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Income Shifting: Can You Benefit from This Tax Break?

If you are in a high income tax bracket, and you know you will be facing a hefty bill when tax time rolls around, then income shifting may be the tax break you are looking for. When done properly, income shifting can ease your burden while moving you into a lower tax bracket without causing any increase in taxation to the person to whom you shift your income.

Income shifting is moving portions of your income away from you and to someone else in a lower tax bracket; thereby lowering you own income and the tax burden you face. You can accomplish this shift in a number of ways. You can give actual cash to someone else, you can give property to someone else, or you can give stocks to someone else. There are a few caveats to keep in mind when giving away cash or goods for income shifting. First, these gifts are subject to gift taxes. You can give a total of $12,000 in cash and goods to an individual tax free every year, and then gift tax kicks in. There are of course ways around this. You and your spouse can each give $12,000 away per year tax free to as many individuals as you like, so to reduce you income by more than $12,000, give financial gifts separately and spread the wealth out among a number of recipients.

Second, these items truly are gifts. Once you give them, they rightfully and legally belong to the person to whom you have given them. You can't transfer $12,000 to your son's bank account around tax time, and then take it back after you have paid your taxes at your reduced rate of income. If you do so, your income shifting has just become illegal, and you will be subject to fines and/or criminal prosecution by the IRS. Lastly, if you give away cash or goods in an amount that exceeds $12,000 to one single person, then it is you who is responsible for the gift tax, not the recipient.

Another way to use income shifting to lower your tax bracket comes into play if you have your own business. Get the family on the payroll and transfer some of the wealth to them. This works especially well if you have minor children. Give them a temporary job doing any business related task - it can be as something as simple as answering the phone or tidying up your files - and then pay them for their work. Pay them just under the minimum amount for taxable income, so they won't have to pay any taxes. Then, write their wages off of your business tax return to lower your own tax bracket.

In some cases, there may even be a way for you to avoid paying Social Security and Medicare taxes on the wages you pay your minor children, though this depends on the state. You can also employ your adult relatives in much the same manner. For adults, you will always have to deduct Social Security and Medicare taxes, but you can justify paying adults more to being with, so you will have an even larger deduction to make from your tax returns.

Like most tax deductions, the line between legal and illegal is thin and often confusing to a layperson. If income shifting is necessary for you to reduce your tax bill, then you almost certainly should have a financial advisor on staff. Your advisor can keep you on the right side of the law while maximizing your deduction potential.