My accountant has a favorite saying when telling me – and presumably anyone else that has had a good year – to whom to make the tax checks payable. He likes to say; “This is a good problem to have”. I get it, you have to pay a bunch of tax because you’ve made good money. That said, excessive taxation really has the potential to take the bloom off the rose.
As we approach Thanksgiving week, we do so with recognition that 2020 may have been a difficult year economically for many. However, there are still some who are facing a significant tax bite. This may have been created through the sale of capital gain property, or perhaps by being in a business niche that has thrived under current conditions.
The good news is currently – and at this point regardless of election outcomes – there are specific, time-tested strategies that can be used to turn this situation around to your favor. Let’s take a quick look at two examples:
Deduction Now / Income For Life / Benefit to Charity Later (AKA: Philanthropy)
One often overlooked area is the use of some form of philanthropic strategy. This type of planning may get dismissed up front because the individual does not consider themselves to be particularly charitable-minded. But, I think it was John D. Rockefeller who said that; “Charitable planning is the ultimate tax dodge”. That doesn’t sound like a statement made by someone who had only the betterment of society in mind!
I think another reason these ideas often get set aside is that on the surface they can appear somewhat inflexible. I’m reminded of a client who mentioned during a phone conversation that he was going to be selling his business to a larger, similar company. I asked him how he felt about the capital gains tax he was going to pay, and as I recall the combined tax was going to consume a third of the proceeds.
When I asked him if he had looked at any type of charitable strategy to soften the blow, he responded that he had taken a quick look at a basic format, but it just didn’t seem to fit his and his wife’s situation. He agreed to let us run some numbers that were more customized and tailored to his family specifics. After giving him a full understanding of how the more nuanced design would work, he said, “Why on earth would I not do this?”
The fact is, there are ways to build extreme flexibility into philanthropic strategies, even to the extent that they can be used effectively as part of a tax advantaged retirement accumulation structure. Again, what we are accomplishing is tremendous tax savings, which in effect means, the IRS is helping to fund your objectives!
Of course, a nice bi-product is that you have the opportunity to do some good at the same time. Without going into detail here, suffice it to say, that the ability to do good can even extend beyond you to your children, grandchildren, etc.
Advanced Pension Design
Another concept that is sometimes missed, but potentially applicable in many situations, is a special form of defined benefit plan known as “cash balance”. In the right situation, this type of configuration can create unusually large, pre-tax contributions benefiting the business owner. Often, these tax-deductible contributions end up being in the $150,000 to $250,000 per year range. That kind of deduction could make a huge dent in an otherwise burdensome tax obligation.
The key to this type of plan usually starts with having the right company demographics, meaning, it helps if the owner is older than the majority of the employees. Fortunately, this is sometimes the case. For businesses with fewer than 100 employees, which again, leaves the door wide open to a lot of companies, this concept should be part of your initial arsenal. And even if you have more than 100 employees, I wouldn’t discount it.
You also have the advantage of deferring any taxable distribution to you from the “cash balance” plan until at least age 72, and even then, distributions can be configured over your lifetime. Tax is only paid as distributions are received.
With both ideas mentioned here, the resulting tax deferral and compounding can mean a huge accumulation and momentum boost.
Let’s face it, finding a way to keep more of what you make, while putting it to work in a way that also mitigates tax on future earnings and growth will turn financial momentum to your favor faster than just about anything else imaginable. And for this, I am thankful.
By: Dan Darchuck, CEO