Tax planning is an arcane field to put it mildly. It is easy enough to see the basic ideas of it, but extremely complicated to implement. It is well beyond the ability of a non-professional to know the options and to keep up to date. Even professional generalists refer most tax planning and implementation to a specialist. It is very easy to be wrong.
An individual can know some of the tactical approaches and can implement a few without much structure or difficulty. Think of the three “Ds” deduct, divide and defer. Most tax planning relies on at least one of them.
Here is a deduct example.
Interest paid is deductible for tax purposes if, among some other conditions, the purpose of the loan was to acquire an asset that produces income. Being able to trace the flow of funds is crucial.
Suppose dear old Mom passes on and leaves me $300,000. I could invest it or pay off my $300,000 mortgage.
If I immediately invest it in bonds earning 4% interest. The $12,000 of income costs income tax. At 40% $4,800. I keep $7,200.
If I use the $300,000 to pay of a 3% mortgage on my home, I save $9,000, $1,800 better, but I like the mortgage because it imposes some discipline on my cash flow, and provides some protection against identity theft.
The tax effective option is to pay off the mortgage and then remortgage the house for the same $300,000 and buy the bonds. Identical situation to the one where I invested Mom’s money in bonds. Either way I have the bonds and owe the mortgage. The difference is the mortgage interest is now deductible against my investment income because the purpose of the loan was to acquire income producing assets.
The mortgage interest of $9,000 offsets the bond interest of $12,000 and I pay tax on the other $3,000. $1,200. I keep $10,800 of the bond interest instead of $7,200 and my mortgage payments are unchanged. I win $3,600. Every year.
Maybe your Mom has not passed on yet, but you might have a portfolio, or a business, or a rental property that can be the money in the middle of the transaction. This is more complicated because there are other factors involved, like taxation of a disposition or a tax on withdrawals from a business. It might take some time to get it all in place. Piece by piece is common. Using all rental income to pay down mortgage and borrowing on a new loan to pay expenses is not uncommon.
You should talk to a professional. Their fee will be tiny in comparison to the potential saving.
As a general rule, it is not clever to owe money that creates interest expense that cannot be deducted for income tax purposes. Minimize it from the beginning and it will make you a lot of spendable cash.
While talking to your professional, ask about looking for divide and defer options.
Tax savings are easy money. Don’t leave any behind.
Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario. In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.
Please be in touch if I can help you. firstname.lastname@example.org 866-285-7772