Tax Planning in an Unsettled Environment

We’ve heard from our portfolio managers that some clients are asking about tax planning in an unsettled regulatory environment. News reports of changes to US tax laws cover a wide range of proposals — too many and at too early a stage to meaningfully discuss planning and tactics. Congressional and Treasury staffs are fully aware that for corporate taxes and wealthy citizens, whatever is passed (the statutory rate) “is illusory because it is manipulated by a phalanx of tax lawyers and accountants,” resulting in significantly lower “effective” tax rates[1] and thereby funds received by the US Treasury.

General taxation rules of thumb or guidelines are also difficult to use. Capital gains changes are in the news and rates appear to be headed up. The advice to sell appreciated assets now at lower rates is contrary to one of the most effective tax strategies: never pay a tax early, if you have a choice. The last successful effort to entice taxpayers to pay early is Roth conversions, which, after paying ordinary income tax rates on the conversion, can grow tax free with tax-free payouts at times far into the future. Current publicity around “super-sized” Roth IRAs and suggested changes by current Congressional committees[2] make the current Roth structure appear to be “too good to be true.” The willingness of legislators to change the rules around distributions from traditional IRAs to prevent multigenerational IRAs beyond ten years ended a widely used estate planning tool and showed a government’s willingness to eschew precedent to the detriment of taxpayers.

As we’ve mentioned in the past, anyone’s basic tax and generational planning should include those items that require no paperwork to be filed. The annual gift tax exclusion of $15,000 to any number of recipients requires no paperwork. Gifts to the same person from both spouses require no paperwork, if made from each separately. An investment account grows relatively tax free if turnover is low and it is invested in growth stocks. If the account stays out of the “retirement assets” bucket, then it avoids the conversion of capital gains to ordinary income at withdrawal. A wealth tax is a tax levied on the net fair market value of a taxpayer’s assets, perhaps annually. A wealth tax would be tied to “ownership of assets.” Creating a trust for a portion of assets transfers ownership to trustees from the grantors, thereby potentially putting the grantors under the threshold for the wealth tax.

Because we don’t know what will finally be proposed, we need a method to orient ourselves to a world where government makes a forced extraction of assets from citizens annually, quarterly and every paycheck. Perhaps the best way to become oriented is to be informed by the newspaper editor’s code. A newspaper story describing the who, what, when, where and how effectively describes a situation to a reader.

1. Who is the taxpayer? (Key: ownership)
2. What kind of income? (Ordinary vs. capital gain)
3. When to recognize? (If at any time)
4. Where? (The US taxes worldwide income; other countries don’t.)
5. How? (The US Internal Revenue Code, as manipulated by Congress and the IRS)

Lowering tax rates, perversely, raises more revenue for the US Treasury and creates the compliant US tax base that politicians claim to want. Raising rates, changing the rules of the game arbitrarily, and creating the uncertainty of constant change are not the ways a sophisticated government should raise the funds it needs. Let the games begin!

If you or any of your other advisors have questions about the issues raised here, please contact your investment manager or one of us.

William H. Darling, Chairman & CEO
Jeanne M. FitzGerald, CPA – Tax Manager


[1] WSJ Letters, 7/13/21
[2] WSJ, 7/3-4/21