Strategic Tax Planning For Powerful Tax Savings
Jeff Camarda Contributor
I have for decades believed that erudite tax strategy is the “master wealth skill”, and that those who develop or find true expertise can compound their development and preservation of net worth by a significant factor.
Getting this message out is a primary reason I write so much on tax, even though my primary professional practice is in investment management and associated wealth strategy.
In this post, I want to focus on some of the tried and true tax angles that have propelled those in the know from “getting by” to “getting rich.” Not to imply that many without the best tax counsel can’t earn enormous, billionaire-class sums. Many do, and still get very, very rich even after paying gargantuan, tear-jerking, suicide-inducing tax bills. But imagine how much richer still these titans might become, if a few billions of tax were saved and invested at compound growth instead? There is a lesson for even the most modestly heeled among us, there.
So below, if you will forgive me, are a few perennial chestnuts.
Real Estate! Property investment has been widely and longfully hailed as the common road to lasting family riches. From the Trump saga to the Rich Dad tutelage, smart real estate accumulation has been a sure path for those that follow the Nickerson-esque trail. Real estate tax advantages have long been robust, and have endured so for many decades, even after the 1980s Reagan tax reform real estate write offs neutron bomb. It still works – works great – provided your tax profile meets the “real estate professional” requirements – which really ain’t that hard. These don’t require you to be licensed as a Realtor or to work in the industry beyond your own properties. This classification is really important in order to capture paper losses and deduct them against other income, instead of locking them into the Reagan-era Passive Activity never-never hope chest. Get it right, and you get hard and current deductions against your otherwise taxable high bracket income. These days, in our experience far too many tax advisors seem to get this wrong, and miss big deductions for clients that really should qualify.
Own Business It should go without saying that owning a business seriously purposed toward earning a profit (to avoid the “hobby rules” trap) offers incredible leverage to deduct legitimate expenses that are utterly lost to W2 employees who work for others. The angles are too obtuse to get into here, but are legion. For instance, I remember a client who on audit was questioned by a field agent about big write offs to run his boat to the Bahamas – depreciating the boat, expensing tens of thousands in fuel, and so on. The agent said “I’d like to take my boat to the Bahamas and write it off!” We showed him how. The expense – a pretty big, tax-saving number – withstood audit. Appropriate business write-offs can be profound, if you spend a bit of effort to learn the rules, or find someone who knows them well and eschews an “you gotta pay your taxes, mate!” attitude.
ROTH 401(k) This tool has emerged as one of the most powerful tax-control techniques around. Most know that Roth accounts grow tax-free, which is as good as it gets. Many don’t know that wisely structured Roth 401(k)s (not Roth IRAs so much) have enormous flexibility as wealth building machines. My team counseled one sophisticated real estate developer who’d on his own figured out how to do lucrative projects inside his Roth 401(k) such that all the appreciation and rent flowed tax free. This itself is a leap well beyond most taxpayers’ strategic acumen. The problem for my team was to control the income tax – he already had that knocked – but to figure a way to get the residual multi-millions of projected Roth value out of his already-taxable estate, which we did, yielding a real cake-and-eat-it-too tax magical situation.
Smart Qualified Plans on a more pedestrian note, business owners can often use tax deductible retirement plans much more to their advantage than is typically the case, if the objective (as it nearly always is) is to pile up tax deductions while putting way more dollars in owners’ accounts than for employees. I say pedestrian because this is really business tax planning 101, straight down the fairway, but I am continuously amazed at how often it is missed by even high-dollar tax advisors. I recall a case where a Manhattan CPA advised a fellow to use a SEP, with deductions in the $20K range. Mind you this client lives near NY and pays NY State and municipal income taxes on top of the Federal burden, meaning he really got whacked. We showed him how, in his fact pattern, using a 401(k) would more than double his CPA-suggested deduction, but that what he really needed (and eventually did) was a defined benefit plan, boosting deductions to about $150K a year. The guy saved pushing $100K a year in taxes, like waving a wand.
Partnership Tax Law Too deep to wet more than a toe here, the complexity of partnership (as opposed to corporate) tax law offers vast opportunity for deft dancers to optimize their positions and mint significant marginal wealth from tax savings. A great example of this is how hedge funds’ so-called “carried interest” facilitates the transmutation of high-bracket ordinary income to much lower bracket capital gains treatment. Even better, the alchemy promotes tax deferral until such capital gains are recognized. Deft dancers, with the right profile, may even be able to use tax-free borrowing out of the partnership to free up needed cash without triggering capital gains recognition. In considering the partnership structure, it is important to balance against opportunities spawned by the new C-corp rates, and the new QBI rules.
In closing, I stress that most readers’ tax advisors may not be even aware of – or believe possible – the many legitimate techniques to build real wealth via tax control. For one thing, tax law is so complex it requires deep study to master. This is hard work. A “yougottapay” stance requires less effort than constant strategic vigilance. For another, one needs an attitude of tax aversion, and a true desire to avoid legitimately avoidable taxes. In my experience, many tax advisors lack this attitude, either by disposition or from inertia. Finally, I think the advent of tax prep software has dulled the edge of many advisors, who may myopically follow the bouncing software ball instead of actually thinking about what’s happening. In the old days with paper forms, instructions, and calculator in hand, one became immersed in the math and logical relationships of how the schedules were connected and what they meant. This if nothing else spurred the quest for opportunity, as one puzzled the relationships and pondered the possible. These days, it can be far too easy to miss checking a box – or misinterpret the dumbed-down software guidance of what the box means and does – and so generate lots of missed tax savings opportunities. For instance, I think a lot of dropped balls on the Real Estate Professional qualification stem from this problem. Software – buggy and with hard coded tax code errors as it can often be – is an incredible tool for the tax advisor, but is no substitute for study and thought.