No! It depends! Really? Well, if. . . than, Maybe
It has long been established (90 some years ago) that taxpayers have the legal right to arrange their affairs in a manner to minimize their tax burden. Yet, we’ve all heard stories of cases where the taxpayer doesn’t get the desired result. Often they end up owing money. How does the everyday taxpayer take advantage of the tax laws to save themselves tax dollars?
Some think that only the wealthy can accomplish this. It is often true that it’s easier for the wealthy but that’s usually because they are involved in a larger variety of activities creating more opportunities to arrange their affairs for tax savings.
It’s not because they are “wealthy." How many famous and wealthy folks have ended up paying fines, penalties or worst yet, ended up in jail over the years?
I’m sure you’ve heard of names like Willie Nelson, Martha Steward, Pete Rose and yes, even Al Capone to name a few.
To successfully minimize your taxes, you need to understand how the system works. There are basically three kinds of tax laws:
1.) Black and White.
2.) Facts and Circumstances.
3.) The unclear, somewhat ambiguous, not quite sure how to apply ones.
Let’s look at a couple examples of how these could affect you.
Written In Stone
#1.) Black and White laws – These are just what they sound like. They are written in black and white in the Internal Revenue Code (which is just a more formal way to refer to the tax law).
If you don’t follow these, you’ll lose about every time. An example would be IRC § 262(b) which states . . . “any charge (including taxes thereon) for basic local telephone service with respect to the 1st telephone line provided to any residence of the taxpayer shall be treated as a personal expense.”
Pretty easy to understand. You may or may not think it’s fair or right, but it’s clearly stated. There are many laws that are in the Internal Revenue Code and are written in such a way that there isn’t too much room for creative interpretation. It just is what it is.
Not Written In Stone
#3.) Yes, I skipped #2 for just a moment. Let’s mention these unclear somewhat ambiguous laws which leave plenty of room to be creative.
However, unless the law has previously been challenged in Tax Court, there are many situations when a taxpayer and the advisors can’t guarantee the IRS will agree with the desired result. These types of laws come up often in complex partnership agreements or in new industries, for example crypto currency transactions.
So, what does a taxpayer do? You need to get competent professional help and then weigh the risks and costs of the position you’d like to take. If the dollars are small enough, you’ll likely error on the side of minimizing your tax liability.
If it is larger amount, you’ll need to determine if it’s worth it to you if the IRS doesn’t agree with your position. Attorney costs and time to fight these types of IRS controversies are quite expensive.
However, someone will eventually take on most of these laws. Be sure you have and are willing to spend the necessary funds to defend your position if you take an aggressive position in one of the many areas of uncertainty.
Often these types of laws come into being by Congress passing a law. Then Congress often gives the Internal Revenue Service authority to write the regulations as to how these laws would be implemented.
Sometimes those regulations get written, and sometimes they are on a back burner for a long period of time. We saw many examples of this during COVID. Even today there are companies promoting Employee Retention Credits which IRS is saying taxpayers don’t qualify for.
Facts And Circumstances
Back to #2). There is a very large body of tax law where a taxpayers outcome is depend upon the facts and circumstances. Many times the regulations will refer to a facts or circumstances test.
Don’t get me wrong, there are still many cases each year where the taxpayer loses because they just don’t have good facts. But these are the types of areas where you can arrange your affairs in such a way as to minimize your tax liability.
Arrange your facts to fit the criteria, and you will likely be successful in reducing your overall tax liability.
Consult With An Expert
It is always advisable to consult with a competent CPA or Attorney. Before you move forward with whatever you’d like to do, take the time to understand the law, ask questions and then determine if you can arrange your facts accordingly. What types of facts will strengthen your position? What types of facts do you need to rethink?
It’s always best to arrange your facts and circumstances from the beginning so that they coincide with the tax result you’d like to achieve. Many times taxpayers lose because they try to make facts fit after everything is completed. The taxpayer ends up with “bad” facts for a less than desirable result when a little preplanning could have produced the desired outcome.
A simple example is choosing to fund an IRA with a Roth IRA or a traditional IRA. A Roth IRA is nondeductible when it is funded. Therefore, if you meet certain requirements (your facts), the IRA will be nontaxable when it is withdrawn. This simple way to arrange your affairs may make a difference in what percentage, if any, of your social security is taxable income once you retire.
For many folks with lower income in retirement, this can make a big difference in the amount of taxes paid on the same amount of income. Distributions from a traditional IRA will increase your taxable income and, therefore, the percentage of your social security that is taxed.
There are an unlimited number of facts and circumstances laws that business owners can take advantage of. Something as simple as what type of entity you choose to operate in, what kind of business vehicle you buy, should you lease or buy that vehicle? The list goes on. The tax answer is “it depends”.
As a taxpayer, you’ll want to listen to your advisor. If they say “yes” or “no”, you may be talking about one of the black and white laws and the answer is what the answer is.
But if they say, “it depends” or “well, maybe” chances are you’ve got a facts and circumstances situation.
Spend some time and be sure you clearly explain what nontax goals are and then ask “Is there anything I can do to give me a better tax answer?” Good facts properly executed will produce the most effective minimization of your tax liability.
Take advantage of whatever possibilities exist to minimize your tax liability for 2024 and into the future.
Alethea D Torbert, CPA, MT
Alethea D Torbert has practiced as a Certified Public Accountant for the previous 41 years and is licensed in both Colorado and Wyoming. Born and raised in Cheyenne, WY, she recently left public accounting but still enjoys helping people to unravel some of the mysteries of the Federal tax system.