Life and Death: The Related Taxes, and How It Affects Your Family

This article is a reprint of Wise Bread's contribution to OPEN Forum from American Express -- where small business owners can get advice from experts and share tips with each other.

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Death and taxes, Ben Franklin wrote, are the only things that are certain in this world. Margaret Mitchell indirectly added babies to the list when she wrote in Gone With The Wind that there's never a convenient time for death, taxes, or childbirth. But even if taxes are inconvenient and death is certain (or the other way around), there is much we can do to make them easier on our family.

Kids and Taxes

If your business isn’t incorporated, hiring your kids can produce substantial tax savings. You can deduct what you pay them, and you won't pay Social Security or Medicare tax, and you usually won't have to pay state unemployment or disability taxes on the money, either. Together, your family will send less to Uncle Sam.

Your children’s income is taxed at the same rate as yours until they are 19 (or 24 if they're full-time students). You can help reduce the tax bite by encouraging them to put the money in tax-free municipal bonds or growth stocks they won't sell until they’re 19 (or 24), when their tax rate probably will be much lower than yours.

If your estate pays enough taxes to take a disproportionate hunk out of your kids' income (as discussed above), you might want to gift some of your money to them. You can give a gift to whomever you like, and as many people as you like, and you won’t pay gift tax if the amount is less than $13,000 per recipient per year. This isn’t to avoid inheritance tax, by the way — in 2010 there wasn’t any thanks to President Bush’s tax legacy — but in 2011 there will be a 35% tax on estates over $5 million as part of Obama’s “tax cuts.” Most people won’t have to worry about that; but if you do, gifts today can avoid taxes tomorrow.

Be careful if you loan your adult children (or anyone else) money. If they want to borrow more than $10,000, you have to charge them interest. If you don’t, you have to report a certain amount anyway, just as if you’d received it from them. Paying taxes on money you didn’t receive doesn’t seem fair, but that’s the way the tax code works.

Another way to help your kids is to help them earn the retirement savings credit. The retirement savings credit can be up to 50% of the first $2,000 they pay into an IRA or company retirement plan, but paradoxically it's only available to low-income taxpayers — the very people who are least able to afford to make the contribution. But you can help, if you have an adult child who's not a full-time student, by giving him or her the money to fund such a retirement contribution. 

Death and Taxes

Now onto sadder topics: If you're terminally ill and want to keep your home in the family, think about selling it to your kids now. It won't help your taxes, but it could save them some after you're gone.

If you have investments that have been losing money on paper, consider selling them, too, before you die. Their value will be "stepped down," as it's called, on the date of your death, and your heirs won't be able to claim the loss, so you might as well do it now.

If, happily, you aren't terminally ill but thinking about living a very long time, keep in mind that a portion of long term care insurance costs are deductible.

Business and Taxes

If you are a self-employed business owner, you have a number of options when it comes to income and expenses. If, for example, 110% of your income is over $150,000 you don't need to make estimated tax payments this year. And you can also push some income into 2012 if you wait to send out bills until December 31st. You can can also chose pay some business expenses before the end of the year to be sure you get the deduction this year.

And now that we're thinking about shifting money, consider shifting some of your own compensation from salary to dividend. Your salary is taxed on the basis of your tax bracket, which is probably 25-35%, but dividends are taxed at a maximum of 15%.

The tax bite on some expenses, like compensation, varies too. If you buy a new company car your first year write off is about $12,000. But Congress has provided a tax incentive for gas guzzling SUVs and pickups, believe it or not. They told the IRS to let you write off $25,000 of the big vehicles expenses the first year, and depreciate the balance over the next six.

Keep track of medical bills carefully. If you have to make modifications to your home for medical necessities, such as wheelchair ramps or hand controls for your cars, for example, you can include those costs in your medical deductions.

Travel expenses related to medical care can be deducted too — and not just car mileage. You can deduct $50 a night per person for lodging if you have to go somewhere for treatment.

Finally, keep in mind that what you do and don't deduct from you taxes, and what income you do or don't report is a serious issue. The tax tips offered here are simply thought-starters. Be sure get advice from a tax accountant or tax attorney to know you're doing it right. Besides, if your taxes are prepared by a professional you are less likely to be audited.