Dollars & Sense: Tax Planning

Increasing Financial Certainty During Taxing Times

by David Albin, wealth advisor, Wealth Building Now

(Editor’s Note:  To best serve high and ultra-high net-worth families, David Albin embraces a holistic analysis of their entire circumstances.  He has assembled specialty experts who help contain taxation and who select, vet, and implement financial tools to economically meet client objectives, ensure liquidity, maintain family harmony, and keep wealth in client families.  He can be contacted at david@wealthbuildingnow.com and (855) 451-0500.  To learn more about his services, please visit www.wealthbuildingnow.com.)

During recent weeks, many individuals have rearranged their financial priorities.  Multiple topics now demand review because of new policies and political decisions and also because of the enactment of high-impact federal financial legislative proposals that have passed through Congress and have been signed into law.  Some of the key issues business owners and individuals are adjusting in their planning include: conserving current income from taxes, ensuring adequate cash flow for operations, providing transfer of maximum net after-tax funds to children and grandchildren, and how today’s adults can maximize the total transfers from their parents and grandparents.  

         As this goes to press, sensitivity about federal income taxes has peaked.  The recently enacted Inflation Reduction Act earmarks $80 billion in new funding for the Internal Revenue Service (IRS), including adding nearly 87,000 new personnel to the IRS over the next decade.  These are huge increases in IRS resources.

         This new IRS funding and staffing certainly mean that individuals and businesses will be well advised to do the very best tax planning possible.  Yet while nearly everyone reports their income and their taxes due, very few do comprehensive tax planning.  The failure to plan well means those taxpayers lose lots of money that could better be put to work for the business’ or taxpayer’s own benefit. 

Funding the IRS Expansion

         The explanations about the Inflation Reduction Act emphasize that the IRS will be operationally focused on enforcement.  That seems to indicate more invasive inspection of business operations and tax reporting is on the way.  There is specific language about the Inflation Reduction Act that says the targets of the increased IRS scrutiny will be small to medium-sized concerns that are closely held and that receive income that may not be routinely reported to the IRS.  Most architectural firms fall into this business classification. 

         In the promotion of the Inflation Reduction Act, it was said that nobody making under $400,000 annually would see their taxes increase.  Numerous statements indicate that $46 billion of the new IRS funding is directed at enforcement.  That would sure seem to fund a lot of enforcement. 

         As the legislation was passed, the IRS had some 74,000 employees, with thousands of them involved in audits.  There are conflicting opinions about what the eventual net new number of auditors may be added as a result of the new IRS funding.

New Auditors to Ensure Large Tax Collections

         In remarks attributed to President Biden, it was reported that he hoped that adding 5,000 auditors would help the IRS enforcement activities raise $700 billion in taxes.  Doing the math on that would indicate that the aspiration is that each new auditor would help bring in $140 million in new revenue.  Whether that tax generation goal is for one year or for a few years is unclear, but the goal does indicate that large collections increases are indeed expected from each additional auditor. 

         Whether more enforcement ultimately takes place for individuals earning below $400,000 remains to be seen.  However, past history indicates that if revenues do not meet expectations that there is a likelihood that the income threshold would be reduced to broaden the base of who was being taxed to increase the total net revenue to the government. 

The Need for Tax Planning

         In the architectural industry, there are a few huge firms and many smaller firms.  Net margins as a percentage of overall project costs reveal modest overall profitability.  That fact emphasizes the need for careful business management and cash management.  Effective cash management starts with keeping customer receivables current.  It also means controlling all expenses that are controllable.  Also, a huge and potentially controllable business expense is taxation.  Please note that, as always, we never advocate bending or breaking tax rules or laws.  We advocate using optimum legal structures that provide significant tax advantages. 

         Tax planning has always been used by the wealthiest Americans because it works well for them.  It helps the wealthy and it can help you lower expenses and improve cash retention for use in your core business or personally.  Here are some stats on why the wealthiest Americans use tax planning. 

         Reportedly, the richest 400 Americans pay a lower tax rate than the bottom 50% of Americans.  The top 400 taxpayers paid about an 8.2% Federal Income Tax rate in 2018, and the average American in the same year paid a 13.3% rate.  The 13.3% rate endured by the average Americans is fully 62% higher than what the wealthiest pay. 

         When you install the best tax planning, not only do you save money in the current year, you create far higher long-term wealth.  That is because tax planning lowers the amount of taxes due, and that leaves more initial money available to keep generating profits and asset growth.  Future asset growth also has more after-tax money compounding.  Even if tax planning merely creates tax deferrals rather than elimination of taxes due, there is still great benefit because of compound growth of larger amounts until the taxes are due. 

Maximizing Money You Inherit

         In the next 20 years, some $30 trillion will be transferred to younger generations.  Much of it is held in IRA and 401K qualified retirement plans.  That money is untaxed, and Uncle Sam will collect taxes on the distributions from those plans.  For years, it was possible to spread inherited qualified plans money over many years of the expected life of the person inheriting the money.  However, that all changed with the SECURE Act of 2020.  Now, most funds passing to non-spouses must be distributed, and taxed, over a short ten years, sometimes with adverse tax consequences. 

         What if you have money coming to you, and you’d like to enjoy taxation at lower rates over more years?  Creating and funding the proper structures beforehand can improve the total net lifetime distributions you may receive.  Where trusts are involved, they are not limited to a ten-year distribution time, so some tailoring of distributions is possible, and remaining funds can grow over time.  Naturally, there are conditions on the eventual distribution of funds that don’t go to you, but proper tax planning may greatly increase the amount that you can enjoy.  Similar planning structures can be used to ensure that your children and grandchildren receive the maximum net distributions. 

Realigning Architects’ Portfolios

         Sometimes professionals may want to change the type of assets they hold, and that can cause large taxation issues.  For example, if the assets have significantly appreciated, divesting of the assets may create large capital gains tax liabilities.  Another issue can be the recapture of previously booked depreciation.  Owners may even wish to transform their holdings into other asset classes, and the taxes they would ordinarily encounter could be prohibitive. 

         With the proper selection of structures to fit the situation, the taxes that could otherwise be staggering may often be deferred for many years.  It is even often possible to change investment categories through structural changes without incurring current tax liabilities. 

         Often such structures include embracing non-profit, charitable organizations.  There are architectural-related charitable organizations that can be worthy of your support, and they include groups engaged in improving building, architecture, and community development.  Through proper structuring, retention of the bulk of current assets, and letting them grow for years and compound with only minimum tax loads taken out year by year, it can result in very favorable outcomes.  In those cases, modeled after what the wealthiest Americans do, you can receive far higher total benefits for yourself while generating substantial charitable contributions. 

Holding Our Own in Uncertain Times

         Right now there is uncertainty over the economic outlook for the coming years.  The increases in energy costs have high ripple impact across the entire business spectrum.  It makes sense to control what you can control and to conserve as much current and future cash as possible.  Always remember that cash is king, and conserving the net cash you can conserve is always an excellent strategy. 

         No matter what the economy does, it appears certain that taxation is likely to be a significant factor as we move forward.  It is important to make the financial arrangements that give you maximum net assets for maximum growth.  This is an excellent time to be sure that tax planning gets the attention from you that it richly deserves.