Strategies To Invest Cash Without Involving The Irs

Cash income, like any other form of income, is subject to taxation. If you receive cash income, you are responsible for reporting it to the IRS and paying the appropriate taxes. Failing to do so is considered tax evasion and can result in legal consequences. It is important to keep track of your cash income and expenses, as the IRS may perform statistical analysis to identify red flags, such as businesses with payroll discrepancies or frequent cash deposits to bank accounts.

To properly report your cash income, you should receive a W-2 or 1099-NEC form from your employer, even if you are paid in cash. If you do not receive these forms, it is your responsibility to track your income and file it using Schedule C on your tax return. Additionally, if you have any other forms of cash income, such as rental income or income from selling items online, you must also report these to the IRS.

There are legal ways to minimize your tax payments and keep more of your earnings. For example, you can consider tax-advantaged accounts, such as tax-exempt municipal bonds, Roth IRAs, or Health Savings Accounts. These options can help you reduce your tax liability while remaining compliant with IRS regulations.

Remember, it is always best to adhere to the IRS's reporting requirements and pay your taxes on time to avoid penalties and keep the IRS off your back.

Tax-free municipal bonds

Municipal bonds are debt obligations issued by public entities, such as state and local governments, or their special authorities. They are used to fund public projects, such as the construction of schools, hospitals, highways, sewers, airports, etc.

Municipal bonds are generally referred to as tax-exempt bonds because the interest earned on the bonds is often excluded from gross income for federal income tax purposes and, in some cases, is also exempt from state and local income taxes. The interest income from municipal bonds is exempt from federal income tax. This means that, depending on where you live, you may never owe income taxes on the payments received from the bond issuer.

There are two main types of municipal bonds:

• General Obligation (GO) Bonds: These are backed by the "full faith and credit" of the issuer, which has the power to tax residents to pay bondholders.
• Revenue Bonds: These are backed by revenues from specific projects, such as toll roads or bridges, airports, electric and water utilities, public or private colleges, and hospitals, among other projects.

Municipal bonds are a good option for income-oriented investors looking to reduce federal and, possibly, state income tax bills. They offer tax-exempt income and high credit quality. The interest rate for tax-exempt municipal bonds is typically lower than that of taxable fixed-income securities, such as corporate bonds and Treasury bonds.

It is important to note that not all municipal bonds are tax-exempt. For interest on a municipal bond to be exempt from federal income taxes, the issuer must meet several requirements in the federal income tax code. Additionally, for interest on a municipal bond to be free from state and local taxes, the buyer generally must be a resident of the state where the bond was issued, although there are exceptions.

Life insurance policies

Whole Life Insurance

Whole life insurance is a permanent policy that lasts the entire life of the policyholder. It offers the ability to accumulate cash value in a tax-deferred account. This means that taxes are not deducted from the accumulated cash value, allowing it to grow at a higher rate. In some cases, you may be able to borrow against this value by taking out a loan.

Universal Life Insurance

Universal life insurance is a flexible permanent plan that allows you to adjust your premiums, cash value, and death benefit as needed. This type of policy provides you with the option to increase or decrease your coverage and the associated costs over time, depending on your changing needs and circumstances.

Variable Universal Life Insurance

Variable universal life insurance gives you the freedom to invest your cash value into different kinds of funds and indexes of your choosing. Similar to universal life insurance, this type of policy also offers the flexibility to adjust your premiums and death benefit according to your preferences and requirements.

Indexed Universal Life Insurance

Indexed universal life insurance enables you to invest the cash value component, which is influenced by stock market performance. This type of policy provides coverage for your entire lifetime, ensuring long-term financial security for you and your loved ones.

Benefits of Using Life Insurance as an Investment

• Access to funds during retirement, supplementing your income
• Tax-deferred growth of your cash value, resulting in higher returns
• The ability to borrow against your cash value through policy loans or partial withdrawals to cover significant expenses, such as education or mortgage costs

Considerations

When considering using life insurance policies as an investment tool, it is essential to be aware of certain factors:

• The cost of different plans can vary significantly, so it is important to compare policy quotes to find the most suitable option for your budget.
• Choosing the wrong type of life insurance policy may result in paying for more coverage than you actually need, leading to higher premium costs. Therefore, it is crucial to assess your long-term financial goals and determine the appropriate level of coverage.

Roth IRAs

A Roth IRA is a type of individual retirement arrangement (IRA) that allows you to set aside money for retirement. It is subject to most of the rules that apply to a traditional IRA, but there are some key differences.

Firstly, contributions to a Roth IRA are not tax-deductible, meaning you cannot deduct them from your taxable income. However, this also means that, unlike with a traditional IRA, you do not need to pay taxes on qualified distributions or distributions that are a return of contributions.

Secondly, there is no age limit for contributing to a Roth IRA. While you can only contribute to a traditional IRA if you have taxable compensation, such as wages, salaries, or self-employment income, you can continue to make contributions to a Roth IRA after you reach the age of 70 1/2, and there is no requirement to start making withdrawals at any point during your lifetime.

Thirdly, the rules regarding minimum distributions are different for Roth IRAs. With a traditional IRA, you must start taking minimum distributions annually by April 1 of the year after you reach age 73, and you may owe an excise tax if you fail to do so. However, with a Roth IRA, you can leave the money in the account for as long as you live, and there is no requirement to take minimum distributions during your lifetime.

Finally, to contribute to a Roth IRA, the account or annuity must be designated as a Roth IRA when it is set up. The contribution limits for Roth IRAs may also be based on your filing status and income.

In summary, a Roth IRA can be a tax-efficient way to save for retirement, as you can continue to contribute to it regardless of your age, and qualified distributions are tax-free. However, it is important to note that contributions to a Roth IRA are not tax-deductible, and there may be limits on how much you can contribute depending on your income and filing status.

Health Savings Account

A Health Savings Account (HSA) is a tax-exempt trust or custodial account that you can set up with a qualified HSA trustee to pay or reimburse certain medical expenses you incur. You must be an eligible individual to contribute to an HSA.

To be an eligible individual and qualify for an HSA contribution, you must meet the following requirements:

• You are covered under a high-deductible health plan (HDHP) on the first day of the month.
• You have no other health coverage except what is permitted under other health coverage.
• You aren't enrolled in Medicare.
• You can't be claimed as a dependent on someone else's tax return.

If you meet these requirements, you are an eligible individual even if your spouse has non-HDHP family coverage, provided your spouse's coverage doesn't cover you.

You can claim a tax deduction for contributions you, or someone other than your employer, make to your HSA even if you don't itemize your deductions. Contributions to your HSA made by your employer may be excluded from your gross income. The contributions remain in your account until you use them. The interest or other earnings on the assets in the account are tax-free. Distributions may be tax-free if you pay qualified medical expenses. An HSA is "portable" and stays with you if you change employers or leave the workforce.

You can receive tax-free distributions from your HSA to pay or be reimbursed for qualified medical expenses you incur after you establish the HSA. If you receive distributions for other reasons, the amount you withdraw will be subject to income tax and may be subject to an additional 20% tax.

You can make contributions to your HSA for the current year through April 15 of the following year. If you fail to be an eligible individual during the current year, you can still make contributions through April 15 of the following year for the months you were an eligible individual.

Charitable gifting of your IRA minimum distribution

Qualified Charitable Distributions (QCDs)

Also known as a charitable IRA rollover, a qualified charitable distribution (QCD) allows you to donate up to $100,000 directly from your IRA to a qualified charitable organization without paying taxes on the money. This option became permanent in December 2015 and offers a great way to easily donate to charity before the end of the year. For those over 73 years old, QCDs count towards the required minimum distribution (RMD) for the year.

To initiate a QCD, contact your IRA trustee or administrator to instruct them to send the funds directly to the eligible charitable organization. It's important to note that the distribution must be made directly from the IRA to the charity, and any distribution made to you first will not count as a QCD. Each year, an IRA owner age 70½ or older can exclude up to $100,000 of QCDs from their gross income. For married couples, if both spouses meet the age requirement and have IRAs, each spouse can exclude up to $100,000, for a total of up to $200,000 per year.

QCDs are not considered deductible charitable contributions, but donors must still obtain a written acknowledgment of their contribution from the charitable organization before filing their tax return. This acknowledgment should include the date and amount of the contribution and indicate whether the donor received anything of value in return.

Benefits of QCDs

QCDs offer several benefits to charitably-minded individuals and couples:

• They allow you to support your favorite charities directly.
• You don't report QCDs as taxable income, so you don't owe any taxes on the donated amount.
• QCDs can provide greater tax savings than cash donations with charitable tax deductions.
• Reduced adjusted gross income (AGI) can positively impact several key calculations, such as determining the taxable portion of Social Security benefits or what deductions and credits donors qualify for.
• QCDs can help you avoid being pushed into a higher tax bracket, which can adversely affect Social Security payments and Medicare benefits.

Case Study: Bob's Enhanced Tax Savings with a QCD

Let's consider an example to illustrate the benefits of a QCD. Bob is 75 years old in 2024 and needs to take a required minimum distribution (RMD) from his traditional IRA. His traditional IRA is valued at $1,050,000, resulting in a projected RMD of $42,683. Bob's ordinary income in 2024 is $80,000, and he files taxes as a single person.

Option 1: Without a QCD

If Bob takes his RMD of $42,683, his AGI will increase to $122,683. If he then donates his RMD income to charity, he can claim an itemized deduction of $42,683, assuming no other deductions. This results in $80,000 in federal taxable income.

Option 2: With a QCD

Bob instructs his IRA administrator to direct his RMD as a QCD to an eligible charity. The RMD is now excluded from Bob's taxable income. Bob takes the standard deduction of $14,600 for 2024, plus an additional standard deduction of $1,950 due to his age and filing status. His total standard deduction comes to $16,550, reducing his federal taxable income to $63,450.

As demonstrated in this example, utilizing a QCD can result in significant tax savings while also allowing you to support charitable causes.

Frequently asked questions