This guide will answer some of the most frequently asked questions I receive about taxes. It will clarify some common misconceptions about tax planning, and you will learn how to identify situations where a consultation with a tax strategist would be beneficial.
What is tax planning?
Tax planning is applying a knowledge of the laws to the facts of your particular situation. It is helping you structure your business(es) in the way that most minimizes taxes. If you are an employee, maybe it involves helping you recognize the benefits of purchasing a rental property or starting a business on the side. It is identifying tools that will allow you to legally increase deductions and put aside more money for other purposes (e.g., business growth, retirement, charitable giving, etc.).
How do I know whether I can benefit from tax planning?
Virtually everyone could benefit from a little tax planning, but here are some scenarios in which good planning is most valuable:
1) When starting or restructuring a business;
2) Several months before selling a business or other large, appreciated asset (such as property);
3) When you are a business owner and your personal net income is over $100k;
4) When you are an employee receiving a W-2 and looking for more ways to lower taxes (beyond just contributing to retirement accounts);
5) When your estate is worth (or may soon be worth) more than $5 million.
The following are some common misconceptions about tax planning.
Can you give me some examples of strategies?
Tax strategies are many and varied. Each situation is different. Here are just a few examples of strategies that, if correctly implemented, can make a big difference on your tax bill:
1) Income shifting;
2) Home rental (IRC 280(g));
3) Restricted Property Trusts;
4) Valuation Discount Planning (which may soon be disappearing);
5) Advanced Charitable Planning (CRTs, CLTs, Charitable LLCs, Conservation Easements, etc.);
6) Fringe benefit planning (HRAs, Education, Insurance, Meal Stipends, etc.).
It is important to note that each strategy has its own set of rules. Those who aren’t aware of the rules or try to cut corners could lose deductions and incur penalties. Good planning requires experience and attention to detail.
Common Misconception #1: I have a CPA, so I don’t need additional tax planning
CPAs play an important role in the world of accounting and tax preparation. They are essential to almost any discussion involving the structure and finances of a business. Most CPAs, enrolled agents, and other tax preparers, however, are not trained in tax strategy. The U.S. tax code, not including court cases interpreting the code, is over 2600 pages long. How could any one professional know it all, much less have the skill set to be able to create a strategy around those laws?
A good tax planner will work with your tax preparer and/or financial planner to create a cohesive strategy. Many individuals hesitate to pay an additional person, but good tax planning can save you thousands, sometimes millions, of dollars. A brief consultation is usually available at no charge. What do you have to lose by getting a second or even a third opinion?
Common Misconception #2: Tax planning will get me audited
Audit rates are currently very low. While it may be true that some choices or strategies tend to increase the chance of an IRS audit, that is not normally the case. A good tax planner will discuss the pros and cons of any strategy, including audit risk. Keep in mind, though, that there is nothing illegal about tax planning. A good tax planner works within the laws, not outside them. If your tax planning is done correctly, there is nothing to fear from an audit (other than some inconvenience, of course).
Judge Billings Learned Hand has said: “Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one’s taxes. Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands.”
The trick to successful tax planning is to find a good tax strategist who is both knowledgeable about the laws and able and willing to work with the other financial professionals in your life. Look around and talk to a variety of people. Don’t be afraid to seek a second or third opinion. Unless the federal government is your favorite charity, there is no reason to pay more in taxes than you are legally required to.