The media has been full of headlines discussing various income tax proposals, many of which focus on the “wealthy.” Fortunately, many business owners fall into that category, and many are concerned about higher future tax rates. Let’s look at why taxes might increase and how to think differently about your personal and business tax plan. Many of you have seen headlines highlighting a variety of income tax proposals, with many of them focused on the “wealthy.” Fortunately, many business owners fall into that nebulous description. When we talk to clients like you, many of them are concerned about tax rates increasing in the future. Let’s look at what you can do and why, to think differently about your personal and business tax planning and why.
challenge is that most simply do not understand income taxes and how they work. Do you drop off your tax documents to the tax preparer, then pick them up, sign them and never look at them?
Let’s rethink taxes, not on a year-by-year basis, but instead over your lifetime. Each time you file an income tax return there is a line called “Total Tax.” That was your annual tax bill, the amount you had to pay the government.
Your Lifetime Income Tax Bill is simply the total of your annual tax bills. Planning each year and trying to forecast the future are important, especially if you are concerned about higher future tax rates.
Do not be alarmed if you find this difficult… most people do. Most people, especially business owners, are too busy to read the thousands of pages in the Tax Code. What probably makes more sense is to simplify your thoughts and start addressing your personal situation. The first hurdle is to consider where tax rates will be in the future; the same, lower or higher? Consider the data.
According to the Federal Reserve Bank of St. Louis, as of April 26, 2021, the US Total Public Debt was $28.529 Trillion. With the current US population at 332.841 million,i that equates to $85,713 of government debt for each American. Combined with projected future fiscal deficits, and the potential infrastructure and other stimulus packages, and that debt may climb.
Congress seems to be intent on increasing taxes on corporations and the wealthy. One concern is that the wealthiest Americans, the 650 billionaires, do not have enough to impact the overall debt. According to Forbes, the total wealth of these billionaires is $4.6 trillion, not nearly enough to reduce the debt, even if the government confiscates 100% of their assets.
Wouldn’t it seem likely that tax rates would have to increase on middle America at some point? Do you want to take the risk that tax rates remain the same?
What can you do today?
Tax Planning is simply the art of paying more income tax at the lowest rate possible. Much of your income, like your salary, has to be paid each year, making planning difficult. More people are concerned is what will happen to their investment and retirement income down the road?
Income tax rates are as low as they have been for several decades. Might it make sense to pay taxes now, rather than deferring them until later? A couple potential tax planning options might include the realization of capital gains, along with Roth IRA or Roth 401(k) conversions.
As investors, purchasing and holding an investment for more than one year typically allows special tax treatment, called long-term capital gains. Might this “tax break” be reduced in the future? Congress has discussed increasing these capital gains rates in the future. Many business owners are selling their businesses before year-end, along with realizing gains in their investment portfolios. These strategies are designed to lock in current capital gains rates in case they increase in the future.
In addition, many of our clients have been converting IRAs and 401(k)s to Roth IRAs/401(k)s. Typically, in a Traditional IRA/401(k), no tax is assessed until you withdraw it. The potential problem is that taxes will have to be paid at the rate the government decides. Essentially, you have a “debt” to the government which has to be paid. By converting those traditional retirement plans into Roths, you pay the taxes now, at today’s rate and the money will never be taxed again (provided you meet the IRS requirements). Another option is to change your Traditional contributions to Roth contributions moving forward.
There are many tax planning strategies, many too complex for this article. Realize that every family is different, so what makes the most sense for you depends on your unique set of circumstances. Either way, seek guidance from your tax professional and create a long-term strategy to potentially lower your Lifetime Income Tax Bill.
Paul Marrella is a wealth manager at Marrella Financial Group LLC/Raymond James Financial Services, Inc., in Wyomissing, public speaker and author. He coaches successful families in managing multi-generational wealth throughout Southeastern Pennsylvania. He can be reached at (610) 655-9700.