Tax planning

Written by: Elissa Wurf, PhD, CFP, CPA

Some financial advisory firms offer tax preparation services, but at Agili, we focus exclusively on tax planning.  At Agili, when we make investments for clients that have atypical tax treatment, we like to review their tax returns to ensure that the investments are reported correctly.  Since our clients typically work with us as well as with a tax preparer, they have the benefit of two sets of eyes on their tax returns.  This can help in catching errors.  With the rapidly changing tax laws that tax pros need to keep up with — including changes for the 2020 tax season that were made after the IRS had already started accepting returns — even the best of preparers may make an occasional mistake.


Tax Preparation

While people with relatively simple tax situations may feel confident preparing their own tax returns using commercially available tax-preparation software, for many people a good tax preparer offers a tangible benefit. Most importantly, a good tax preparation professional will know what the numbers should say.  The problem with tax preparation software is “garbage in, garbage out.”  One wrong answer to a question in the software can lead you down the wrong pathway, and if you are not an expert on tax law, you may not know that your return is flawed.


If your faulty input leads to under-reporting income received, the IRS is likely to catch it, since they are able to match the information that they receive from employers and financial institutions with the information that you report on your individual tax return. Then you will receive a correspondence audit letter (often in the June of the year following the due date of the return) where the IRS will propose a correction and assess you the additional tax along with interest and penalties.


But if your faulty input leads to an over-reporting of income received, the IRS may not catch it because critical information may be missing from the information that the IRS collects.  For example, for taxpayers over age 70.5 who make charitable contributions from their IRAs that follow the rules for “Qualified Charitable Deductions” (QCDs), there is not any indication on the 1099-R that some of the annual distribution has been contributed directly to a qualifying (public) charity.  The charity must provide a letter of acknowledgement to the taxpayer, so the necessary documentation for excluding this income from taxation is not available to the custodian.  If the taxpayer does not understand that the QCD can be excluded from income and convey that information to the tax preparer, the money contributed to the charity could be included as taxable, leading to an overpayment of tax.


Accurate tax preparation is important, serving a historical reporting function.  But relatively little can be done after December 31st each year to change a taxpayer’s situation.  In contrast, tax planning such as that provided by your Agili Financial Strategist serves a proactive purpose to try to minimize future taxes during the year ahead.


Tax Planning

Any time you plan to make a large financial move, it is wise to consult a your Agili tax planner or a tax professional beforehand.  Too many people talk to their tax preparers and financial advisors only after the fact! But many financial moves can have large negative and, in some cases, unchangeable, consequences.


For example, if you sell a collectible car that you purchased for a thousand dollars and restored and then sold for $35,000, you will have a large capital gain to report.  During my tax preparer days, a client was upset at the amount of tax he owed—when the large balance due was a result of his own failure to report the unusual income at the time it was received.


Avoiding Potential Booby Traps through Adept Tax Planning

Our tax codes and other regulations have potential booby traps in them that can lead you to mistakenly pay more tax than you are required to.  For example, there are “cliffs” in the amount of modified Adjusted Gross Income (mAGI) where receiving just $1 in additional taxable income will trigger larger Medicare premiums for an entire year.  A knowledgeable tax planner can help a client avoid this.


Many critical tax booby traps involve transactions that occur when people retire and move their money from their employer’s qualified retirement plan to their own IRA. If a taxpayer receives a check that is made out to their own name (rather than to the name of the new custodian “for benefit of” the taxpayer) and it is not deposited within 60 days to the new IRA account, the taxpayer will be taxed on the entire retirement balance immediately. 


Additionally, most taxpayers are probably not aware that you cannot do more than one “rollover” (that is, where you receive a check made out to your name) within 365 calendar days. The “one year rule” in this area refers to 365 days and not a calendar year.  If you do two rollovers within 365 days, the second rollover will be treated as an excess contribution and the taxpayer will be subject to a 6% excise tax for every year the excess is kept in the account.  (Note: These booby traps that occur with rollover checks, which the IRS considers “distributions” will not occur with direct transfers that are made electronically from one account to another, since the IRS does not regard electronic transfers as “distributions.”)


Working with your Financial Strategist at Agili can help you avoid these critical errors that are not remediable, and which incur large, immediate tax payments.


Managing to the Tax Brackets

The key to tax planning is not necessarily to lower taxes during the current tax year, but to take the long-term perspective and plan to lower taxes over your lifetime. Since we don’t know what future tax rates will be, there is always some risk, but at the same time, we can attend to the probabilities. For example, the current low tax rates set for individuals by the Tax Cuts and Jobs Act are set to expire at the end of 2025. Even though Congress can act to change this, it is quite likely that future tax rates will be higher than current ones.


If one examines the current structure of tax brackets, it is apparent that there are areas where there are more tax planning opportunities.  While the tax system is progressive so that not every dollar of income gets taxed at the same rate, tax brackets are spaced unevenly.  For example, there is only a 2% difference between the first two brackets (10% and 12%) but then a 10% jump up to the third bracket (22%).  Planning to stay in the 12% bracket rather than having income in the 22% bracket will be more beneficial than planning to stay in the 10% bracket as opposed to moving to the 12% one.


The Key to Tax Planning:  The Arbitrage between Current and Future Expected Tax Rates

Your Agili Financial Strategist, acting as your tax planner, focuses on the difference between current tax rates and unknown but expected future tax rates. The general principle is that if you are expecting your income and/or income tax rates to go up in the future, then you want to pay more tax now at lower rates, so you accelerate income and defer deductions.  Conversely, if you are expecting your income and/or income tax rates to go down in the future, you want to pay less tax now and more in the future when the rates will be lower, so you defer income and accelerate deductions.


If you know ahead of time that you are going to have unusually high income for the year, you may be able to reduce your tax burden with tax planning. For example, you can pair a large income event such as the sale of a business with a large charitable deduction such as a contribution to a Donor-Advised Fund, or you can pair a Roth conversion with a large charitable contribution.


Another tax-planning strategy is to sell securities for a tax loss to balance out large capital gains (“tax loss harvesting”).[1]


Some taxpayers have the possibility of relatively low-income years before they claim Social Security and before Required Minimum Distributions (RMDs) from IRAs take effect. During these years, a knowledgeable tax planner can position a client for lower taxes later by advising them to incur more taxable income in the low-income (i.e., low tax bracket) years.


Strategies that incur more taxes now to lower them in the future include: 1) “tax gain harvesting,” where, if you have highly appreciated securities (and you don’t want to use these to satisfy your charitable intentions), you can sell the securities (ideally at the 0% capital gains bracket, if your income is low enough) and then immediately buy them back, re-setting your tax basis and reducing the tax on future sales;[2] 2) Roth conversions: You can convert funds from your traditional IRA (where the tax is deferred until the money is withdrawn) to a Roth IRA (where you pay the tax immediately so that you avoid tax later on the appreciation of the assets) and potentially can pay tax at lower rates; and 3) starting to spend from your tax-deferred accounts (rather than just from the taxable accounts) in the early retirement years to lower later RMDs.



Taxes are never going to go away, but as Judge Learned Hand said, “Anyone may so arrange his affairs that his (sic) taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury” (Gregory v. Helvering, 69 F.2d 809, 810-11 (2nd Cir. 1934)). Your Agili Financial Strategist acts as a tax planner on your behalf, always cognizant that taxes paid are dollars that cannot be invested to help you achieve your long-term goals.

[1] If you do this, you should be careful not to distort your asset allocation.  You may wish to realize a tax loss and then buy the security back but watch out for the “wash sale” rules, which will disallow claiming the loss for tax purposes if you buy back a substantially identical security in any account (including your spouse’s accounts) within 30 days.

[2]There is no wash sale rule for gains.