaller amount of taxes in a given year than you would if you received the money all at once; receiving a lump sum could push you into a higher tax bracket. With an annuity, on the other hand, part of each annuity payment is taxable, and part is nontaxable. Moreover, it’s possible for the taxable amount to be so small that it will have no impact on your tax bracket.

Basically, each annuity payment you receive represents a return of principal (or your nontaxable investment basis), plus a taxable interest portion. If you want to figure out which payments are taxable, multiply each payment received by an "exclusion ratio." The exclusion ratio is determined by dividing your nontaxable investment in the contract by the contract’s expected return (value).

If you purchase a deferred annuity, the annuity can earn interest tax-deferred on an annual basis. The interest is not taxable in the current year as long as no withdrawals are made. Since you may be in a lower tax bracket by the time the annuity is paid out (during retirement, perhaps), the income tax effect could be minimal.

Disclosure: None of the information in this document should be considered tax or legal advice. You should consult your legal or tax advisor for information concerning your individual situation.

Annuity/life insurance contracts are not issued by Lincoln Investment or its affiliates. All contracts, features and guarantees, including optional fixed subaccount crediting rates or annuity payout rates, are backed by the financial strength of the issuing insurance company and do not apply to any subaccount. In addition, the financial ratings of the issuing insurance company do not apply to any non-guaranteed separate accounts. The value of the subaccounts that are not guaranteed will fluctuate in response to market changes and other factors. Neither Lincoln Investment, nor any of its affiliates, makes any representations or guarantees regarding the claims paying ability of the issuing insurance company.