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The
Dollars and Sense of Tax Planning
By
Ronald S. Niemaszyk
November, 2002
According to the Internal Revenue Service (IRS), tax
returns showing more than $50,000 in adjusted gross income made up only 27
percent of returns filed for tax year 1999.
But the individuals and families that filed these returns paid 77.8
percent of all income tax collected that year.
Even with the supposed tax relief for 2001, the average family earning
$65,000 paid approximately $5,000, or about 7.5 percent of its income, to the
federal government. As income
goes up, the percentage paid goes up – often dramatically and that does not
count state income, Social Security, or real estate tax.
What did you pay last year? If I ask a group of people what they paid in taxes last year,
the majority will say something like, "I didn't pay anything, I actually
got money back," or "I paid a few hundred dollars."
With the government withholding from almost all types of income, it has
successfully changed the focus from how much money is being paid into the
system to what the last line on your tax return says.
As an accountant, one of my goals is to help my
clients build both business and personal wealth. One element of building wealth is managing and controlling
expenses. Given the fact that
taxes are one of the largest expense items, they are often the best place to
start in terms of financial planning. Income
taxes, especially for business owners, are something that should be reviewed
regularly, and a long-term plan should be put in place to ensure that tax
expenses are minimized. In my
experience, this planning can make the difference between an individual or
family earning a good living and building wealth.
Changes: As unsettling as the numbers above may look, there
is some good news. Last year, the
government made a number of changes to the tax code and regulations regarding
mandatory withdrawals from retirement accounts. These changes will reduce taxes for everyone, and create
special opportunities for business owners because of the additional control
they have over timing of expenses and revenue.
If you already have a plan to minimize tax exposure in place, it needs
to be reviewed. If you do not
have a plan, now is a great time to put one together.
The changes are broken down into four major areas.
-
Falling
tax rates
-
Reduction
and repeal of the estate tax
-
Increases
in limits to retirement account contributions
-
Special
tax benefits regarding education
It is important to note that the majority of the
changes are to be implemented gradually through 2010. In 2011, everything is scheduled to go back to the way it was
in 2000. When the changes were
first announced, most observers felt extremely confident that Congress would
make the changes permanent, but many things have changed since then.
The recent return of deficit spending leaves the Congress less than
willing to act. At this point,
the House has passed legislation to make the changes permanent, while the
Senate recently voted it down. As long as questions remain, it is important that tax
planning done today is flexible and easily adapted to whatever changes are
made before 2011.
With the falling rates, some obvious steps should
be taken. The higher the tax rate
is, the more valuable the deduction. Therefore,
you should attempt to incur expenses in the period with the highest rate.
The opposite is also true. The
lower the tax rate is, the more valuable the revenue.
If it is possible to push expenses into future periods, this is the
time to do it.
Estate Planning: The changes to the estate tax laws have
received the most publicity. Given
the dramatic nature of the changes, I have made it a point to review all of my
clients' will and trust documents. One
common problem that I have noticed is that some of the older documents were
written with references to the "credit amount" as opposed to a specific
dollar amount. Due to the changes
in the law, these references may have an impact on calculations. This can lead to a change in the way assets are distributed
and betray the original intent of the will.
It is important that these documents are reviewed and updated.
Often the importance of estate planning regarding tax
benefits is stressed. I have
often heard people say, "Since estate taxes won't apply to me I don't
need to pay a lawyer to write my will."
While it is true that tax benefits are one of the primary
considerations when preparing an estate plan, almost everyone should have the
basic documents in place. This is
especially true for parents and business owners.
You should always have a will, durable power of attorney for property,
and a power of attorney for healthcare. These
documents will ensure that you are cared for in a manner that you choose and
will protect your family.
The next area of changes is retirement planning.
The increase in contribution limits will benefit everyone.
The 50 and over catch-up rules provide even greater benefits to those
nearing retirement. Tax deferred
savings vehicles are the best retirement savings tools available.
You
should always contribute the maximum amount allowed.
Retirement: The biggest changes to the retirement rules also
affect the estate planning rules. They
involve the mandatory distribution from retirement plans when individuals
reach age 70½. In the past, the
government had an extremely confusing set of rules for calculating the
mandatory distribution amount. Last
year those rules were modified. The
mandatory amount is much easier to compute and has decreased for most people.
The changes also provide some options that assist the holders of these
accounts to pass them on to their children and grandchildren.
Structured properly, this will allow the money to grow in a tax-free
environment for longer periods. It
is a very complex area and each situation requires specific analysis, but this
is a great opportunity for helping you to build wealth and pass it on to
future generations.
There is one other thing to consider about
retirement accounts. The falling
stock market over the past couple of years has had a negative impact on many
retirement accounts. A couple of
years ago the government created an amazing retirement savings tool, the Roth
IRA. Many people are familiar
with the Roth IRA. The only
difference between the Roth and a traditional IRA is that money put into a
traditional IRA is deductible. Money
put into a Roth IRA is not deductible, but when you take the money out of the
Roth, you have absolutely no tax liability.
That means any interest or capital gains are distributed free of any
taxes. The Roth IRA makes sense
for almost every investor. You
are able to convert a traditional IRA to a Roth, but you will incur a tax
liability. Now that account
balances are low, it may be a good time to think about converting.
This is another area that requires some detailed analysis to determine
whether it is appropriate for you.
Education Options: Finally, consider educational saving.
As I watch my daughters, Emma and Sophie, grow, I realize how important
this subject can be. Here again, the changes are very powerful.
The new 529 plans are an absolute necessity for anyone with children,
grandchildren, nieces, nephews, or anyone who they expect to be assisting with
education expenses. The accounts are very flexible and there are many different
options to consider. Unlike many
other saving vehicles, there are no income limits for individuals making
contributions.
In past years, I have obtained a number of new
clients from other accountants. Several
of them have shared with me similar scenarios.
The client complained about his taxes being too high, to which the
accountant responded, "If you didn't make so much money, you wouldn't
pay so much in taxes." While
this is true, I have found that many accountants hide behind this excuse,
instead of doing the necessary legwork and planning to ensure that taxes are
as low as they can be.
Sometimes it is the accountant's fault and
sometimes it is the client's. I
have had meetings with clients where I have outlined how I could save them
substantial amounts in taxes. While
most everyone is interested, some decline the offer because they do not want
to pay the additional accounting fees that it would take to prepare the plan.
Developing a tax plan and strategy takes time,
knowledge, and money. The plan
may involve family members, partners, or key employees, and should address
everything from how to maximize your after-tax income today, to how to build
wealth and pass it on to as many generations as possible.
Ronald
S. Niemaszyk is a Principal in Jordan/Patke & Associates, a certified
public accounting firm in Deerfield, IL. He can be reached at 847-382-1627 or
rsniemaszyk@msn.com.
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