Tax Planning Has Never Been More Important
November 30, 2009
Similar to a holiday buying rush, the current political mood seems to be “spend now, worry about paying later.” Although we can hope for the best, chances are that wealthy families will have a growing bill to pay (both in absolute dollars and as a percentage of the total) in the coming years in the form of higher taxes. Speculation on future tax law changes is not an exact science, but even if Congress cannot come to an agreement on new tax legislation, it has the luxury of allowing the sunset of the Bush tax cuts at the end of 2010, without casting a vote. Among other bad effects, this would increase the top marginal rate to 39.6% from 35% and reinstate the 36% bracket. Now is a great time to take a fresh look at your tax planning.
Assess Your Current Position and Make Projections on the Future
The first step is to examine your current and projected financial picture. How has your net worth and cash flow changed and why? Identify any changes in your financial and personal goals. As time passes, situations change, and what may have been an effective tax strategy in the past may no longer be adequate or necessary. Updated projections on future cash flow provide a clearer picture of what strategies may be most appropriate.
Defer Income, Accelerate Deductions, Utilize Credits
Reducing taxable income is primarily accomplished by deferring income to a later date or by increasing the amount of deductions claimed. Strategies include contributions to retirement plans such as a 401(k) or 403(b), deductible contributions to a traditional IRA, increased charitable giving and prepaying property taxes. Certain tax credits can lower your total taxes due and should not be overlooked (i.e. carryforwards from prior years). For example, there are now numerous energy tax credits that you might qualify for to reduce your overall tax bill.
Controlling the timing of income recognition involves both the deferral of income, as mentioned above, and the acceleration of income into the current year. The general rule of thumb is to defer income to the future to take advantage of the time value of money. However, if there is a high likelihood of higher future taxes, consideration should be given to the acceleration of income into a current year at lower tax rates. An example is the conversion of a traditional IRA to a Roth IRA. In most cases, the amount converted is included in taxable income in the year of conversion. This will increase taxable income in the current year. However, distributions from Roth IRAs are generally not included in taxable income. So the taxpayer is prepaying taxes at a rate they hope is lower than when they begin taking distributions for retirement cash flow.
Streamline Your Investments for Tax Efficiency
The structure of your investment portfolios is a critical part of optimizing your tax strategy. Proper use of municipal bonds is an easy example, but there are many other levels to enhance your portfolio efficiency. Also, take advantage of the lower capital gains or qualified dividend rates by proper basis accounting and sales strategies. (Brightworth portfolios utilize many tax-efficiency techniques.) Consider different techniques for converting ordinary income to capital gains through special rules such as the net unrealized appreciation (NUA) of company stock in retirement plans.
Bringing it All Together
Especially in times of transition — retirement, major stock sale, business liquidity event — it is important to focus on your tax planning. Many great opportunities slip away for lack of a plan. Your unique goals, cash flow situation, and investment assets play a major part in determining what will be an effective strategy. Make sure to consult your Brightworth advisor for how taxes may affect your overall wealth plan, talk with your CPA for specific tax advice, and stay vigilant on this topic to avoid paying more than your fair share!
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