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What Are the Best Tax Shelters?

December 08, 2021

What is a Tax Shelter?

A tax shelter is a tool to reduce or eliminate taxes. While taxes are inevitable, using tax shelters can help reduce and legally avoid certain expenses. We have compiled some of the most effective and attainable tax shelters as well as information on how to use them to your advantage. 

However, it is important to be cautious about which tax shelters you choose to use. Some tax shelter opportunities rely on criminal tax evasion, such as lying on a tax return or using offshore accounts to avoid US tax law. These types of tax shelters can result in criminal prosecution or hefty fines. 

Tax Deductions 

Tax deductions are the most basic form of tax shelter. Some forms of income or expenses can be written off and thus deducted from your taxes. Many tax deductions are made available to help small businesses or incentivize support of non-profit or community-based programs. However, there are other wide-ranging opportunities for tax deductions such as healthcare costs or student loans.  

For example, a business can deduct certain products if it is both “ordinary and necessary” according to the IRS. If a grocery store buys lettuce in bulk to stock the shelves (a necessary and ordinary occurrence), the owner can deduct the lettuce from their taxes. 

There are, of course, many other ways one can use tax deductions to their advantage. Reviewing the IRS code or contacting a tax specialist is an important way to be aware of every possibility to reduce taxes through tax deduction.  

Retirement Accounts 

Since the government offers incentives for investing in your future, qualifying retirement plans include tax deduction opportunities. Take 401(k)s as an example: 

In a 401(k), there is a set limit to how much money you can contribute to your account per year. In 2022, the limit is $20,500. This means you can place up to $20,500 of pre-tax income into your 401(k) account each year. This money is not part of your taxable income until it is withdrawn when you retire. 

There are, however, certain requirements when using a 401(k) to ensure it is used for retirement. The funds placed in the 401(k) become available to withdraw only when you are 59 ½ or older. This does not mean that it is impossible to make withdrawals, however, it would involve a heavy cost. If a withdrawal is made early, you would be forced to pay a 20% tax as well as a 10% penalty. This means if you had planned to withdraw $10,000, you would only end up with $7,000.  

Despite this, 401(k)s are important long-term tax shelters due to their lucrative tax benefits. Retirement plans embolden your financial security late in life. If these tax shelter benefits are used correctly, you have the potential to avoid taxable income on tens of thousands of dollars each year until you retire. 

The ROBS Transaction 

This tax shelter prioritizes those who would like to start a business or expand their already established business through funds from a retirement plan. While most plans, including 401(k)s, would force any withdrawal from the retirement account before 59 ½ to pay hefty fines, through the ROBS strategy you can circumvent these taxes and penalties for early withdrawal entirely. This transaction allows for the use of retirement plan funds without incurring taxes for withdrawal if said funds are used to finance a business startup or capital expenditures. 

In the simplest terms, the ROBS strategy allows an individual to use a retirement plan to buy stock in your own business venture. You can then use this investment to fund your business. 

This option provides opportunities to expand the horizons for the typical American. Many can realize their small business dreams under a realistic timeline without navigating the confusing system of bank loan approvals. To better understand how a ROBS strategy can be used, here are two examples that might be helpful. 

While using the ROBS strategy can be advantageous, it is necessary to balance the goal of becoming a business owner with personal financial security. ROBS transactions do involve some level of risk as each withdrawal is from an account typically reserved for your retirement years. In addition, a retirement plan set up through the ROBS strategy is still a fully functional retirement plan. This means any employees hired by the business need to be provided access to it as they would with any normal plan. 

Setting up a ROBS plan through a licensed provider can mitigate some of this risk. If your ROBS plan is not enacted by a licensed professional, you could turn your small business dreams into a risky venture or violate tax code. Many unlicensed providers also encourage clients to engage in a ROBS plan no matter how economically viable it is for the client.  

At LRS we are not only licensed to enroll ROBS company plans but will consult with you to ensure that using ROBS is the right investment for you.  

Real Estate 

Purchasing real estate can give homeowners several tax-shelter options not provided to their renting counterparts. These options, however, can only become available once your itemized deductions surpass the IRS standard deduction. The standard deduction in 2022 for married couples filing jointly is $25,900, and $12,950 for those who are single or file separately. 

The first of these tax deductions regards property taxes. Homeowners can deduct property taxes up to $10,000. Determining how much you can deduct on property tax is based on the value of your property and several other factors which can vary by state.  

One can also deduct certain home business expenses. The pandemic has forced many individuals to adapt to working from home. For those who are self-employed and use a room in their home exclusively for work, you may be able to deduct certain expenses. You can choose either a simplified or regular method to evaluate the number of deductions made valid through your home office or business space. 

Typically, the largest tax deduction for homeowners is mortgage interest. Couples who are filing jointly can deduct interest on $750,000, while single filers can deduct interest on up to $375,000.  

At Leading Retirement Solutions, we offer company plans with a variety of investment options. Some of these non-traditional investment opportunities include real estate. We want to ensure you can take full advantage of your retirement plan as well as the investment opportunities it offers. 

Tax Sheltering Evaluation 

If you have any questions about tax-shelter options in retirement plans or how to use non-traditional retirement investments to your advantage, do not hesitate to contact LRS. 

For more information about using the ROBS strategy as a tax shelter, check out our ROBS resources

For more tips and information regarding retirement plans, contact us.

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