Four Situations Where Long-Term Tax Planning is Crucial

 

For high-net-worth individuals (HNWIs), taxes are never simply an April affair; tax reduction possibilities may present themselves at any time of year.

 

But to truly maximize your strategy, you need to consider this year and several years down the line. Why? HNWIs often have access to unique financial opportunities that are only available—or can only be utilized to the fullest—with careful planning over the course of several years. That’s why we encourage you to cultivate a long-term mindset when it comes to your taxes; it’s one part of a holistic approach to wealth.

 

Let’s look at some situations where longer term tax planning makes more sense than year-to-year planning. 

Unusual Income Amounts

Are you anticipating a year (or even several years) with low or no income? This is not as uncommon as you might think. For example, many people who can afford to do so retire before their mid-60s. Or, maybe you’re mid-career, but you sold your business and decided to take a year to re-center.

 

Either way, a year where you’re in a lower tax bracket can present an advantage. For example, rather than simply paying the least amount of taxes possible, you could convert some of your traditional retirement accounts to Roth IRAs. In the short term, this would raise your tax burden for the year—but long-term, you’ll have locked in what will likely be a lower tax rate on those funds than if you had withdrawn them later, for example as part of your Required Minimum Distributions.

 

On the flip side, say you work in an industry where there are large bonuses at the end of year-long projects, or at certain predictable milestones. In this scenario, if charitable giving is part of your plan, a Donor Advised Fund (DAF) may make sense. You could set up a DAF in a year where your income is up and prefund your charitable gifts for a couple of years. This way, you’ll be able to deduct a large lump contribution from your taxable income during your high-income year … and then distribute those funds to charity at a leisurely pace during the years following.  

Alternative Investments

Alternative investments, often referred to as “Alts,” can include everything from joining a private equity fund, to investing in fine art, to real estate investments, or even cryptocurrency. A key takeaway: this format is complex and often less liquid than traditional investments, but it can provide additional tax planning opportunities in the right situation.

 

For example, a private equity fund may have a hold period of 10 years. Or a real estate investment may not be fully built and ready to sell for four years. Alternative investments can mitigate tax liabilities by incorporating tax-deferred or tax-exemption strategies into your portfolio.

 

For example, you could use a Private Placement Life Insurance policy. Tax on the income generated by the investments within the policy are typically tax-deferred, and the death benefit is typically tax exempt. It’s an example of maximizing your tax efficiency, while also giving yourself peace of mind.

 

Additionally, real estate is an asset that can provide rental income and appreciation, and acts as a natural hedge against inflation since property values—and the associated rents—tend to rise with inflation.

 

Talk with your Wealth Advisor, tax professional, lawyer and investment advisor about solutions that may be right for you.

Starting or Selling a Business

When starting a business, most owners want to strike a balance between limiting their personal liability, while also maximizing their opportunity for profit. The business structure that’s right for you could take several forms. You’ll also need to match your chosen business structure with other considerations: What accounting method will you use (cash basis or accrual basis) and would it make sense to opt for a more complicated compensation structure, such as deferred compensation or phantom stock?

 

Carefully considering these at the outset will save you headaches down the road. Similarly, when you decide to sell your business or retire, plan in advance. If you’re retiring and passing the business to a business partner or relative, will you continue to draw income from your business? How will the ownership structure need to change? Will you cash out? And how much? Also, in what areas do you have expertise that needs to transition to the next generation?

 

Similarly, if you’re selling, what kind of sale are you thinking? An ESOP, to private equity, or to a local businessperson already in your industry? These could end up being very different-looking types of transactions. In each case, you may end up wanting to maximize the appeal of your business to potential buyers in different ways.

 

Ultimately, the smoothest business sale is likely the one with several years of preparation poured into it.

Estates, Trusts, Wealth Transfer and the Next Generation

Wealth transfer strategies can enhance your ability to maximize what you pass to the next generation. This could mean everything from gifting assets now using your annual exclusion or lifetime gift tax exemption, to setting up a Grantor Retained Annuity Trust (GRAT) for an asset you anticipate will appreciate in the near-term.

 

You should also consider the following question when it comes to your estate: Is fair equal, or is equal fair?

 

In this instance, equal means the assets are divided equally amongst all those who receive them, regardless of circumstance. Fair, on the other hand, means that each beneficiary is given special consideration. For example, if one child has worked for years as a manager in your fast-growing business, you may want them to inherit a greater share, to reflect their contributions. Or, if two of your three children have young kids, you may leave them a larger share to reflect this additional responsibility. On the flip side, if a child of yours has substance abuse problems or an addictive personality, you may want to place restrictions on when and how much they inherit.

 

To do this effectively, you need to communicate to all of those involved well in advance. Express your intentions (this is more important than sharing dollar amounts) and share how you plan to transfer wealth to each. Then work with your full wealth team to activate your plan. And be sure to revisit your plan every few years: your circumstances, your children’s circumstances and estate tax law may have changed.

Your Wealth Team Can Help with a Longer Horizon

At 1834, our goal is to serve who you are now—and who you want to become. We’re always happy to talk about your long-term financial and personal goals. In fact, we recommend it. Let’s make sure your financial plan evolves in tandem with you.