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Shedding Light on Tax Shelters

Several easy vehicles can legally reduce your income taxes.

The term “tax shelter” often conjures thoughts of deceptive, complex and illegal offshore finagling to avoid or minimize one’s tax burden. In reality, simple home ownership and sale; health savings and retirement accounts; life insurance; and the traditional 401(k) and IRA are among the best, easiest vehicles for legally reducing the amount of income taxes New Jerseyans owe.

In fact, one of the most popular, perennial tax shelters in New Jersey remains the principal residence exclusion, declares Len Sprishen, tax attorney at Cranford-based MSPC CPAs. “Subject to certain provisos, married couples filing jointly can exclude up to $500,000 of gain on the sale of a home, which means up to half a million dollars is entirely free of income tax.” Single filers can exclude up to $250,000 of gain on the principal home sale.

More Tax Benefits of Marriage

Married couples in New Jersey with assets in excess of $675,000 – the value of the state’s estate tax exemption – also can utilize a credit shelter trust, a popular estate planning technique, Sprishen says.

“Because estate taxes are not imposed when assets pass to a surviving spouse, and the $675,000 exemption is available to each spouse to protect their beneficiaries’ inheritances, leaving all the assets to a surviving spouse upon death avoids the estate tax – but wastes New Jersey’s $675,000 exemption,” he explains. “But using a credit shelter trust often can avoid this result by preserving that exemption. For example, if a married couple collectively own assets worth $1.3 million and direct $675,000 of those assets into the trust upon the wife’s death, there will be no estate taxes if the value of the husband’s assets does not exceed $675,000 upon his death. The $675,000 passing upon his death will be shielded by his exemption, and the assets passing from the trust upon his death will be protected by his wife’s exemption.”

Another popular tax shelter involves the use of a Health Savings Account (HSA) and Health Reimbursement Account (HRA) to receive tax-free reimbursement of out-of-pocket healthcare expenses, Sprishen adds. Life insurance also remains an effective tax shelter, as investment gains on paid-in premiums generally can be borrowed tax-free, while death benefits also pass to beneficiaries tax-free.

Tax Advantages of Home Ownership

Besides exclusions that apply to selling a house, simply owning a home might be the best tax shelter available, states John Blake, CPA and manager, Klatzkin & Company of Trenton. “You start saving money as soon as you close on the house, and you can take a tax deduction for all or part of your mortgage interest, points paid to get the loan, property taxes and interest on certain home equity loans,” he explains.

In addition, “if you purchase a house for investment purposes, you can write-off upkeep and maintenance costs, and depreciation on the property as well as deduct mortgage interest and real estate taxes,” Blake says. “Although you will be taxed on the capital gains from the sale of an investment property, a 1031 Like-Kind Exchange provides the opportunity to postpone paying the tax by investing the proceeds from the sale in a similar property. You will still have to pay taxes on the capital gains from the original property, as well as the new one when it is sold.”

Traditional 401(k) Plans and Roth IRAs

Funds invested in an employer-sponsored 401(k) plan in New Jersey are made with pre-tax dollars. If you are self-employed, the annual contribution is tax deductible in New Jersey and the investment growth is tax-deferred: You save money by deferring the tax payment until retirement or age 59½. “In most cases, you will be in a lower income bracket by then which will reduce the tax payment due,” Blake reports. “The IRS regulations regarding 401(k) tax benefits limit the amount you can invest annually with pre-tax dollars, as well as when you can withdraw funds without incurring a 10 percent early-withdrawal penalty.”

New Jersey conforms to the federal income tax treatment for investing funds in a Roth IRA, as well as taking money out. “Although direct contributions to a Roth IRA are not deductible on your tax return, qualified distributions are excluded from income in New Jersey,” Blake states. “A qualified distribution is one which is made after the five-taxable-year period beginning with the first taxable year for which a contribution was made to the Roth IRA. As with a 401(k) plan, generally you must be 59½ to take a distribution without a penalty.”

Although many of New Jersey’s tax shelters are easy, straightforward vehicles for reducing taxes on income, a tax accountant can guide you in choosing options in your best interest, and ensure you are meeting all IRS requirements.


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