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Tax Planning – What We Do For You Behind the Scenes

On the surface tax planning may appear boring, but its value can be extremely easy to overlook. Unfortunately it does not show up as additional earnings in your account, so two accounts with the exact same earnings for the year may have dramatically different after-tax results. We believe that by personally preparing the tax returns for many of our clients and overseeing their investments, we are in a better position to uncover and maximize the best tax savings strategies.

I don’t always make a big deal out of this additional service that we provide to clients in our Tailored Relationship Services model, but it is important. As a CPA with a master’s degree in Taxation and with over thirty years of experience with hands-on tax preparation, tax planning comes second nature to me.

This year the SECURE Act and the CARES Act allows clients to waive the 2020 IRA Required Minimum Distribution (RMD). This will avoid taxable distributions and keep more money in your IRA growing tax deferred. Some of our clients should consider taking their RMDs regardless of the exemption, as they are in extremely low or zero rate tax brackets. I have run a report of all my RMD clients and compared the normal distributions back to their tax returns to see if this would be of benefit to them. I have contacted those clients where this strategy will work. If I have not called you individually, rest assured we have reviewed your taxes and determined that there was no benefit for you. However, if you would like to talk though these implications, give us a call.

Roth IRA Conversions from your Traditional IRA:  Because the SECURE Act ended the opportunity for inheritors of taxable IRAs to “stretch” distributions over their lifetime, inheriting a tax-free Roth IRA is now even more attractive than a traditional tax-deferred IRA. While a conversion from a regular IRA to a Roth IRA does create current taxable income on the amount converted, all future earnings will be tax-free. If you intend to leave IRA money to the next generation, it may make sense to start converting traditional IRA money into a Roth IRA. But the core question is whether you are willing to prepay the taxes now that are due on the untaxed IRA account in order to gain this future tax benefit. This is a tax strategy that I have personally executed for myself, but most of my clients bristle at the tax costs. I would be happy to visit with you personally about whether this strategy is right for you.

What we automatically do as part of our service to you

As part of our tax sensitivity in managing investment portfolios, we regularly look for opportunities to maximize after-tax portfolio returns beyond investment selection, asset allocation, and periodic rebalancing. We utilize the following tax-optimizing techniques in our client portfolios:

  • We try to hold investments in taxable accounts for more than one year before selling them so that long-term capital gains rates will apply. The tax difference can be significant. (However, we always assess the potential risk and return tradeoffs that result from any decision to extend a holding period.)
  • We seek to place the interest-earning portion of portfolios in tax-deferred accounts given interest income is taxed at the top marginal ordinary tax rate, unlike long-term capital gains. Long- term capital gains are blessed with a lower (and alternative) tax rate than ordinary income. When possible, we place assets with high appreciation potential in taxable accounts to capture this rate savings because the same gain in an IRA is taxed at the higher normal rates when distributed.
  • We do careful analysis before selling investments that have large built-in gains, unless the sale is justified by a higher expected return from an alternative investment or is necessary to maintain portfolio asset allocation objectives.
  • When raising cash in your portfolio, we do so by selecting securities or individual lots of a security that have the lowest taxable gain consequences.
  • During market volatility throughout the year, as well as regularly during our year-end review, we look for opportunities to “harvest” capital losses. These realized losses can then be used to offset realized gains this year or in future years. In either case, proceeds can be placed in a comparable investment, so the portfolio allocation remains intact.

Tax-optimization practices

Here is a short list of nearly timeless tax-wise practices to always stay aware of and which we highlight to our clients around this time each year:

  • Maximize the use of tax-deductible retirement plan contributions each year to lower your tax liability as much as possible. The SECURE Act now permits savers to continue contributions to IRAs even after age 70½ (provided you have earnings from wages or self-employment income).
  • Make annual or one-time gifts to family members to remove taxable income from your portfolio, potentially reduce family-wide tax liability, and reduce your taxable estate during your lifetime. Many people mistakenly believe that the person making the gift receives a tax deduction. This is not the case, but moving assets that you are confident you will never need can transfer the income on these assets from yourself to another individual who may be in a lower tax bracket, thus maximizing after-tax family assets.
  • Gift appreciated securities held for more than one year directly to charities or to a charitable donor-advised fund (DAF). The tax deduction is for the value of the gift, and taxes on any built-in capital gains are eliminated.
  • For those over age 70½, we can help you process qualified charitable distributions (QCDs) from IRAs, especially if you would not otherwise receive an advantageous tax deduction for gifting taxable assets. This technique would avoid the taxes on your IRA distributions. You won’t receive a charitable donation deduction, but this strategy is particularly important if you can no longer itemize your deductions.

Please let us know any questions you may have about how these tax strategies can be beneficial for you.

Ron Dickinson, CPA, CFP®, MPA-Tax

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