***Classifying Your Income: tax-minimizing advice from the new book, Trump University Asset Protection 101

The good news is, you made money in 2007. Hopefully, a lot of it.nn But do you understand that not all the dollars you earned are the same in the eyes of the IRS? Until you define the kind of income each of those dollars represents to the tax collector, you stand little chance of minimizing the money you give to Uncle Sam in taxes.nnLet’s take closer look at how the IRS classifies your income - and explore some unique tax-minimizing opportunities you might be missing.nnEarned Income - Okay, we’ll start with the most basic. Earned income is income that you earn for your personal services. It is subject to both income tax and self-employment tax (Social Security and Medicare). The most common type of earned income is W-2 wages (salary, etc.). However, net income from a self-employed business (filed on Schedule C) is also considered earned income. This is the type of income you want to minimize - or even avoid, if possible - because it is taxed most heavily.nnPassive Income - Passive income generated from something other than personal services. It is subject to income tax, but is not subject to self-employment tax. The most common type of passive income is the income you generate from rental properties that you own. You see, the income you generate from rental property is not based on your personal services, but rather on the value of your property and the rental income that it generates. Passive income can also be generated by your personal involvement, or lack thereof, in your business. Certain business entities, such as limited partnerships, can create passive income.nnPortfolio Income - Portfolio income is income you earn on your investments. This type of income includes interest, dividends, and capital gains. It is subject to income tax, but not self-employment tax. In this way, portfolio income is very similar to passive income. One major difference between the two is the ability to pay even less tax by generating capital gains. Currently, capital gains are taxed at a maximum rate of 15 percent. That’s right, a maximum of 15 percent! It is highly unlikely that this historically low rate will be around forever. Therefore, it would be a very wise move to analyze your investments to see if there is a way to maximize your overall return by taking advantage of this tremendous tax break while it exists.nnDeferred Income - Deferred income is income that you do not pay tax on currently, but that you expect to pay tax on at some point in the future. That tax could be paid next year, 10 years from now, at retirement, or possibly never. Retirement plans are an easy way to set up deferred income; you take a current deduction today for the amount you contribute to your retirement plan. You will most likely pay tax when that money is removed from your retirement plan. However, that time will hopefully be many years from now, when you may be in a lower tax bracket than currently. Section 1031, or like-kind, exchanges are another way to generate tax-deferred income for real estate properties. In this scenario, you can sell a piece of property at a gain and defer the tax on that gain by acquiring another investment property. There are certain parameters you have to meet, but tax-savvy investors would be wise to know all the ins and outs of Section 1031 exchanges.nnTax-Free Income - Tax-free income is exactly that, wonderfully tax free. The primary tax-free income bonanza for most working Americans is experienced on the sale of their personal residence. If you use a home as your main, or principal, residence for any two out of the preceding five years, any gain on the sale of that home would be tax-free up to the first $250,000 of gain for a single filer - or $500,000 for married filers.nnOften, investments that yield tax-free income, even though the returns may be lower, will have an effective rate of return higher than many after-tax investments. For example, let’s say you are doing well and are in a 35 percent federal tax bracket and a 5 percent state tax bracket, for a total income tax rate of 40 percent. You shop long and hard for a good money market rate at your local bank and find one willing to pay you 6 percent on your money. However, 40 percent of that income will be lost due to income taxes. Therefore, your 6 percent investment has an effective rate of 3.6 percent. That’s not exactly what you signed up for. You’ll do much better if you can find a tax-free investment that will return 5 percent. Adding a few thousand or more tax-free dollars to your portfolio can generate wealth at an amazing clip.nnMy purpose in giving this quick overview is to get you to begin to understand that your situation can change - if you allow it to! When you work for a company, it issues you a W-2. That is a classic example of earned income. You have no control over the type of tax you pay or the amount of tax you pay--unless you put some of the income into your company’s retirement plan.nnBut when you are self-employed, you have the ability to dictate what type of income you receive. That is only one of the reasons why I constantly push my clients to look for ways to generate types of income that yield preferential tax treatment. Armed with the right information, you can structure your income and emerge a winner at tax time.nnThe advice in this article is adapted from the new book Trump University Asset Protection 101: Tax and Legal Strategies of the Rich by J.J. Childers, with a foreword by Donald J. Trump. Published by John Wiley & Sons.nnn

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nJ. J. Childers is an attorney dealing primarily with the topics of asset protection, estate planning, and tax reduction. He travels the country extensively working with individuals and companies to help them with their small business wealth structuring. He is author of the new book Trump University Asset Protection 101.