Uncertainty brings a big chill. Yet, decisions need to be made so that we can each move ahead towards a brighter future. I’ll share three ‘guiding principles’ bestowed to me by wise people. I’m not talking about how to allocate your IRA investments or short-selling an underwater home… I’m talking about taxes – income, gift and estate.
Some of the more common tax “uncertainties” involve the simplification of tax laws, expiration (or extension) of the Bush tax cuts, taxation of global business, and “extenders” that have gone ignored (e.g. the AMT exemption, charitable giving for IRA holders 70-1/2 and older, etc.). Cohesive long-term policies to foster economic and job growth fail to emerge. We sense some sort of tax hikes lurking ahead. And debates rage about “fairness” and “sacrifice” vs. the top 1% of taxpayers who shoulder about 40% of the US income tax burden (compared to the bottom 50% who pay only 2%).
Nevertheless, you’ve got to plan and act. Business owners may face significant acquisition, expansion or sale opportunities, and individuals may be wrestling with 401k contribution levels or gifting and estate transactions. I share 3 guiding principals in tax planning.
Pay the Minimum Amount Legally Required. Recall Arthur Godfrey’s quote “I’m proud to pay taxes in the US; the only thing is I could be just as proud for half the money.” Take advantage of permitted deductions, credits and income/asset shifting strategies.
Diversify Taxation. The stories about an executive who allegedly pays a lower effective tax rate than his secretary highlight the tax differentiation of ordinary and tax-exempt income, dividends and capital gains. (I’ll bet that the Sage of Omaha pays a lot more in income taxes than Ms. Bosanek). It may make sense to diversify your investments in three “buckets” – after-tax, tax-deferred, and real estate/business assets. Tax rates vary and tax rules change over time. Selectively drawing your cash flow may better allow you to control you tax bill.
Don’t Let the Tax Tail Wag the Dog. Tax reduction is a consideration but shouldn’t be the only consideration. Examples include reluctance to diversify out of an heirloom investment with a low cost basis, unintended tax consequences from ‘tax shelters’ (remember those in the 70’s and 80’s?), and retiree’s general practice of depleting after-tax accounts before touching IRA funds. Another is holding a volatile investment for a longer time to qualify for favorable capital gains. Say you recently bought a stock for $15 and it zoomed to $20, 33% tax bracket, and you have the potential of cutting your tax bill by deferring the sale for the 15% long-term capital gains rate. The ‘thriftiness’ in waiting is lost if the stock price fell 5%. After-tax sales proceeds (selling today) at $20 at your 33% rate (short term gains) are similar to selling at $19 at the lower capital gains rate.
We’re always going to face uncertainty. Tax planning is no exception. Always consult a tax professional as I’m not licensed to provide tax advice.