How Wealth Advisors Can Help do Tax Planning for The Two Types of Taxpayers
Effective tax planning is an important component of building wealth and is generally split into two time periods: near-term (i.e. the current tax year) and longer-term (beyond the current year). Near-term tax planning is primarily focused on minimizing your current tax liability and avoiding surprises and penalties at the tax deadline. Longer-term tax planning is primarily focused on strategically minimizing your taxes over your lifetime, even if it results in paying more taxes in the current year.
Another aspect of near-term planning is managing your federal and state tax liabilities through your withholdings and/or estimate tax payments. How you actually pay them depends on how you feel about managing your obligations throughout the year and your comfort with surprises come tax time. In general, this tends to push taxpayers into one of the camps when it comes to paying taxes throughout the year.
Those with a preference to avoid negative surprises and penalties (most, but not all taxpayers)
Those whose preference is not giving the IRS an interest-free "loan" (and may not care too much that they may owe taxes and penalties at the deadline)
Most taxpayers don't like a "negative surprise" when they file their taxes, obviously. There are a lot of reasons why you may find yourself in this unpleasant situation. A common reason is that you may not be withholding enough taxes from your paycheck. This issue is particularly acute with equity compensation such as Restricted Stock Units (or RSU's) since the federal statutory withholding rate is a flat 22%, which could be much lower than your marginal tax rate of 32% or 37%. Another reason is not withholding taxes for portfolio income (dividends, capital gains, etc.).
Often an unexpected tax liability will also include a penalty for not meeting the required quarterly tax payments. Just because you're withholding taxes regularly doesn't mean you're withholding enough to avoid penalties (you can read more about estimated tax payments here).
Penalties accrue based on required quarterly payments, and while often not significant in dollar terms, penalties can be a source of frustration, akin to getting a parking ticket. However, there is another way to look at penalties. If you think of a tax penalty as a "convenience fee" for keeping your money longer (and possibly earning interest), they can seem much less punitive. Some taxpayers prefer this approach.
You can also have a "positive surprise", meaning a large refund. A common reason is your tax advisor (or tax software) instructs you to pay the "safe harbor" amount based on last year's tax liability (generally, either 100% or 110% of the prior year amount, depending on your situation) to avoid penalties. This amount could be much more than this year's liability; thus, unknowingly paying in too much. While almost everyone prefers a refund versus owing more, again, some taxpayers don't like to tie up their money with the IRS. And, with the recent spike in interest rates, "loaning" your cash to the IRS is getting more costly.
In an ideal situation, a taxpayer withholds enough taxes quarterly (or makes estimated payments) to avoid penalties and knows the amount of any additional tax due in April. However, tax obligations can change significantly from year-to-year making perfect foresight difficult (if not impossible). Since managing your taxes well can be time consuming and costly, tax preparers will usually keep calculations simple and conservative to avoid negative surprises. Unfortunately, that may still result in a negative surprise though, to the chagrin of the first type of taxpayer, or a large refund, to the chagrin on the second type of taxpayer.
Wealth advisors, however, are uniquely positioned to help both types of taxpayers manage their tax payments as well as strategically plan for both the near and longer-term. These types of advisors typically have not only experience with and knowledge of taxes, but they manage your financial plan and take a more comprehensive view of your overall financial health. In addition, wealth advisors can coordinate with your tax preparer to ensure accuracy and consistency with their tax filing approach.
Give us a call the next time you're thinking about taxes. We're ready and willing to help.
Setarcos Wealth Advisors LLC ("Setarcos") is a registered investment advisor. Advisory services are only offered to clients or prospective clients where Setarcos and its representatives are properly licensed or exempt from licensure.
The information provided above is for educational and informational purposes only and does not constitute tax advice and it should not be relied upon as such. Setarcos and its advisors do not provide legal, accounting, or tax advice. Consult your attorney or tax professional.
Updated: Nov 30, 2023
The first time I heard Charlie Munger’s name was in the late 90s. I was working at an actuarial consulting firm starting to develop an interest in financial markets and investing and someone said, ‘hey, you should check out Warren Buffett and read his shareholder letters’. I did both. Warren had the spotlight, but he talked about Charlie in every letter. He was hard to ignore. For the next few years, though, he was just a name to me. Warren’s ‘sidekick’ and Berkshire’s vice chairman. I didn’t pay much attention to him. That all changed a few years later.
In the early 2000s, I decided to start attending the Berkshire shareholder’s meeting in Omaha. If you’ve never been or seen clips from the meeting, Warren and Charlie sit side by side at a table in front of thousands of shareholders and answer questions (not provided to them in advance). Warren speaks first (unless the question is directed at Charlie) and then, most often, asks Charlie if he has anything to add.
That was the first time I heard Charlie speak. Warren is brilliant. Charlie might have been smarter. Warren would give long, insightful responses to each question. Charlie, if he offered a response, was brief and answered with piercing insight. His responses were to the point and perfectly reasoned. He would quote Marcus Aurelius in one response and then apply the laws of thermodynamics in another. I was in awe.
After that, I started paying attention to Charlie. I read everything I could from him and about him. I started paying attention to the Daily Journal annual meetings (in which he also answered shareholder questions for hours). I read old transcripts from the Berkshire meetings. And, like my experience reading Warren’s letters, my mind expanded again.
Like so many in this business, Charlie, along with Warren, has been a mentor to me. Odd to say about someone you never met, but at least one definition of a mentor is ‘an experienced and trusted advisor’. That fits.
I’ve learned a ton from Charlie over the years, both about how to be a thoughtful steward of our client’s wealth and about how to make myself a better person. How lucky to have had someone like this in our orbit for so long.
I will miss his wisdom and guidance, but I’m grateful for everything he left behind.
Updated: Dec 5, 2022
Donor Advised Funds (or DAFs) are an increasingly popular way to make charitable donations to 501(c)(3) organizations. The reasons for their popularity include:
· Being able to donate to the DAF today and recommend which charity (or charities) receive the funds in the future
· Receiving a charitable tax deduction in the year that you give to the DAF, not in the year that you distribute the funds to the charity (note: in order to utilize the deduction, you must itemize your deductions rather than take the standard deduction)
· Investing undistributed funds while they remain in the DAF
· Last, by not least, there can be significant tax advantages when you donate appreciated stock rather than cash to your DAF
Regarding the last point, let’s look at an example. We’ll assume you bought a share of stock for $50 and you held it until it reached $100 today.
Also, we’ll assume the highest marginal tax rates apply:
· Federal ordinary income of 37%
· California state income state of 12.3% (applicable to both ordinary and capital gains)
· Federal long-term capital gains of 20%
· Federal investment income tax (ACA tax) on sale of stock of 3.8%
When you donate to charity (or a DAF) you receive a tax deduction in the amount of the donation. You receive the same tax deduction whether you donate $100 of cash or a $100 of stock. However, when you donate appreciated stock, you never pay the tax on the capital gain, which is why donating appreciated stock is usually better than donating cash.
Let’s compare the two options using the assumptions.
As shown in the table below, donating $100 cash (Option 1) will actually cost you $50.70 since you save $49.30 in taxes from the charitable tax deduction. But what if you donate $100 of the appreciated stock (Option 2)? You still receive the same charitable tax deduction, but you also avoid the tax on the capital gain of $18.05. When you add those two benefits, the cost of donating the stock goes down to $32.65. The difference is the result of avoiding the capital gains tax!
Now, what if you assume you donate stock that has appreciated less and lower marginal tax brackets? These assumptions would reduce the tax benefit of donating the appreciated stock. But the larger point still remains: donating appreciated stock is usually more tax efficient than donating cash because you’re avoiding the tax on the gain (assuming you don't exceed the limitations on stock donations).
You can read more about DAFs here. Let us know if you’d like to further discuss all the benefits of opening a DAF and/or gifting strategies to maximize the tax benefits.
Setarcos Wealth Advisors LLC (“Setarcos”) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where Setarcos and its representatives are properly licensed or exempt from licensure.
The information provided above is for educational and informational purposes only and does not constitute tax advice and it should not be relied on as such. Setarcos and its advisors do not provide legal, accounting, or tax advice. Consult your attorney or tax professional.