HIDE CASH FROM THE IRS—LEGALLY

There are loopholes in what gets counted as income. Arrange your affairs to exploit them.

Adjusted gross income—line 37 of the 1040—drives all manner of penalties, surtaxes and phaseouts of benefits. Noteworthy is an Agi-powered boost in Medicare premiums that will cost a couple up to $8,899 in 2017. Some states, like New York, kick up property taxes for people with high AGIS.

The tax code is littered with assaults on your AGI. Some education or adoption credit or tax-deferred IRA will be dangled, then snatched away if line 37 is too high. This is how politicians can brag about promoting college or adoption or retirement yet trim the cost.

The problem is likely to get worse, not better. Republicans are gunning for cuts in the visible tax rates. But the country is already $14 trillion in the hole. Solution: Declare tax cuts or entitlements in

the headline, then take them back in the footnotes.

What do you do? Doctor your income so that line 37 goes down. Here are ten ways to do this.

Maximize retirement. Your contribution of up to $18,000 ($24,000 for those 50 and up) to a 401(k) reduces AGI. If neither you nor your spouse has a retirement plan in a current job, you can deduct $5,500 ($6,500 for oldsters) going into an IRA.

Build your Hsa. Health savings accounts are triple-tax-free: a deduction, tax-free compounding and tax-free withdrawals. If your family is covered by a high-deductible health insurance plan, you can deduct contributions of up to $6,750 ($1,000 more if you are 55-64). Withdrawals are tax-free if used to cover medical costs.

You have to stop contributing when you’re in Medicare, but you can let the account compound indefinitely and use it late in life to reimburse yourself for medical expenses incurred years earlier. It acts like a supercharged IRA.

duck refunds. If you overdo your estimated state income taxes for 2017, you get a deduction for the outlay, but some or all of the resulting refund will boost your AGI in 2018. (Just how much depends on the estimated tax you pay on January 15, 2018 and other factors.) To put it in other words: Having an oversize deduction one year followed by extra income the next does not leave you whole. If your bracket stays the same, the boomerang leaves you worse off because it inflates AGI.

donate from an ira. Once you turn 70½, use distributions sent directly from your IRA to a charity to cover contributions you would otherwise have made in cash. The outlay (max: $100,000) counts toward mandatory IRA withdrawals but never shows up in AGI. If you otherwise would have used appreciated stock to be philanthropic, bypassing capital gains en route, the choice is more complex. Use tax software to see if you are better off bypassing AGI or bypassing capital gains.

Take losses. It’s almost always a good idea to sell stinkers from your portfolio. Capital losses can absorb any amount of capital gains (say, from unwanted mutual fund distributions) plus up to $3,000 of other income. Both absorptions lower AGI.

own index funds. In your taxable accounts, go for something like the Vanguard Total Stock Market ETF (VTI). This giant fund, which has a lot of overlap with the S&P 500, has done a hair better than that index over the past decade. And it has done so with minimal tax pain to the customers. It doesn’t pay out capital gains.

Contrast that with Growth Fund of America, which has tied VTI over the de-

cade. But its active management churns up capital gains. If you owned $100,000 of it in December, you had $5,570 of needless taxable income thrown into your AGI.

Taper your career. Objective: maximize the above-line-37 deduction for health insurance. You can write off premiums, including Medicare premiums, against self-employment income; you can’t write them off against other income.

Say you’re a self-employed lawyer in your early 60s making $120,000 and planning to work one more year. And let’s say health insurance for you and your spouse is running $16,000 a year.

Work one year full-time and you’ll deduct $16,000. Work three years at onethird time and you’ll deduct $48,000.

own Munis. Tax-exempt bonds aren’t entirely tax-exempt: The interest gets added to AGI in some of the AGI penalty formulas, such as the one boosting Medicare premiums. But even here, the municipal bonds help you. They create less gross income.

Suppose part of your retirement income is going to be interest on $1 million of bonds in a taxable account, and you’re in a combined 33% federal/state tax bracket. Choice 1: Vanguard Intermediate Corporate Bond ETF (VCIT), yielding 3.4%. That’s $34,000 of income before tax and $23,000 after. Choice 2: Vanguard Tax-exempt Bond ETF (VTEB), yielding 2.3%. That delivers $23,000 net of federal tax and a bit less after state tax.

Putting aside the somewhat higher credit quality of the munis, this is pretty close to a tie so far. But the muni fund lessens the havoc on line 37.

Under present law, VTEB keeps $34,000 out of the AGI figure used to determine how much income gets whacked by the 3.8% Obamacare tax. The next tax cut may repeal the 3.8% tax. But it will almost certainly leave in place the Medicare premium penalty. VTEB is $11,000 better than VCIT on that score.

leverage rental property. Up to a point. Let’s say your balance sheet is destined to have $400,000 of mortgage debt. It could be on a home you live in or it could be on an apartment building you hold for investment. Either way, the interest is deductible. So it seems not to matter where the mortgage goes. But it does matter. Investment property interest comes out of line 17, so it shrinks the AGI on line 37. The home-mortgage interest is claimed below line 37. It doesn’t protect you from the AGI bandits.

caveat: This is a tricky business. You may not be able to deduct the interest if you mortgage the apartment building after buying it, and you will probably run into trouble if the mortgage interest puts your rental into the red.

plan your divorce. Alimony (but not a lump-sum settlement) moves AGI from one ex to the other. The potential tax benefit should be part of the negotiation.