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Unusual Tax Savings Hiding in Plain Sight

Aug 16, 2022

In retirement every penny counts. It doesn't matter if it is is a penny saved from market losses, or at the gas pump, or from over paying on taxes.

There are lots of ways to save on taxes in retirement. Today, we are going to explore some of the more unusual ways...

See, one of the things that makes America great, is our tax system (what?!?)

Yes! You read that right! Our tax system is one of the secrets behind our great little economic engine, and when you understand why - it opens up a world of tax saving opportunities.

One of the jobs of our tax system is to incentives investments in "strategic technologies and sectors." Once such sector is Energy. Energy independence has long been a priority on Capitol Hill (even though it might not always feel like that!). In the lengthy and complex tax code lie provisions for energy companies – and those tax breaks are sometimes available to investors, too.

Digging into the nitty-gritty, the tangible costs of drilling for oil and gas are 100% deductible and follow a set depreciation schedule. So, big projects that an energy firm takes on can result in immediate tax savings to offset taxable profits. Intangible costs are also able for a write-off. Finally, lease operating costs and other administrative expenses can count against income to lower each year’s taxes.

All this translates to major tax savings!

There is even a special tax break for smaller energy producers, known as the “depletion allowance.” This provision allows firms producing under 50,000 barrels of oil per day to keep 15% of their revenues tax-free. There are a few other requirements, too.

That all might sound like Greek to you, and that’s just fine.

All you and I should concern ourselves with is how these tax-preferred investments might fit into a portfolio. There are a few vehicles we can use to capture these significant tax breaks. Of course, being mindful of risk and not putting all our eggs in one basket is critical to ensuring a diversified portfolio.

Here's what you need to know:

  1. Investors often tap these types of securities through “Master Limited Partnerships.” MLPs, as they are known, are registered with the U.S. Securities and Exchange Commission (SEC) and pass-through tax savings to the investor (partner). A notorious aspect of owning MLPs is that come tax time each year, owners receive a K-1 that is more complex than a basic Form-1099. There are many publicly traded MLPs and funds that invest in these types of firms.
  2. “Royalties” are earned by individuals who own land on which oil and gas is drilled. Income generated from royalty is paid to investors in the form of dividends. Investors can purchase shares of royalty trusts to gain exposure to this space, but those vehicles do not offer direct tax benefits.
  3. “Working interests” is a risky oil play. This method gives investors a percentage of ownership in drilling operating interests. Like many of these kinds of complex projects, you might have to be an accredited investor (which has certain income thresholds and net worth requirements) to participate. Income garnered from working interests is considered self-employment compensation, so it’s subject to self-employment taxes.

Investments with direct tax advantages should be owned in a taxable account, not an IRA or 401(k) since those retirement accounts are already tax-sheltered.

Before doing anything, though, it is important that you work with an experienced financial planner who is well-versed in not only investments but also the tax angle. These are complicated matters that can offer tax savings with the right strategy.

At Yields4U, we work to help educate investors so they can build the retirement of their dreams. To learn more ways to save on taxes in retirement, click here.

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