Friday, January 22, 2016

Save Taxes By Being A Tax Contrarian


n 2015, contrarian investors were the winners. With both the Dow Jones Industrial Average and the S&P 500® Stock Index in negative territory for the year, the smart money defied traditional logic and invested where the lemmings were loath to go.
The same could be said about maximizing tax savings. You have to resist the temptation to follow the traditional behaviors of tax planning if you want to be a tax contrarian.
Here are some tips for avoiding “same old same old” tax strategies for yourself and your business. With the right tax advisor, opportunities can exist to save on taxes. It just takes breaking bad habits. And it’s a new year, so why not?

Look beyond the deduction
A rookie mistake is to assume the only way to save taxes is to obtain a deduction. Tax deductions are great, but deferrals, recharacterizations and advantageous tax-year timing can also pay dividends. In fact, in some cases, it is smart to intentionally pay taxes up front.
For example, consider the Roth 401(k) feature in a qualified plan. It seems counterintuitive to use after-tax contributions in a 401(k) when pre-tax dollars can be used.
The reality is that designating some or all of a 401(k) contribution to a Roth can save future taxes. Sure, the contribution is now after-tax, but the account builds tax-deferred and generally pays out tax-free. You’ve paid tax on the seed but not on the harvest.
Another example, this time for your business, is supplementing a qualified plan with a nonqualified deferred compensation plan for key employees. Even though the company informally funds the plan by setting money aside, it doesn’t get an immediate tax deduction for its outlay. The deduction only comes when the compensation is actually paid out.
In the meantime, however, the company benefits from a golden handcuff on its executive, receives an accounting credit for the future deduction and owns a corporate asset to offset its liability.
The deferred deduction is minor compared to the other benefits of setting up the plan.

Tax planning involves more than saving taxes today
Just as diversifying an investment portfolio is advisable, so too is diversifying taxes. What is usually tax-deferred today will be taxed tomorrow and perhaps at higher rates.
Take, for example, the money in a qualified plan or IRA. Deferring taxes is a great feature, but that money will eventually be taxed, and at ordinary income tax rates (versus capital gains).
Some business owners and executives can have too much of a good thing by concentrating all their wealth in qualified plans. The price they pay is higher taxes when the money comes out. A diversification strategy makes more sense.
In addition to accumulating wealth in qualified plans and IRAs, some dollars can be directed to capital gains property while other money can go into tax-advantaged products.
An obvious example of capital gains property for a business owner is company stock. With proper exit planning, the growth in the value of the business represents a source of wealth that will be taxed at a lower capital gains rate when the stock is sold. As far as tax-advantaged products, examples include municipal bonds, cash value life insurance and annuities. These products have differing tax advantages and represent opportunities to diversify taxes.

New and exotic doesn’t necessarily mean smart and efficient
Contrarian tax planning calls for focusing on tried-and-true techniques before being bedazzled by the newest and shiniest scheme marketed in a promoter newsletter. What profit is there in being the test case for a tax trick that may not work?
In consumer products, it’s natural to want the latest and greatest. The same doesn’t necessarily apply in the world of finance. Particularly in the area of taxes, it’s often the pioneers who get shot.
For example, a popular estate planning technique used by wealthy business owners is called a “Zeroed-Out GRAT”. This is a grantor retained annuity trust that discounts the supposed worth of the arrangement to the point where it’s valued at almost nothing for gift tax purposes.
While this is a commonly used concept today, it took the Walton family (of Walmart fame) nearly 10 years of litigation with the IRS to have the Zeroed-Out GRAT accepted by the government.
The best tax advice is to get advice that fits your specific needs. Find a tax advisor who knows what tax opportunities already exist and make them work for you.

Stay current
On the flip side, tax law is constantly changing. Be sure to stay current on new opportunities. Consider these very recent examples.