Tax Planning

Building for the Future, Enjoying the Present

Tax Planning is a delicate process. It requires the integration of tax law, investment management, and risk management to achieve overriding goals or objectives. One should focus on the objectives (wealth accumulation, asset transfer, protecting loves ones, etc.) and then use tax planning to optimize the planning. Those who make minimization of taxes as the ultimate goal usually must sacrifice some other objective. This is why “balancing” is necessary—so that tax planning does not become an end itself but only part of the overall wealth management process.

Estate Planning

For families whose wealth is exposed to death taxes, estate planning is an essential exercise. Wills and trusts can protect against unnecessary taxes. Prudent gifting can help successor generations now while reducing taxes later. Life insurance can provide liquidity to pay for taxes which cannot reasonably be avoided and where family assets are concentrated in non-liquid investments, such as real estate or businesses. Life insurance, however, requires a willingness to part with dollars during lifetime in order to provide significantly greater funds for survivors at death. Is life insurance “expensive"? It depends upon one's definitions and the consideration of the time value of money.

Income tax planning includes multiple factors:

Contributing to retirement plans is a trade-off between paying taxes now or later. Sometimes it is better to pay now than later.

Balance is a good idea when deciding how much to contribute to retirement plans. Families with significant taxable assets (those created with after-tax dollars) have considerably more flexibility and stability when major sums are required, such as for a vacation, home remodeling, a business opportunity, or a family emergency.

Investment management for non-retirement plan accounts should always take taxes into consideration. For years dividends and capital gains subjected one to the maximum tax rates. First, capital gains were given preferential treatment, and then, within the last few years, dividends also are now eligible for favorable tax treatment. Gains and losses should be evaluated to see if “loss harvesting” can improve a portfolio while reducing taxes from the sale of appreciated assets. Mutual funds in the past have generated unexpected and undesired taxes, so care should be taken in their selection and monitoring.

Tax-free income through the use of municipal bonds sounds appealing to everyone, and for the right person and situation can be an intelligent choice. As with so many things, however, there are trade-offs here as well, and tax-free bond funds should be studied very carefully.

Tax-deferred programs are easy for financial services people to sell, and they too have much to recommend them. Compared to most other tax-advantaged programs, however, tax-deferred products (such as annuities) have significant costs and traps that can reduce their overall effectiveness in many cases.

There are investment programs that generate tax deductions or, even better, tax credits. As with anything else, there are costs and disadvantages and usually these programs should be used only by the more sophisticated investors with qualified tax, legal, and investment guidance.

Finally, today's tax management issues are complicated by the creep of Alternative Minimum Tax (AMT). The tax code requires taxes to be computed under two formulas, the regular tax code and the AMT schedule. You must pay according to whichever system generates the higher number. Originally, AMT was created to make sure the "super wealthy” paid their fair share, but now inflation has brought millions of people into AMT in a way never intended. Both political parties talk about the importance of reforming AMT, but agreeing how to change it has been difficult.


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