Estate Planning: Tax Planning
Paul Tarins, RICP®,WMCP®,CSRIC™
Tax planning is a year-round process, not just something that happens in the weeks leading up to April 15. It's a wise move to keep your tax planning efficient, educate yourself about potential tax scams, and plan your charitable distributions.
Do you have a 401(k) or a traditional IRA? If so, you will receive income from both after age 72. However, if you have saved and invested much of your life, you may also end up retiring at a higher marginal tax rate than your current one. In fact, the income resulting from a required minimum distribution alone could push you into a higher tax bracket.
What’s a pre-tax investment?
Traditional IRAs and 401(k)s are examples of pre-tax investments. You can put off paying taxes on the contributions you make to these accounts until you start to take distributions. When you take distributions from these accounts, you may owe taxes on the withdrawal. Pre-tax investments are also called tax-deferred investments, as the invested assets can benefit from tax-deferred growth.
Under the SECURE Act, once you reach age 72, you must begin taking required minimum distributions from traditional IRAs, 401(k)s, and other defined contribution plans in most circumstances. Withdrawals are taxed as ordinary income and, if taken before age 59½, may be subject to a 10% federal income tax penalty. Contributions to a traditional IRA may be fully or partially deductible, depending on your adjusted gross income.
What's an after-tax investment?
A Roth IRA is a classic example. When you put money into a Roth IRA, the contribution is made with after-tax dollars. As a trade-off, you may not owe taxes on the withdrawals from that Roth IRA (so long as you have had your Roth IRA at least five years and you are at least 59½ years old). With distributions from a Roth IRA, your total taxable retirement income is not as high as it would be otherwise.
Should you have both a traditional IRA and a Roth IRA?
It may seem redundant, but it could help you manage your tax situation. Keep in mind that tax-free and penalty-free withdrawals from a Roth IRA can also be taken under certain other circumstances, such as the owner's death.
Smart moves can help you manage your taxable income and taxable estate. If you're making a charitable gift, giving appreciated securities that you have held for at least a year is one choice to consider. In addition to you receiving a potential tax deduction for the fair market value of the asset in the year of the donation, the charity may be able to sell the stock later without triggering capital gains.
Remember, however, that this article is for informational purposes only and is not a replacement for real-life advice, so make sure to consult your tax, legal, and accounting professionals before modifying your charitable giving strategy.
Avoiding tax scams
Year after year, criminals try to scam certain taxpayers. And year after year, certain taxpayers resort to schemes in an effort to put one over on the Internal Revenue Service (IRS). These cons occur year-round, not just during tax season. In response to their frequency, the IRS has listed the 12 biggest offenses—scams that you should recognize and schemes that warrant penalties and/or punishment.
If you get an unsolicited email claiming to be from the IRS, it is a scam. The IRS never reaches out via email, regardless of the situation. If such an email lands in your inbox, forward it to email@example.com. You should also be careful when sending personal information, including payroll or other financial information, via an email or website.
Each year, criminals call taxpayers and allege that said taxpayers owe money to the IRS. Visual tricks can lend authenticity to the ruse. For example, the caller ID may show a toll-free number. The caller may mention a phony IRS employee badge number. New spins are constantly emerging, including threats of arrest and even deportation.
The IRS warns that identity theft is a constant concern—and not just online. Thieves can steal your mail or rifle through your trash. While the IRS has made headway in terms of identifying such scams when related to tax returns and plays an active role in identifying lawbreakers, the best defense is to be cautious with your identity and information.
Return preparer fraud
Among the many honest professionals, there are also some con artists out there who aim to rip off personal information and grab phantom refunds, so be careful when selecting who prepares your tax returns.
Some taxpayers claim that they are gathering funds for hurricane victims, an overseas relief effort, an outreach ministry, and so on. Be on the lookout for organizations that use phony names to appear as legitimate charities. A specious charity may ask you for cash donations and/or your Social Security number and banking information before offering a receipt.
Inflated refund claims
In this scenario, the scammers do prepare and file 1040s, but they charge big fees up front or claim an exorbitant portion of your refund. The IRS specifically warns against signing a blank return and trusting preparers who charge based on the amount of your tax refund.
Making a charitable contribution
Making gifts of shares may be a good tax strategy for you. Why sell shares when you can gift them? If you have appreciated stocks in your portfolio, you might want to consider donating those shares to charity rather than selling them.
Donating appreciated securities to a tax-exempt charity may allow you to manage your taxes and benefit the charity. If you have held the stock for more than a year, you may be able to deduct the fair market value of the stock from your taxes in the year that you donate. If the charity is tax-exempt, it may not face capital gains tax on the stock if it sells it in the future.1
Keep in mind that this article is for informational purposes only. It's not a replacement for real-life advice. Make sure to consult your tax, legal, and accounting professionals before modifying your gift-giving strategy.
When is donating stock a better choice than gifting cash or just selling the shares? There are several reasons to consider donating highly appreciated stock to a tax-exempt charity. For example, you may own company stock and have the opportunity to donate some shares. There are also potential tax benefits to consider if you donate appreciated securities that you have owned for at least one year.
If you sell shares of appreciated stock from a taxable account and subsequently donate the proceeds from the sale to charity, you may face capital gains tax on any potential gain you realize, which effectively trims the tax benefit of cash donation.
When is donating cash a choice to consider?
If you donate shares of depreciated stock from a taxable account to a charity, you can only deduct their current value, not the value they had when you originally bought them.
Remember the tax rules for charitable donations.
If you donate appreciated stock to a charity, you may want to review IRS Publication 526, Charitable Contributions. Double-check to see that the charity has non-profit status under federal tax law and be sure to record the deduction on a Schedule A that you attach to your 1040.
If your contribution totals $250 or more, the donation(s) must be recorded; that is, the charity needs to give you a written statement describing the donation and its value and whether it is providing you with goods or services in exchange for it. A bank record or even payroll deduction record can also denote the contribution.
Gifting cash or securities to an organization is a wonderful opportunity. But keep in mind that tax rules are constantly being adjusted, and there's a possibility that the current rules may change. Make certain that you consult your tax, legal, and accounting professionals before starting a new gifting strategy if you intend to use the gift as a tax deduction.
Paul Tarins is an investment adviser representative of and offers investment and advisory services through Portfolio Medics, a registered investment adviser. Nothing contained herein should be construed as a solicitation for investment advisory services. Sovereign Retirement Solutions and Portfolio Medics are not affiliated.