Tony's Tax Tips

Earn As Much As You Can

This article originally appeared in the Pasadena Star News on March 18, 2006.
Everyone's goal should be to earn as much income as they possibly can but pay the least amount of tax allowed by law. The maximum Federal individual income tax rate is 35% of your taxable income. The maximum California individual income tax rate is 9.3% (let's call it 10%). The combined Federal and State individual income tax rate is approximately 45%.
C. Anthony Phillips, CPA

If you have $1,000,000 in ordinary income, the maximum individual income tax you will pay is approximately $450,000. You get to keep the other $550,000. Therefore, it makes sense to earn as much income as you possible can.

PAYING THE LEAST AMOUNT OF TAX - The difficult part is legally paying the least amount of tax on all the income you earn.  Paying the least amount of tax generally can not be accomplished with one large rapid adjustment made by the taxpayer.  It is usually takes a series of small adjustments made over a number of years. 

TAX PLANNING STRATEGIES - The best tax planning may not necessarily be the maximization of your itemized deductions such as medical expenses, state income or county property taxes, interest, charitable contributions or miscellaneous itemized deductions.  Take for instance, the mortgage interest deduction.   It makes sense from an investment return viewpoint to have a mortgage on your principal residence to increase your financial leverage, but it does not make sense from a tax viewpoint. 

Let us assume you are in the maximum combined Federal and State individual income tax rate of 45%.  Let's also assume you pay the holder of your mortgage $1,000 of interest.  Subject to a couple of limitations on mortgage interest, you may be able to deduct $1,000 from your taxable income and save $450 in tax ($1,000 interest multiplied by the 45% tax rate).  In order to receive this deduction, you had to give the holder of your mortgage $1,000 in interest.  This means that your net cash outflow is $550 ($1,000 interest less the tax savings of $450).  It would be better to not have a mortgage payment deduction and pay the tax on $1,000 of income at the 45% tax rate and have a cash outflow of only $450.  You would achieve a cash savings of $100 ($550 less $450). 

Tony Phillips, CPA has a certified public accounting firm, Phillips & Company in Pasadena.  He is also President of Downstream Exchange Company an accommodator in 1031 exchanges which helps investors save taxes when they sell their investment property.  

The above is not intended to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer.