Podcast | “Greatest of All Time” Internal Revenue Code Sections

LISTEN NOW

If you are unable to access the podcast below, look for PBMares AdvisoryWatch on Spotify.

Transcript

Andrea
It’s tax season, and as we march toward April 15th, we are thinking about reducing our tax liabilities and preserving our hard-earned dollars. The best companion in this process is a trusted advisor who will guide us through the options and solutions. Luckily for us, today, we have one of those trusted advisors who had one of our highest-attended webinars on this topic. This is a must-listen.

Today’s guest is Sean O’Connell, a senior partner on PBMares’ Tax Team. Virginia Business has named Sean a Super CPA so many times we have lost count. And they are not wrong because I have the pleasure of working with Sean, and he is indeed super. Sean leads a group in the firm called Emerging Tax Issues Group, which focuses on all things tax.

Sean is deeply committed to his clients and always looks out for them to give them peace of mind that their financial future is sound. Today, Sean will give us some of the highlights of his greatest tax strategies.

Hi, Sean. Thanks so much for joining us today.

Sean O’Connell
Hello, thanks for having me. Good to be here.

Andrea
Okay, Sean, you and I often have really interesting conversations. I love talking to you. Right before we got started here, you told me that there are three buckets of taxpayers in the United States. Let’s talk about those three buckets.

Sean O’Connell
Yes, well, there are the taxpayers who prepare their tax returns. They do it themselves. My parents did this. My dad worked for the government. Around this time of year, they filed the tax return after preparing it. They did it by hand, and it wasn’t complicated, but it was time-consuming, and they did their best and filed the return. So, there are still a lot of folks out there typically using software to prepare their returns. And that’s certainly an option. Then there’s the group of folks like several of my siblings. I’m the youngest of six children. My siblings typically use tax preparers. They hire someone to prepare and help them file the tax return. They sort of fill out the forms and make sure everything is correct. And that’s a valuable service in the United States. And then there’s a third level that engages a tax advisor who can help them with tax planning and strategizing, saving them a lot of money. Tax advisors aren’t for everyone, but for those that either have a high income, have a business, or have other tax opportunities, tax advisors can pay off and do so every day for many Americans.

Sometimes, people might engage someone they think of as a tax preparer and don’t realize that the same person can provide them with valuable tax advice if they ask questions and engage at perhaps a higher level.

Andrea
That last group could be people who maybe have some wealth they want to pass on to their children, or they’ve inherited some large sum of money or property that they’re thinking what do I do with this? And you learn that through just building a relationship, really becoming that person’s true advisor. Is that right?

Sean O’Connell
Yeah, that’s right. You see this in many other fields, including health care and even chiropractics. They have people who come to them when they are in a jam and need to get something worked out, and then they have that adjustment, and then they don’t see them again. But they have other patients they see regularly, and they’re under the care of a chiropractor, for example. And so we have a lot of relationships where those clients and taxpayers are under our care for long-term tax planning and wealth-building purposes.

Andrea
Here’s a shameless plug since I’m in the marketing group here. Sean works very closely with our wealth management team. So it’s not just Sean; it’s a whole team of people that could really be the advisor and, like I said, ensure that peace of mind. And I know that Sean does this. We have so many client surveys, and Sean has glowing reviews from his clients.

So why don’t we get started? The greatest of all time. You’ve identified these top 10. Can you give us a little idea of how you arrived at the top 10 strategies?

Sean O’Connell
Well, we had some help from our clients. We have a lot of data, and we can mine that data to see what tax strategies people are taking advantage of and how much they’re saving due to these tax strategies. And so our criterion was that as far as the greatest code section of all time, it needs to be taxpayer-friendly. It needs to be something that offers a saving or an advantage, not a punitive code section or some surtax. And the second thing is that it’s not obscure. It can benefit many people.

For example, some people in your neighborhood can benefit from these strategies. Not only is it a good thing, and some people benefit, but they can also save significant dollars. There’s a deduction, for example, for teachers who can deduct $250 or $300 of their classroom supplies. Well, that’s good. And every teacher in the United States takes advantage of that. But it’s not a big dollar item. So that’s not on the list. And apologies to my wife and others who are teachers. And then lastly, the last criteria was that it isn’t a one-time stimulus or incentive; it’s around for a long period. It has a lasting impact. It’s not a one-hit wonder.

Andrea
Not a one-hit wonder. I think these things you’ll list are probably some that we’ve heard of. So okay, why don’t we get started? We’ve built suspense here. So how about we do speed dating for the greatest of all time? We’ll start at number 10. I’ll give you the code section and the topic, then let you riff on these. How about that?

Sean O’Connell
Okay, that’s great.

Andrea
All right, coming in at number 10 is Code Section 1031 Like-Kind Exchanges.

Sean O’Connell
Yes, 1031 has been around for a long time, primarily involving selling real property. This could be residential, commercial, or even raw land. Any real estate sold at a gain isn’t currently taxed if the seller invests in other real estate within 180 days of selling the relinquished property. This deferment is because the cost basis of the replacement property is reduced by the gain they didn’t pay on the first deal. This creates numerous planning opportunities. For instance, some people sell real estate to gain liquidity. Still, we’ve identified replacement properties that generate rental income, or they might use all proceeds to invest in new real estate, and then borrow against it, still qualifying for no taxation under 1031. This, however, does not apply to principal residences. There’s a different deal for properties in which we live. But for other types, 1031 applies to any other type of real estate.

Andrea
There is a connection, though, and I want to make sure we bring this up because it will be another topic. This is related to the Tax Cuts and Jobs Act of 2018, correct?

Sean O’Connell
The Tax Cuts and Jobs Act modified Section 1031 but made it more restrictive. Previously, 1031 was popular for any type of property, including aircraft, vehicles, trucks—anything could be exchanged. The Act narrowed it to just real estate.

Andrea
I’m plugging a later podcast on the Tax Cuts and Jobs Act because I know that Sean and his team are analyzing it extensively. Those provisions are going to be sunsetting in the next few years, right, Sean?

Sean O’Connell
Yes, and generally, the Tax Cuts and Jobs Act was a tax-beneficial tax-cutting act, but it included provisions that raised revenue, such as narrowing code section 1031. Generally, if it all goes away and expires, that’s a tax increase for most Americans. However, within it, some elements could revert to tax opportunities that we could go back to.

Andrea
Alright, that will be a huge podcast a little bit later. Let’s just stay on track here. Coming in at number nine, Tax Code Section 25-C; Energy Credits.

Sean O’Connell
This section has been around for a long time, facilitating improvements to our homes for energy efficiency. This could involve heat pumps, insulation, doors, windows—all those improvements. In 2022, the Inflation Reduction Act significantly expanded the amount of credit available. It used to be up to $500 for a lifetime. The limit is $1200 annually, but for energy-efficient heat pumps, it can be up to a $2000 credit if it meets the energy efficiency rules. And for solar, the credits are even more substantial. There is no annual cap on the credit you can claim for solar panels, which is 30% of the cost for the next ten years.

Andrea
You mentioned a magic phrase there: heat pump. This is a very personal issue for me, as I had to replace a failed heat pump on a very cold day here in Virginia. Let’s say it cost $5,000. So, did I hear correctly that I could claim a $2,000 credit toward that?

Sean O’Connell
Yes, $2,000 is the maximum credit, although it’s the lesser of $2,000 or 30% of the cost. If your heat pump costs $5,000, your credit would be $1,500. We ensure it qualifies, as most new models do. There’s an online directory of qualifying heat pumps to check this.

Andrea
The lesser of 30% or $2,000. Before we move on, I wanted to discuss vehicles because there has been some confusion. There’s been a credit for electric vehicles for several years now. However, the new act specifies that you don’t qualify for that credit if your income is over $300,000.

Sean O’Connell
Exactly, the credit for energy efficiency improvements at home, like the heat pump, does not depend on your income. This differs from the credit for electric vehicles, which is income-dependent.

Andrea
Alright, coming in at number eight, Section 529: Qualified Tuition Accounts.

Sean O’Connell
Section 529 is a federal code for college accounts that allows tax-free earnings if used for qualifying educational costs. Many states, like Virginia, offer additional incentives, such as a state income tax deduction for every dollar contributed. These accounts are versatile; they apply regardless of where the child goes to school, and the contributor does not need to be related to the beneficiary. This flexibility allows even neighbors to contribute and receive a tax benefit, enhancing community support for education.

Andrea
That’s interesting and ties back to our initial discussion about building relationships and understanding the personal aspects that can influence financial decisions.

Sean O’Connell
Absolutely. It’s worth noting that tax incentives can vary significantly by state, creating unique opportunities for saving and planning.

Andrea
Number seven is Code Section 179: Election to Expense Property.

Sean O’Connell
Yes, Code Section 179 is well known among business owners because it allows the immediate expensing of property used in business up to the amount of net income. This includes new and used property, with the current cap currently $1,160,000 for the year. This provides significant tax relief for business owners who purchase property for their operations.

Andrea
That’s a substantial benefit for small and large businesses alike. Moving on to number six, Section 168K: Bonus Depreciation. What can you tell us about this?

Sean O’Connell
Bonus depreciation is similar to Section 179 but offers even more aggressive tax savings. Currently, businesses can deduct up to 80% of the cost of new or used personal property in the year of purchase, regardless of their profit levels. This can greatly increase cash flow and encourage investments in new equipment.

Andrea
That sounds like a great incentive for businesses to invest in growth. Can you share an example of how this might be applied in real scenarios?

Sean O’Connell
Absolutely. Let’s say a construction company buys a fleet of trucks for $1 million. They can immediately deduct $800,000 from their taxable income this year. This substantial deduction can significantly reduce their tax liability, promoting further business expansion.

Andrea
That’s quite impactful. Can you share any interesting stories from your practice that illustrate these benefits?

Sean O’Connell
Just recently, a client engaged in a large transaction involving selling and replacing business properties under Section 1031. The client was strategic about using this provision to defer taxes by reinvesting the proceeds into new properties, optimizing their tax position while enhancing their business operations.

Andrea
It’s always enlightening to hear how these strategies work in real life. Let’s move on to number five, Section 121: the Exclusion of Gain from the sale of a residence.

Sean O’Connell
Section 121 allows individuals to exclude up to $250,000, or $500,000 if married, of gain from the sale of their principal residence, provided they’ve lived there for at least two of the last five years. This can significantly benefit homeowners, especially in a rising market.

Andrea
This seems particularly relevant to many people. How does this interact with other tax provisions?

Sean O’Connell
It’s standalone in many ways but interacts with other provisions when considering the overall tax strategy, especially when planning for multiple property sales or dealing with rental properties. Each situation can provide unique opportunities for tax savings.

Andrea
Okay. For number four, we’ve got Section 501c3, Exempt Organizations.

Sean O’Connell
Yeah. I think the tax opportunity we’re talking about here are charitable contributions for individuals. A lot of Americans are very charitable. They give to other groups, they give to other families, they give to other individuals and what the deduction hinges on is, is this one of those organizations that is set up and approved under code section 501 C3 that has been registered with the Internal Revenue Service and has an exempt purpose that is satisfactory to qualify that any cash given to it, any property given to it is tax deductible to the donor. Now there are other not-for-profit organizations like your civic club or you know a homeowner association those types of things.

But that doesn’t mean they’re in the big provision of 501 C3, that this is where foundations and other organizations spring up to, to capture that code section so that donors can give and get a tax deduction. What we find is that everybody’s familiar with giving cash and taking a charitable deduction. What they’re not as familiar with is giving other types of property, including appreciated property.

Maybe they’ve got some investments that are up in value. And when they donate that type of property, they’re able to deduct the full fair market value and no one has to pay any tax on the gain or the appreciation people can donate real estate. And of course, people are also familiar with giving property that is not appreciated, like used clothing and used furniture. You’re deducting the fair market value at the time you donate it, you know, the thrift shop value, so that’s also an opportunity. But there’s one thing that has really become popular and I want to outline it a little bit. It’s called a donor advised fund. In the old days, wealthy people would set up family foundations and those types of things. But it’s really become much more prevalent to have an easy giving account, let’s call it, where you can transfer cash or property into it and take a deduction at that time. But meanwhile, you still sort of got it in this donor advised fund, this family giving account, and you sit around the dining room table with your family and say, you know, we’ve got ten thousand dollars in this thing. What what types of programs do we want to support? What types of groups do we want to get involved with and give to? And even though you’ve still got it in your own kitty, you took the deduction upfront and you were able to give, in some cases, property to it or investments that had gone up in value and no one has to pay any tax on that on that game. So donor advised funds are very popular and most of the investment houses offer them – anyone that offers IRAs or those types of things, also has donor advised funds. This is a good way to bunch deductions into one year to get a big upfront tax benefit and a more significant tax benefit.

Andrea
Okay, let me ask you a question about the donor-advised fund. I love watching shows on PBS. And so the credits at the end or at the beginning, they say this made possible by the John Smith Family Foundation. Would that be an example of a donor-advised fund?

Sean O’Connell
Yes, it would. Now, a family foundation, as I said, is a little older concept, and it’s a very high net worth concept. They’ve taken the time to set up this thing that has expenses, has property. And the rest of America, most of us aren’t in a position to set up a family foundation, but we’re all in a position to set up a donor advised fund. And the other advantage it can give us is that even if we don’t know yet which college or hospital or charity or church that we want to support in the future, we can set aside those dollars now and take the deduction now. And there’s no taxation on the earnings in these accounts.

Andrea
Very interesting. As we get to the top three, what’s number three?

Sean O’Connell
The third spot goes to Qualified Retirement Plans under Section 401k. These plans allow employees to defer a portion of their salary into retirement accounts, which grows tax-free until withdrawal.

Andrea
Retirement planning is crucial. What are some of the nuances here that people might not be aware of?

Sean O’Connell
Many people don’t realize the full range of options available within 401k plans, including Roth options and various matching contributions. These can significantly enhance an individual’s retirement savings and tax efficiency.

Andrea
That leads us nicely into the second top spot. What’s in second place?

Sean O’Connell
The second top spot is the Qualified Business Income Deduction under Section 199A, which allows eligible self-employed and small business owners to deduct up to 20% of their qualified business income from their taxes.

Andrea
And finally, what is the top tax strategy or provision on your list?

Sean O’Connell
The top spot goes to Roth IRAs under Section 408A, which offer tax-free growth and withdrawals. This can be a game-changer for long-term savings and is especially powerful for younger investors who have time to let their investments grow.

Andrea
Sean, this has been incredibly informative. Before we wrap up, do you have any final thoughts or advice for our listeners?

Sean O’Connell
Always be proactive about your tax situation. Engage with knowledgeable advisors, stay informed about changes in tax laws, and always plan. Effective tax planning is a year-round activity, not just something to consider at tax time.

Andrea
Thank you, Sean, for sharing your expertise with us today. For our listeners, remember to check our website for more resources and detailed information on each of these tax strategies. Sean, we hope to have you back soon to dive deeper into some of these topics.

Sean O’Connell
It’s been a pleasure, Andrea. Looking forward to next time.

Andrea
Take care, everyone, and keep planning smart!