Saturday, October 22, 2016

Is there such a thing as too much tax planning?


I haven’t yet met the person who claims that they want to pay as much in income taxes as they possibly can. On the other hand, I’ve not yet met the person who didn’t want to pay as little as legally possible. But some carry the theme of paying as little as possible to a point where they risk future pain that may be greater than the pain of paying a little bit more income tax now.
Look at it this way. In my professional career, the top federal income tax rate has spanned from a low of 28 percent to a high of 70 percent. That actually makes today’s top tax bracket on the lower side of the midrange of taxes for the past 35 years. When it comes to long term tax planning, it is a coin toss decision regarding future tax rates. Therefore, all you can do at this point is to plan for the laws as they are now.
When it comes to paying as little as legally possible, you must take into account certain future occurrences that are most likely going to impact you in retirement. These are Social Security income and required minimum distributions from retirement accounts.
In essence of what we are trying to do is to plan your lifetime income tax bill as opposed to a single focus on any particular tax year. This process is most likely to occur for people in a transition year. Your transition may be a job change, retirement or starting a business.
In a job change year, it could cut either way. You may find yourself with unusually high income because of deferred compensation accounts, unused vacation or sick time, or other bonuses that vest upon your departure. In this case, it may be wise to think about additional retirement contributions or deductible payments like charitable contributions to keep your unusually high tax bracket in check.
The other side of the job change equation is you may find yourself out of work for a while with unusually lower than normal taxable income. In these cases, it may be wise to accelerate income and consider measures such as converting traditional retirement accounts to Roth accounts or to accelerate any capital gains in your portfolio or other investment assets.
This same possibility occurs for people that retire before age 70½ when required minimum distributions from retirement accounts must begin. If you find yourself in a tax bracket lower than what it will be upon receiving social security and retirement distributions, you may be wise to accelerate some income to use up the lower rates available now while preventing creeping up to a much higher bracket later when the income begins to flow again.
Don’t wing this. Get the help of a professional tax planner to be sure that all of your bases, such as the alternative minimum tax, are properly covered.