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Money W-2 Tax Savings

Tax Advantaged Accounts

Tax advantaged accounts allow individuals to avoid or delay paying taxes on their income. There are many types of retirement plans1 but only the following accounts are the ones being discussed with the addition of a few tax avoidance accounts. 

  • Self Directed Retirement Account (SDRA)
  • Defined Benefit Plan
  • Individual Retirement Account (IRA)
  • 401(k)
  • Health Savings Accounts
  • 529 Plans – Educational Savings Account
  • FEIE
  • Expatriate

Self Directed Retirement Accounts (SDRA)

The classification of Self Directed can be placed on most Retirement Accounts both Traditional and Roth. This maximizes the flexibility in the Retirement Accounts utilization and investments options. 

The following is a list of increased utilization benefits and investment options to SDRA’s. 

  • Can leverage debt
  • Take out a non recourse loan up to the lesser of 50k or 50% of the account value
  • Individual can partner with SDRA to make purchases
  • All investments are applicable including alternative investments except for the following
    • Life insurance2
    • Collectibles
      • Antiques
      • Works of art
      • Rugs
      • Metals and Gems
      • Stamps and coins
      • Alcoholic beverages
      • Certain other tangible personal property

Prohibited Transactions3 can remove the tax shelter status of the entire SDRA if violated forcing the entire value of the retirement account into the individual’s gross income. Prohibited transactions generally include the following transactions:

  • SDRA monies being used to provide ANY benefit or advancing the interests of any disqualified persons or fiduciary
  • Receiving payment from the SDRA or any party dealing with the plan
  • Any of the following acts between the plan and a disqualified person:
    • Selling, exchanging, or leasing property
    • Lending money or extending credit
    • Furnishing goods, services or facilities

Disqualified Persons

  • Lineal Ancestors and Descendants
    • Grandchildren
    • Children
    • Spouse
    • Parents
    • Grandparents
  • Fiduciary or other people providing services to the SDRA
    • Accountant
    • Financial Advisor
  • 50% Entity
    • Any LLC or Corporation that you and/or any disqualified person, singularly or cumulatively, own 50% or greater equity stake

NonDisqualified Persons

  • Non Lineal Ancestors
    • Sister
    • Brother
    • Uncle
    • Niece
    • Nephews
    • Cousins

Paperwork to look out for

  • Unrelated BusinessIncome Tax (UBTI)
  • Not subject to Unrelated Debt-Financed Income Tax (UDFI)
  • Form 5498 Valuation Form

Ideas for SDRA

  • Real Estate
  • Crypto
  • Startups and Private Placements 
  • Loans
  • Crowdfunding and Peer to Peer platforms

Defined Benefit Plans

  • Defined benefit plans are retirement accounts that guarantee a defined payout 
  • The administrative costs incurred to offer these plans are high
  • Employer contributions are considered a company expense
  • Employee contribution limit is $230,000 of compensation (2020)
  • Most benefits are insured up to a certain annual maximum by the federal government through the Pension Benefit Guaranty Corporation (PBGC)

Individual Retirement Accounts4

  • Individual Retirement Accounts (IRA) can be set up at ANY AGE (even newborns) as long as there is earned income
  • Traditional IRA is funded with pre tax monies, deferring the tax burden until retirement allowing the full investment monies to grow
  • Roth IRA is funded with post tax monies, incurring the tax burden immediately allowing the investment to be withdrawn tax free.
  • Maximum contribution is $6,000 (2018) towards ALL IRA accounts
  • Individuals making over $137,000 annually (2019) need to do a Roth Conversion to participate in a Roth IRA
    • Roth Conversion is simply moving money from the tax deferred IRA to a Roth IRA and paying the taxes due on the money at that time 
    • Steps to perform Roth Conversion
      • Contribute to a traditional IRA 
      • Move the money from Traditional IRA to Roth IRA
      • Fill out form 8606 on taxes

401(k)5

  • $19,5006 Elective contribution limit (2020)
  • $37,000 Non-Elective contribution limit (2020)
  • $57,000 Total contribution limit (2020)
  • Non-elective business contributions are considered business expenses
  • Non-Elective Deferral limit is up to 25% of employees salary
  • Elective Deferral limit is the Smaller of 100% of compensation or $19,500 (2020)
  • You can have multiple 401(k) plans with multiple employers but not multiple 401(k)s with the same employer, they have to be held with unrelated businesses
  • All contribution limits are aggregated together regardless of how many different plans you have

Health Savings Accounts7

Health Savings Accounts (HSA) are fully tax sheltered accounts that are funded by pre tax monies, grow tax free and are not taxes upon their withdrawal if used for health care related expenses. 

  • HSA do not have a required withdrawal date and can stay invested indefinitely.
  • Once a year HSA can be rolled over into any investment similar to an IRA
  • HDHP Contribution Limit for 2019 is $3,500 for Self-only and $7,000 for Family
  • Monies withdrawn prior to the age of 65 and not use on health care are taxed as normal income and and penalized at a rate of 20%
  • Monies withdrawn after the age of 65 and not used on health care are taxed as normal income

How to qualify for an HSA

  • You are covered under a high deductible health plan (HDHP)
  • You have no other health coverage except what is permitted8
  • Not enrolled in Medicare
  • Not claimed as a dependent on someone else’s tax return

529 Plans – Educational Savings Account9

  • Contributions do not lower federal taxes
  • Contributions might lower state taxes or provide matching grants, rules vary by state
  • Monies grow federal and state tax free
  • Withdraws paying for educational purposes are not taxed on a federal level and in most cases state level
  • Withdraws not paying for educational purposes are taxed on federal and state personal income including a 10% penalty on earnings
  • Individuals are not restricted on which state they are required to invest their Educational Savings Plans monies
  • Any 529 can be used to pay for any college in any state 
  • The beneficiary of a 529 plan can be changed at any point
  • Savingforcollege.com – website providing evaluation of 529 plans

FEIE

One tax strategy that is advantageous for remote workers or remote based businesses is the Foreign Earned Income Exclusion (FEIE)10. This tax exclusion allows the first $105,900 (2019) to be excluded from Federal taxation. This can be implemented while retaining a United States citizenship.

To claim the FEIE, the foreign housing exclusion, or the foreign housing deduction11, you must have income while in a foreign country, your tax home must be in a foreign country, and you must be one of the following:

  • A U.S. citizen who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year,
  • A U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty in effect and who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year, or
  • A U.S. citizen or a U.S. resident alien who is physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.

Here is some advice on the actual implementation of the FEIE:

  • You need to stay outside the United States for 330 days out of any 365 day block of time. The 330 days do not have to be within the same calendar year nor do they have to be consecutive days in a row. For example if you leave on June 1, 2015 and return June 1, 2016 you will have spent 363 days outside of the United States. You can also return to the USA multiple times in-between those dates as long as the number of days spent inside the USA is not over 35.
  • Notes as to what counts as time spent inside the USA. Any minute spent inside the USA during any calendar day is considered a full day spent inside the USA. This includes any time on any air transport coming or going from the USA.
  • Breaking up the time spent outside the USA into two separate tax years will require you to amend your previous tax years returns as you have to finish your 330 days prior to qualifying for the FEIE. Only the monies earned during the time spent outside the USA will be subject to the FEIE.
  • You have the option but not the requirement to inform your employer to stop withholding your Federal taxes from your paychecks by updating your W-9 on file with them. By not updating them you should expect a large refund at the end of the year. However if you do update them and for whatever reason do not qualify for the FEIE you will owe a lot of penalties and interest for not paying your Federal taxes on time. 

Expatriate

To avoid paying taxes entirely would require an individual to expatriate from the United States. This means to surrender your United States Citizenship and acquire citizenship in another country. The idea behind this is to follow Harry Schultz three flag theory12 which has been expanded into a five flag theory. Each of the following points is considered a flag or country.

  1. Passport and citizenship – in a country that does not tax money earned outside the country or control actions.
  2. Legal residence – in a tax haven.
  3. Business base – where one earns one’s money, ideally somewhere with low to no corporate tax rates.
  4. Asset haven – where one keeps one’s money, ideally somewhere with low to no taxation of passive income and capital gains.
  5. Playgrounds – where one spends one’s money, ideally somewhere with low consumption taxes or refunds on VAT

Acquiring a second citizenship or second passport allows for easier traveling or business in multiple countries. Some foreign financial institutions do not allow American clients or provide additional barriers for Americans to conduct business. Many countries in the world allow individuals to gain a citizenship by spending one day a year in the country13.

How to obtain a second passport.

  • Citizenship by descent – some countries allow you to become a citizen if your parents or grandparents were once citizens. 
  • Naturalization – Living a long time in another country to acquire citizenship 
  • Economic citizenship – Investment or donation into the country
  1.  https://www.irs.gov/retirement-plans/plan-sponsor/types-of-retirement-plans ↩︎
  2.  https://www.irs.gov/retirement-plans/investments-in-collectibles-in-individually-directed-qualified-plan-accounts ↩︎
  3.  https://www.irs.gov/retirement-plans/retirement-plan-investments-faqs ↩︎
  4.  https://www.irs.gov/retirement-plans/individual-retirement-arrangements-iras ↩︎
  5.  https://www.irs.gov/retirement-plans/401k-plans ↩︎
  6.  https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-401k-and-profit-sharing-plan-contribution-limits ↩︎
  7.  https://www.irs.gov/publications/p969
     https://www.irs.gov/forms-pubs/about-form-8889 ↩︎
  8.  https://www.irs.gov/publications/p969#en_US_2018_publink1000204039 ↩︎
  9.  https://www.sec.gov/reportspubs/investor-publications/investorpubsintro529htm.html ↩︎
  10.  irs.gov/individuals/international-taxpayers/foreign-earned-income-exclusion ↩︎
  11.  irs.gov/individuals/international-taxpayers/foreign-earned-income-exclusion-requirements ↩︎
  12. en.wikipedia.org/wiki/Perpetual_traveler ↩︎
  13.  Mexico, Panama, Paraguay, Serbia, Georgia, Colombia, Armenia ↩︎