2010 tax guide: Strategies to lower your taxes and help you keep more money

February 5, 2010

Recent and anticipated tax law changes provide new opportunities to avoid overpaying taxes.

Key Points

The difference between tax avoidance and tax evasion is that the first approach is legal. Although the looming 2011 tax increase for "the rich" (that is, you) seems unfair, many will just take their lumps and shell it out. Others are wondering what they possibly do can to lower their taxes and keep more of their hard-earned money for themselves and their children.

Now is the time to stop wondering and start acting, because recent and anticipated tax law changes provide new opportunities to avoid overpaying taxes. Read on to find out how you can legally protect more of your income, shelter your investments, and secure your future.

You and your children can enjoy lifetime tax-free income.

Starting this year, you can convert your existing IRA and a portion of your profit-sharing money into a Roth IRA. The rule precluding conversion by people with higher incomes no longer applies. Although you'll pay tax on pre-tax dollars on conversion, if you convert your IRA in 2010, you can spread the tax burden over 2011 and 2012. Therefore, it makes sense to delay filing your 2010 tax return to determine the 2011 rates, because you can choose whether to report the tax in 2010 or spread the tax burden over the succeeding two years. It is anticipated that, later this year, legislation will pass including higher income tax rates for 2011. Don't forget that after you convert your IRA, you must wait at least five years and be aged at least 59 1/2 years, disabled, or deceased to ensure that all growth will be tax-free.

Although the Roth money is income tax free, it is still subject to estate taxes. Wealthy people whose estates may be subject to the death tax will save 45 percent on the cost of conversion by paying tax on conversion into a Roth, because the tax dollars will reduce the size of their estates. If you anticipate that your future tax rates will be higher than they are today, then conversion makes greater sense. Even if your life expectancy is less than 25 years, your children eventually will enjoy income tax free treatment as they take your Roth distributions.

Roth monies are not subject to required minimum distributions during your lifetime. Some people have expressed concern that our Congress will take away the Roth advantage, but I don't share this concern because, historically, any tax breaks that have been killed have been grandfathered into the law, protecting those who currently enjoy benefits.

A special rule does not allow you to only convert your after-tax IRA accounts. You can get around this rule by transferring some or all of your pre-tax IRAs into a qualified plan and then converting the remaining after-tax IRAs the following year to help reduce the cost of converting. One can continue to make after-tax IRA contributions annually and then immediately convert them to Roth IRA accounts. This is another opportunity to save $5,000 or $6,000 on a tax-free basis each year. The law requires you to go through this two-step process and does not allow you to directly fund a Roth IRA. However, you can fund $16,500 or more in a Roth 401(k) each year, and this process works similarly.

Whether or not you choose to convert to a Roth IRA, it makes sense to add your spouse to your office payroll. As long as your spouse's compensation is reasonable, it will justify your spouse joining you for continuing education travel as a member of your practice and will allow you to increase retirement plan contributions. For example, if the annual salary is set at $25,000, then your spouse could contribute $16,500 into a 401(k) plan (or $22,000 if aged more than 50 years) each year either on a pre-tax or Roth 401(k) basis.