Are you getting conflicting tax advice from different sources? Are your tax planning strategies compatible with your …
 

Many taxpayers and investors have something in common. They pursue "hot tips" to find investments or tax avoidance opportunities. The better approach is to begin with an organized system of investing and an organized systematic approach to tax avoidance. The same is true with respect to asset protection from future lawsuits, saving for future college or other education expenses, starting or selling a business, providing financial help for your parents, planning for your own retirement and preserving your estate for your loved ones instead of the IRS.

Investment Allocation Planning

For an investor, developing a diversification strategy based on each investor's short term, intermediate and long term financial goals is the best way to have an organized system of investing. The goals help the investor to decide what proportion of his savings should be in different types of investments. Then, the investor looks for specific investments that fit within the selected categories - up to the allotted amount for each category. As circumstances change, the allocations can be changed - but "hot tips" are generally ignored in favor of a pre-planned system of investing. The plan helps the investor to avoid losses due to the emotions of greed or fear. In most cases, a structured system of investing will produce higher long-term yields with less risk. However, most investment managers are not tax specialists and they often shy away from tax planning.

Many investors use the services of various brokers to help them locate and select investments. Frequently, they have different brokers or managers taking care of funds for themselves, a spouse, a parent, a retirement plan and funds in different trusts. Quite often, the various advisors or managers are working at cross purposes with each other. Sometimes, one advisor is buying XYZ Corp. while another is selling it. You end up in the same net position - less the brokerage fees on both trades. Perhaps you subscribe to an assortment of investment newsletters - all of which are offering conflicting hot tips on what to buy and what to sell each month. (Sometimes, the best thing to do is nothing.) Have any of your investment advisors ever suggested that you take some money out of their investment account and use it to pay off a high interest rate home loan?

Education Funding

Do you have children or grandchildren who are not yet in college - and do you intend to help them with their education expenses? Have you talked with your tax preparer, broker, insurance agent or attorney about how to accomplish that in the most efficient manner? If so, have they been giving you conflicting advice? Are you making the best use of the available tax incentives for college funding ? Are your education savings invested so they will mature with minimum risk at the time the funds are needed?

Asset Protection from the Lawsuit Epidemic

Are you concerned about future lawsuits because of the litigation epidemic in the U.S.? if you are a professional person like a doctor, engineer, lawyer, CPA, consultant or investment advisor, you have a high risk of exposure to lawsuits. Business owners, parents of teenage drivers, owners of rental properties and anyone with substantial income or assets are also far more likely to be sued than employees and those who are not well-to-do. Asset protection is nothing more than an organized approach to risk management, which includes (1) liability insurance, (2) the separation of ownership of assets in a family, (3) the use of corporations, (4) limited liability companies, limited partnerships, trusts, bankruptcy and creditor exemptions. And - for some - it may include the use of overseas trusts to protect a nest-egg of assets in case all else should fail. These arrangements often require a compromise with your investment, tax or other objectives.

U.S. Business Planning

If you own a business, there is often a temptation to separate your planning decisions for the business from those that you make for your personal affairs. Where you don't own a controlling interest in the business, that's understandable, but if you do own the controlling interest, your business decisions will be more effective if they are integrated and coordinated with your personal financial and tax planning. Asset protection for business assets is different from the methods of protecting personal assets. Tax avoidance for the business may result in higher taxes for the owner. Most business owners assume their business will provide the income they need for retirement but they may not have actually prepared a plan to make that happen and to provide the liquidity needed. A family owned business usually causes a need for estate liquidity or at least for a succession plan to sell the business at the time of your death. With the explosive growth of the Internet and the world Wide Web, more U.S. businesses are becoming involved in global trade either as importers, exporters or both. Many U.S. businesses are beginning to consider opening foreign branches or divisions. However, venturing offshore entails complex tax issues that should be considered in advance. 

International Business and Investment Diversification

If you have a desire or need for international diversification of your investments, for an overseas trust, for a foreign corporation, foreign limited liability company or international business company, the international tax rules are extremely complicated and need to be coordinated with your U.S. tax planning arrangements.

Retirement Planning

Is retirement an important goal to you in the near future? If so, have you given any serious thought to how and when you will be able to retire? Will you need to adapt to a lower standard of living? Will your resources be adequate to take inflation into account if it should resume? Are you using tax efficient methods of accumulating funds for retirement? Are your retirement savings goals coordinated with your other investment goals? Could a lawsuit wipe you out and force you to continue working? What if you have an extended disability before you are ready to retire? If you are self-employed or own a business, how will you extract the money from the business to fund part or all of your retirement? If you engage in estate planning to avoid estate taxes, will you still have enough assets for a comfortable retirement?

Long Term Disabilities or Illnesses

About the time you are looking forward to retirement, you may discover that a parent may have a need for extended care or medical services. If you are an only child (or the only one in the same locality as your parent), will your parent be able to move in with you or will they need to move to an assisted living facility? What if one of your parents is disabled because of a stroke - or has Alzheimer's Disease? Will they have the funds to pay for 24 hour a day care? If not, will you be able to help them? Many families have discovered that a parent's serious illness has wiped out their savings for their children's education and their own retirement. Have you factored this into your other planning? Have you considered this contingency for yourself or your spouse? If one of you needs extended care, will you have the resources to pay for it? Could your disability or incapacity in your later years cause a serious financial burden on your children?

Disinheriting The IRS

Someone once said the best will should read, "Being of sound mind, we spent it all."

However, having enough to live comfortably and to be prepared for those contingencies that can be reasonably anticipated is difficult to do with any accuracy. The safest method of planning is to be sure there's enough to regardless of how long you may live and to expect that there will be something left for your heirs. If you have a modest estate, a few simple steps will enable you to leave the rest of your assets to a spouse and then to your children without any estate tax. If you could have an estate of more $1 million per spouse, it will require some advance planning to disinherit the IRS as an unintended beneficiary of your estate. Estate planning is a process of trying to keep as much of your hard-earned assets from being consumed by lawyers and the government as possible. However, your estate plan needs to be coordinated with your retirement goals, your asset protection strategies and your business succession planning. And of course, there are substantial tax implications.

Return on Investment from Tax Planning 

Tax planning is the process of identifying legal opportunities to reduce your taxes without spending more money in the process. For some reason, a lot of people expect to recoup more than they spend on tax planning within a few weeks or months and then generate additional tax savings over time. If that can be done, it's an extremely high return on investment. Like many investments, extremely high returns are hard to find. However, many taxpayers are not specialists in finance or related topics and are not well versed on how to compute the rate of return on an investment involving a sunk cost. 

Most investors are familiar with the simple kind of return on a fixed income investment with a probable return of principal. For example, you deposit $1,000 in a certificate of deposit and the bank agrees to pay you 3% per year. At the end of a year, you get back $1,030 or you can reinvest it for another year at a different rate of interest.

Another example is an investment in shares of stock in a major corporation. Perhaps you invest $10,000 in the shares of XYZ Manufacturing Corp. The company pays a 3% dividend so that you get a dividend of $300 and after a year, the price of the stock has increased (perhaps) to $10,500. If you were to cash in at that time (ignoring commissions), you would get a total of $800 on an investment of $10,000 - which is a return of 8% on your investment.

But these are returns within a single year. Most investments are multiple year investments. 

But what about investments where the only return is the income (or savings) that you expect? For example, you spend $1,000 on some energy saving products for your home because you believe you will save $100 a year in electrical or gas expenses. Superficially, that's a 10% return per year. But it will take you ten years to merely get a full return of your original investment -- with no profit. How long would it take for your investment to double? At $100 a year it would take 20 years. Using the rule of 72, that represents a return of 3.6% per year -- after taxes. 

Taxes have a substantial impact on the rate of return and complicate the process of estimating the rate of return. If the tax savings are likely to be received within a year, a simple way to estimate the rate of return is to simply deduct the tax savings from the initial investment and then use the rule of 72 to  estimate the annual rate of return. For example, if you own a business and spend $1,000 on some equipment, it may be fully deductible in the year it is purchased. If you are in the 40% combined tax bracket (federal, state and social security taxes), you will recover $400 in tax savings. Your after tax investment is therefore $600. If the investment is expected to generate $100 a year in savings, it will take 12 years to double your money. Using the rule of 72, that's an annual rate of return of about 6% per year. 

An investment in tax planning services is similar to an investment in deductible equipment where there is an expected return for a number of years.  For example, assume that you spend $1,000 on tax planning advice and implementation services. You are expecting to recover $300 a year in tax savings because of that advice. If the $1,000 is deductible (it may not be), and if you are in the 40% marginal tax bracket, your out-of-pocket cost is actually $600. If the $300 represents tax savings, those tax savings are equivalent to an income of $500 a year before taxes. It would take just two years for the $600 investment to double. Using the rule of 72, that's a return of 36% per year. 

What about tax savings that won't occur for many years -- such as estate taxes? If a tax advisor can show you how to save $300,000 in estate taxes, and the fee for the services is $3,000, do you really need to compute the rate of return on the investment? Just for the sake of argument, let's assume the expected tax savings are just $24,000 for an investment of $3,000.  To estimate a rate of return you have to first make an estimate of how long you will live. A simple rule of thumb is that men will live to about age 75 and women will live to about age 80 -- assuming average health conditions. If you are a man who is 45 years old, it will take at least 30 years to realize the benefit of the expected tax savings. To use the rule of 72, you first have to estimate how many times the "investment" will double.  Once will result in $6,000 of savings. Twice will result in $12,000 and three times will result in $24,000 of savings.  The number of years is 30 which means the investment will double each 10 years.  Using the rule of 72, the annual rate of return would be 7.2% per year. 

In many cases, tax planning results in tax savings substantially in excess of the fee paid to the tax professionals. In that case, there is little need to worry about computing the rate of return on the investment. But when the immediate tax savings don't exceed the immediate cost of the services, the rate of return may still be much better than the return you could get (after taxes) on any other investment of comparable risk. 

Comprehensive, Multi-Generation Tax Planning

You can be sure you will get conflicting tax advice from different investment advisors, brokers, insurance agents, financial planners, trust officers, tax preparers, business advisors and various lawyers. If you decide to use the services of multiple advisors, you need one more advisor - someone who can help you to sort through the conflicting advice to develop a coordinated and comprehensive plan to minimize your taxes. If you have a financial planner who does not have a very strong background in taxes, then you need an advisor who does have that background.

Most of the payback from the services of financial planners comes from tax savings. They make their money by managing your investments, but they provide the payoff for you in the form of tax savings. If you don't have a need for an investment manager, then you should consider a tax planning consultant as your financial coordinator.

If you have a substantial estate (one that is likely to be exposed to federal estate taxes) and if your children are financially successful, then your estate planning could become a serious problem for your children or even for your grand-children. Multi-generation estate planning and income tax planning is needed to avoid creating problems for your heirs while you are trying to solve some problems for yourself.

As a tax planner and consultant, I don't 

• provide investment advisory services,
• sell any investment or insurance products,
• provide legal services, 
• provide valuation services, 
• provide audit services, 
• provide general accounting services or
• computer consulting services.

I limit my services to tax planning. As a tax preparer, I generally limit my work to the preparation of information returns involving foreign trusts or businesses and to the preparation of U.S. tax returns for foreign persons. I do not want to be in competition or to be perceived as being a competitor to your primary tax preparer because that's not what I do or wish to do for my clients.

What I can do is to help you to develop an integrated tax avoidance strategy to minimize your income taxes, capital gains taxes, employment taxes, corporate income taxes and estate or gift taxes. I will work with your other advisors to help you to get the best mix of tax planning combined with your investment plan, your asset protection plan, education funding objectives, international diversification goals, business plan, retirement plan and estate preservation objectives. For those who perceive a need for international asset protection, business opportunities or investment diversification, I can help them to be sure they aren't going to get into any battles with the IRS that they can't win.

Vernon K. Jacobs

Your suggestions for improving this web site are welcome.  Vernon K. Jacobs, Webauthor .