High net worth individuals and families are typically smart about managing money, but things can go sideways when it comes to taxes.
Even after 25 years as a CPA, I’m continually surprised to see highly successful people waiting until just before April 15th to do anything with their prior year’s income taxes. At that point, it’s just too late for tax planning. By putting off the task, taxpayers miss a number of golden opportunities to reduce taxes.The good news is that getting ahead of the curve is relatively easy: Simply reach out to your tax advisor and let them know of any big financial changes in your life or your business during the past year. The heads up will give your advisor time to start thinking about your next move before the end of the year, when you have far more ways to minimize taxes.
The Strategy For Lowering Income Taxes
In fact, the most effective tax planning takes place in the last two months of the calendar year.
Savvy CPAs like to have a tax return about 85% calculated by November or early December. The reason: They want to determine the breakeven point for the Alternative Minimum Tax (AMT) as quickly as possible. This is the point where income tax is reduced by increasing current year deductions, but not too much to push you into AMT. (The remainder of the tax preparation is done before April 15th following the tax year.)
The AMT kicks taxpayers into a lower tax bracket, but it takes away many deductions that are allowed if you are not in AMT. The bottom line is when in AMT, a larger share of your income goes to the government. For people living in California, New York and other high income tax states, the breakeven point is even more critical because the deduction for state income taxes is taken away in AMT.
Taking Action To Reduce Taxes
Once the AMT breakeven point is known, a tax advisor can recommend a whole series of steps to reduce your tax burden:
- It may make sense to pay state or real estate taxes in the current tax year instead of waiting until January or April of the next year.
- If you’re going to receive a big bonus or stock award, your advisor might suggest taking portfolio losses to offset any realized gains.
- You may be able to reduce your tax burden by accelerating a charitable donation pledged over multiple years to a single year.
All the while taking into account the AMT impact.
Proper year-end planning is especially critical for people with significant stock options or stock grants. If an individual is making $200,000 a year, but will realize a $1 million gain during the year due to an IPO or liquidity event, it’s essential to confer with your tax advisor as early as possible.
Wealth Transfer Strategy
Reducing income taxes is one half of the equation. The other half is proper estate planning. The end of the calendar year is also the trigger event for minimizing inheritance taxes. If a couple works as a team, the savings can be substantial.
If you know you will have more than a $5.250 million estate, you’re going to pay estate taxes. Thus, wealth holders have only three choices: Give your money to your heirs, donate to your favorite charities or send it to the government.
To have more control of where your wealth goes by minimizing estate taxes, the key objectives are:
- Utilizing the “annual gift exclusion” a married couple can give a child or any other person a total of $28,000 – $14,000 a year per person. If you do not use the annual gift exclusion in a year, it is gone forever.
- If you have appreciating assets, why not let them grow in the name of the beneficiaries? An early gift can achieve this. Your tax advisor can work with you to determine the right amount and the best approach.
- If you have minor children, a simple trust can be set up to make these annual gifts.
Unfortunately, too many high net worth individuals who will have a taxable estate don’t utilize that benefit or have any gift planning program in place.
When it comes to both estate and income tax planning, my advice is always the same. “Just Do It.” Don’t wait until April. Do it before end of the year. Everyone will be happier.