Looking for some tips heading into the tax-filing season? Look no further than Mitt Romney’s 2010 and preliminary 2011 tax returns that he released last month.
Though he earns a fortune that average filers can only dream about, the former Massachusetts governor and Republican presidential candidate made some smart moves that those in lower income brackets might also use to trim tax bills, tax specialists said. Romney and his wife, Ann, filing jointly, paid less than 15 percent of their income in taxes, below the average of about 20 percent paid by those in the top 1 percent of incomes.
The Romneys took advantage of lower capital-gains tax rates, charitable tax deductions, write-offs of asset gains, and other measures to hammer down what they legally owed on tens of millions of dollars in reported income.
“I think I have 1040 envy, for sure,’’ James Angelini, a professor of taxation at Suffolk University’s Sawyer Business School, said after reviewing the Romneys’ tax returns.
But as successful as the Romneys may have been in lowering their tax bill, they underscore a fact of life that filers should keep in mind: You’re probably going to pay federal taxes, even if you find a host of tax breaks. The Romneys hired the Big Four accounting firm PricewaterhouseCoopers LLP to prepare their returns and still paid $3 million in federal taxes in 2010, on more than $21 million in income.
Here are some other lessons that average taxpayers might learn from the Romneys’ tax filings:
Not all income is taxed equally. The Romneys reported zero dollars in wages, salaries, and tips, which would have required paying income taxes at a top rate of 35 percent. Instead, the vast majority of their income came from returns on investments, qualifying for lower 15 percent capital gains and dividend tax rates.
This should be a reminder to most filers: Take advantage of lower capital gains and dividend tax rates when possible.
Tax specialists say too many people miscalculate or outright miss these major tax advantages, especially if they’re preparing their own returns and are unfamiliar with what qualifies as capital gains and dividend income. Stock dividends, for instance, qualify for the 15 percent rate if they are held for at least 60 days, said Angelini.
Maximize deductions for charitable donations. The Romneys have donated millions of dollars to charities over the years - a projected $4 million last year alone, their returns show. Most of their donations went to the Church of Jesus Christ of Latter-day Saints, known as the Mormons.
Charitable donations are a common tax deduction, but the Romneys made the most of them by also giving via “appreciated securities,’’ such as stocks that have risen in value over the years, according to tax specialists. By making some of their donations this way, they were able to deduct the full value of the assets while avoiding taxes on investment gains.
“The Romneys are doing this on a very large scale,’’ said Mark J. Alaimo, an accountant at Sullivan Bille PC and a financial planner at Wealth Management Advisors LLC in Tewksbury. “But others can do it on a smaller scale. It’s a smart move.’’
Beware the Alternative Minimum Tax. Besides paying millions of dollars in federal taxes, the Romneys also paid large sums in state and local taxes over the years.
But some taxpayers, especially wealthy ones like the Romneys, don’t always get to deduct those taxes due to higher incomes that qualify them for an Alternative Minimum Tax, originally created to prevent the wealthiest American from using deductions and other breaks to avoid paying any taxes. Since the AMT is not automatically indexed for inflation, it has expanded to include many middle-income families, who, tax specialists say, may need to comply with its provisions.
The Romneys’ income was so high, it exceeded the $447,800 AMT threshold that effectively prohibits the deduction of state and local taxes, some $1.5 million in the Romneys’ case. Because of the AMT rule, they had to pay more than $200,000 in additional federal taxes in 2010, according to Angelini.
The lesson: Pay attention to the Alternative Minimum Tax, which can affect families with household incomes as low as $74,450. You may not qualify for some deductions.
Err on the side of caution. The Romneys reported some small investments in entities with headquarters located overseas, such as in the Cayman Islands, Ireland, and the Netherlands. Tax specialists say this can be a touchy issue, because of cases of wealthy Americans hiding cash in overseas bank accounts to avoid US taxes.
But the Romneys, tax specialists say, did just the opposite, meticulously identifying small amounts of investment income from overseas and paying all taxes on them.
Tax specialists say those with overseas holdings of any kind should follow the Romneys’ lead: Report and pay taxes on any foreign investment income, no matter how small. “They’ve properly followed [tax code] procedures,’’ said Angelini. “There’s no problem here. They’re not trying to avoid taxes.’’
Take what’s legally coming to you. The Romneys didn’t take advantage of certain tax breaks, but that doesn’t mean you shouldn’t.
Tax specialists, for instance, expressed surprise that the Romneys appear to have had little, if any, money in tax-free municipal bonds. “A lot of people, usually the wealthy, take advantage of municipal bonds,’’ said Angelini. “They’re not taxed, and they have small interest-rate returns. They’re simple, good investments.’’
Taking advantage of legal tax breaks is simply a taxpayer’s right, even if some provisions might come across as unfair or unwise from policy standpoints, tax specialists said.
“If there are any grounds for complaints, they should probably be directed at Congress,’’ said Robert M. Finkel, a business and tax attorney at Morse, Barnes-Brown & Pendleton in Waltham. “Congress is the one that writes the tax laws.’’