Here are some examples of ways that financial advisers can help clients to reduce their tax burden.
For most tax experts, it's not a matter of “if,” but “when,” as far as higher taxes go. “One way or another, whether we end up with a Republican or a Democrat as the next president, it would appear that taxes are going up, because the tax issue is not going away,” said Stanley Smiley, senior vice president of advanced planning at Cetera Financial Group, which has $82.5 billion under advisement.
Some of the proposals being presented by President Barack Obama could reduce or eliminate the tax benefits of itemized deductions, he noted.
“If they take away itemized deductions, there won't be a lot of opportunities to reduce the tax bite,” Mr. Smiley said. “You need to look at investment products for what they spin off in the form of taxable income.”
With that in mind, there are a few strategies that still can be applied ahead of some looming deadlines, and there are also some standard practices that continue to make sense.
There is never a bad time to consider tax planning, but right now, with Congress and the president battling over how best to manage the budget, tax preparation should be a top priority, said Rex Ritchie, director of advanced wealth and qualified plans at Woodbury Financial Services Inc., an independent broker-dealer member of The Hartford Financial Services Group Inc.
“If you have an income tax liability — meaning you make enough money that you have to pay in — this is a great time for tax planning,” he said. “"Defer and deduct' have to be considered.”
Along the lines of deferring and deducting, the following are some examples of ways that financial advisers can help clients to reduce their tax burden.
Maximize contributions to 401(k) plans
The first step in any tax-planning strategy always should be to max out contributions to qualified retirement plans, including employer-sponsored 401(k) plans and individual retirement accounts.
For individuals under 50, the maximum annual contribution to a 401(k) plan is $16,500, and that climbs to $22,000 for those 50 and older.
The annual IRA maximum is $5,000 for those under 50 and $6,000 for those 50 and older.
However, the IRA contribution deduction is eliminated under certain circumstances. For instance, if a married couple filing jointly has an adjusted gross income of more than $179,000 and one spouse has an employer-sponsored qualified retirement plan, the IRA contribution cannot be deducted.
If neither spouse has a qualified retirement plan, the IRA contributions can be deducted regardless of income.
Consider tax-deferred annuities
Money sitting in nonqualified accounts, whether in cash or in packaged products such as mutual funds, could be transferred into a tax-deferred annuity as a way of compounding investments on a tax-deferred basis.
The rationale for moving certain long-term assets into a tax-deferred annuity is to avoid annual taxes on gains. The taxes still will have to be paid eventually. But, ideally, by deferring them until after retirement, when income would likely be lower, the overall tax bite should be reduced.
This a strategy best applied only after contributions to the available qualified retirement accounts have been maxed out.
Take advantage of ETFs
Convert mutual fund investments into comparable exchange-traded funds to avoid the tax consequences that come with annual capital gains distributions.
It will be especially evident this year, as mutual fund investors have been moving a lot of money in and out of the markets. Heavy redemptions can lead to some forced selling by portfolio managers, which triggers capital gains and adds transaction costs to a fund.
This strategy is appropriate only when there is a comparable ETF to swap for a mutual fund already in a client's portfolio.
Charitable gifts
There's no time like the present to make a charitable gift to a worthy cause.
This is one of the few areas not currently on the tax reform chopping block.
Deductions worth up to 50% of adjusted gross income can be made in a single calendar year. And anything over the 50% AGI mark can be carried over as deductions for the next five years.
Make that big purchase
For clients living in states without a state income tax, such as Florida, it is still possible to deduct sales taxes against ordinary income, which means this might be a good time to make that big purchase before the holidays.
This tax law benefit, which does require a bit of extra record keeping, was introduced in 2008 and has been extended through the end of this year.
No word yet on whether the law will be extended.
Sell appreciated assets
Sell that appreciated asset by the end of 2012 and save on some capital gains taxes.
For clients sitting on a second home or antique car that is ripe for a sale, take note.
If there's a possibility of selling any appreciated asset over the next few years, it might be worth it to pull the trigger before the end of next year, when the tax rate on capital gains will jump to 20% from the current 15% rate.
Transfer assets to adult children
Another way to offload an appreciated asset without taking a tax hit would be to transfer ownership to an adult child.
Through the end of 2012, the value of an asset given to a qualifying child can reach $5 million for a single person or $10 million in value for a couple. After 2012, the gift tax on any such ownership transfers will kick in on assets valued at more than $1 million.
A key benefit to these particular ownership transfers is that the capital gains do not transfer to the adult child, meaning the new owner can turn around and sell the asset without paying taxes on gains accrued from the time the parent originally purchased it -- assuming the gains don't push the child into a tax bracket above 15%.
There are, however, restrictions on how old a child must be before he or she can receive the gift without carrying over the capital gains.
Assets transferred to children under 19 will be taxed at the parents' tax rate. And if a child is attending school full time, he or she must be at least 24 to avoid being taxed at the parents' rate.
Declare a dividend
For your clients who operate C corporations, which are taxed separately from their owners, there is an opportunity to pay a dividend at the 15% tax rate through the end of 2012. Also, because dividends are not considered earned income, there is no Social Security tax deduction on the distribution.
Starting in 2013, dividends are scheduled to be taxed as ordinary income.
The thing to keep in mind here is that, as with a publicly traded company, the dividend payout applies to all shareholders. That means anyone with an ownership stake in the C corporation is entitled to a proportionate dividend payment, whenever one is issued.
Email Jeff Benjamin at jbenjamin@investmentnews.com
