Tax avoidance/mitigation query

[gregory r.]

Suggestions from the wise(r) needed: We rec'd out CPA's income tax returns last night and again owe the Feds $11,287 ($7K last yr). Our CPA's simple suggestion was to up our quarterly additional tax payments by $3k (we do $500 qrtly payments now). Current scenario.

2016 Gross income = $311,156
Taxable income = $265,207

Wife maxes 401k + catch up
I do 12% to Roth 401k and 2% pre tax 401k (new job 1 year)
We have 1 kid (18) at home in college-only dependent
We pay $500 quarterly additional tax payments currently
We both claim 0 deductions thru the year on payroll
Hardly any mortgage interest claim ( 1 year left to pay on house)
Charity...minimum
real estate taxes accounted for/ interest paid accounted for

* Plan to*
Max my pre-tax 401k to hit overall ceiling
Aside from the CPA's simple suggestion to pay more quarterly payments is there anything else we can do to
1. lower our taxable base while receiving some benefit throughout the yr (401k pre-tax increase contribution, wouldn't be much before ceiling was hit)
2. Other alternatives
3. Hate to stop Roth 401k as most of our portfolio is in tax advantaged accts now.

Any viewpoints welcome....

 

[jwkde]

besides W-2 income, what other sources of income do you have?

 

[LOL!]

I would not be using a Roth 401(k) in your tax bracket. The ages of your kids suggests that you all may be old enough to put $24,000 into you 401(k) plans. (You did mention "catch up.")

I invest tax-efficiently in a taxable account, so that I have no income on the top half of Schedule B and only qualified dividend income on the bottom half. Then also don't forget to tax-loss harvest.

You can do Roth conversions later in life when not working. So the "Hate to stop Roth 401k" is puzzling to me.

You did not mention other typical things: HSA or FSA. And what about Backdoor Roth IRAs?

Charitable donations (perhaps through your Donor-Advised Fund) are also helpful.

And to be clear, when you say you "owe" taxes, you mean you owe more than you had withheld because $11K on $300K+ income is almost no tax at all.

 

[2017ish]

Tough call on Roth versus non-roth. We did it a couple of years when our income dipped down (including this half year), but are seriously lopsided going into retirement. (~80% portfolio is deferred). But, given where you are at in the 33% bracket, I'd consider going traditional, with plans to convert when you are in lower brackets--even if that isn't until retirement. We'll be aggressively converting from age 57 through 70, but even paying for conversions at 28%, we are ahead of the game.

With regard to the withholding, I don't understand why the accountant is recommending quarterlies when you can adjust your W-2 withholdings for a lot less hassle. For example, We do "0" dependents on the w-4s, plus an additional $XXX from each of our payperiods. Since DW has variable income with bonuses, I do a dummy tax return in Oct or so, to ensure that we are in a safeharbor--otherwise adjust as needed for the last few payperiods (occasionally resulting in next to no takehome)

 

[gregory r.]

jwkde - actually none.....just w-2

 

[gregory r.]

LOL- Thanks for the reply- Wife maxes hers 401k out. I did Roth 401k as a tax diversification means, since we can't do standard Roth. Yes, we plan to do some back door after FIRE since the tax brackets will be lower. Maybe I need to re-think this strategy and convert to pre-tax 401k, then just do back door conversion. Wife does an FSA as well. Back door conversions now would incur large tax hits and not sure the long term benefit would be realized, maybe maybe not?

 

[gregory r.]

2017ish- thanks....I had that same issue with the CPA' suggestion, just let payroll handle the additional tax contribution. I think I may re-think the ROTH 401k, seems the obvious low hanging fruit, then do back doors after FIRE in 2 yrs (both 57 now)

 

[nun]

Given your income level a regular 401k seems like a better option than a ROTH 401k. I like to keep up with my tax bill so I'd pay more quarterly so I have no tax to pay at the end of the year.

 

[LOL!]

I'm chuckling at the cognitive dissonance: You contribute to a Roth 401(k) for tax diversification, but won't do backdoor Roth because of the "large tax hits."

If you did traditional 401(k) and back-door Roth, then the taxes would be no worse than what you are doing now.

 

[gregory r.]

LOL - yeah me too....we have only ever paid the last two years....wife had a larger than expected increase and larger bonuses, so all this occurred rather quickly.....need to re-think that strategy ehh

 

[kaneohe]

I would not be using a Roth 401(k) in your tax bracket. The ages of your kids suggests that you all may be old enough to put $24,000 into you 401(k) plans. (You did mention "catch up.")

......................................................

You can do Roth conversions later in life when not working. So the "Hate to stop Roth 401k" is puzzling to me.

.....................................

+1 on the suggestion to use traditional 401K .......or at least to think about it.
The decision to Roth or not is supposed to be a quantitative decision, not a qualitative one, based on your tax rates now vs when you withdraw. You are in a high tax bracket now so would save a lot by going traditional. Your tax rate when you withdraw is not clear so you have to do some thinking about that which sometimes is not obvious. If your tax rate will be lower then, it would make sense to go traditional, save taxes at a high rate now and pay less later.

Roth IRA Rules of Thumb - Fairmark.com Fairmark.com
see the section on Roth account vs deductible contribution.

 

[pjigar]

Here is the list of options you want to explore:
Max out pretax 401k
Max out posttax Roth or back door Roth ira
Max out pretax HSA and invest i.e. Don't withdraw/spend
Max out pretax FSA and spend on healthcare
Max out post tax 401k if your plan allows which can be later converted to Roth IRA when you change job or 59.5 year old.
Donor advised fund

PS: The list applies to both spouses.

 

[LOL!]

Note that HSA and FSA cannot be done in the same tax year in most situations. There is a clear conflict described at irs.gov, so be sure to understand that before doing.

 

[pjigar]

Note that HSA and FSA cannot be done in the same tax year in most situations. There is a clear conflict described at irs.gov, so be sure to understand that before doing.

Yes, you can. There are HSA qualified FSA accounts offered where max contribution is $2400 per year.

 

[Hyperborea]

LOL - yeah me too....we have only ever paid the last two years....wife had a larger than expected increase and larger bonuses, so all this occurred rather quickly.....need to re-think that strategy ehh

That right there along with not maxing your traditional 401k is the source of much of your extra tax. Bonuses are generally withheld at a flat supplemental rate of 25% and given your income that is too low so extra tax will be due. There may also be a similar state tax rate on bonuses that isn't sufficient.

There are two options: 1) you can have your employer withhold more by filing the W-2; or 2) you can pay a lump sum at tax time. As long as you are meeting the safe harbour requirements then (2) is IMNSHO the best option. Before retiring I did a mix of (1) and (2). I did enough (1) to keep me in safe harbour and then did (2) with the rest.

 

[COcheesehead]

We in a similar situation as you.

In addition to what others have said, you might want to consider:

Opening a deferred annuity as a supplement to your deferred tax accounts. No contribution limit, can pull money out at anytime, no RMD's at 70.5 and if you open it at a place like Fidelity, the fees are very low, .25%. Lots of investment options including indexes. We love ours.

Donate appreciated shares to a trust and take the deduction immediately while lowering your future cap gains on that investment. Fidelity Charitable Trust is a good one.

Buy whole life insurance to bury cash and give you tax free income later. Look to add a LTC rider as well to cover long term care needs. A lot a people on here will hate this suggestion because they are anti whole life insurance, but for folks with incomes like ours, it sometimes makes sense.

Use ETF's in taxable accounts for investment efficiency.

Buy Muni's for taxable accounts.

We are fortunate to have such issues, but it pays to be tax savvy.

 

[pb4uski]

jwkde - actually none.....just w-2

Then not much you can do other than contribute the max to 401k/IRAs and HSAs (if available).

To me it is six of one/half dozen of another whether you increase your withholdings by $12k a year or increase your estimated payments, but if you decide to increase withholding just increase them by $14k of the year and skip the estimated payments (or vice versa... leave your withholdings at M0 and do $14k a year of estimated payments).

 

[jarts98]

Count me with the others suggesting use of the Traditional vs. Roth 401k. You are in a high tax bracket so the reduction in your income is pretty valuable.

Back door Roth's could still be done to stuff a few dollars in that tax structure.

Unfortunately (in some sense!), you have a lot of W-2 income which has the worst tax treatment out there! Of course, a lot of people would like to have that problem......

jarts98

 

[LOL!]

Yes, you can. There are HSA qualified FSA accounts offered where max contribution is $2400 per year.

Of course, but that is outside of "most situations."

 

[LOL!]

Opening a deferred annuity as a supplement to your deferred tax accounts. No contribution limit, can pull money out at anytime, no RMD's at 70.5 and if you open it at a place like Fidelity, the fees are very low, .25%. Lots of investment options including indexes. We love ours.

This usually doesn't make sense since one can invest tax-efficiently and pay less tax than 0.25% a year on the investment. Plus with an annuity, the gains are taxed at ordinary income tax rates and not at the much lower long-term capital gains tax rates.

 

[LOL!]

Buy whole life insurance to bury cash and give you tax free income later. Look to add a LTC rider as well to cover long term care needs. A lot a people on here will hate this suggestion because they are anti whole life insurance, but for folks with incomes like ours, it sometimes makes sense.

Once again, that is great tax advice: Pay more in fees than you would have to pay in taxes leaving less in your pocket. Makes sense to me.

 

[COcheesehead]

Once again, that is great tax advice: Pay more in fees than you would have to pay in taxes leaving less in your pocket. Makes sense to me.

Told you folks on here hate this advice.

 

[pb4uski]

This usually doesn't make sense since one can invest tax-efficiently and pay less tax than 0.25% a year on the investment. Plus with an annuity, the gains are taxed at ordinary income tax rates and not at the much lower long-term capital gains tax rates.

+1 If you're investing fixed income in a taxable account go with tax-free muni fund rather than an annuity.... better after-tax returns and liquidity.

 

[pb4uski]

Told you folks on here hate this advice.

OP doesn't have any taxable investments at this point (all W-2 income) so I would prefer taxable equities at 15% over a pie-in-the-sky whole life scheme (and BTW... I own whole life myself and used to work for a mutual insurer).

 

[COcheesehead]

This usually doesn't make sense since one can invest tax-efficiently and pay less tax than 0.25% a year on the investment. Plus with an annuity, the gains are taxed at ordinary income tax rates and not at the much lower long-term capital gains tax rates.

No RMD's in an annuity.
Future taxes are individual in nature so whose to say they won't be lower when you pull it out? It just creates another bucket you can pull from to blend into your future income stream.
Money left to ride long term in a deferred account usually outperforms a taxable account.

Also keep in mind, the gains are taxed. The original investment is not.