It would be very difficult to find two families with
exactly the same total income who also paid the same amount of income taxes.
Some families rent while others own a home. Some families receive tax free
medical benefits from an employer. Others have to pay for those expenses with
after tax dollars or do without. Some families have learned how to get a tax
deduction for many of their expenses. Other families have virtually no
deductions.
Two investors with the same total assets to invest will
rarely pay the same taxes. Some investors will choose to buy tax exempt
bonds. Others will invest in tax deferred annuities. Some investors will buy
growth stocks instead of bonds. The most conservative investors will invest
in fully taxable C.D.s and savings accounts. Some astute investors will
decide to take money out of heavily taxed investments and use that money to
pay off a home loan - even though it results in a loss of the home mortgage
interest deduction.
Some families put their children through college the
hard way - with after tax dollars. Other families spend the time to learn how
to legally transfer taxable income to their children so the income will be
either tax free or taxed at a very low tax rate. Generally, this requires
that the family has some business income (other than from a professional
practice) or some investment income.
There are many legal ways to defer the tax on long term
capital gains for a long time. If you're selling a business, you often have a
lot of ways to structure the sale to get the best result after taxes.
But there's a catch.
To use these legal devices, you need to be aware of
them and how they work before you need them. If you have sold a highly
appreciated asset already, don't call your tax advisor to see if there is
anything they can do to help you. The answer is almost certain to be "I'm
sorry. It's too late. Why didn't you call me before you did the deal?".
There are about 20 million businesses in the U.S. About
18 million of them are doing business as a proprietorship instead of as a
corporation. These businesses often need to accumulate working capital for
inventory and receivables with after tax dollars. Some business owners
accumulate those assets with dollars that are taxed at federal and state
personal tax rates of 35% to 50%. Others accumulate working capital at
corporate tax rates of 15% to 20%. However, different tax advisors often have
strongly diverse views on this subject. My view is that the best approach
depends on when you think you will really need to "cash in" and convert your
corporate assets into personal assets. It also makes a big difference whether
you are likely to make $5,000 a year, $50,000 or $500,000.
The federal estate tax has been called a "voluntary
tax" because there are so many legal ways to avoid this tax with advance
planning. However, few families will spend the time or money to restructure
their assets to prevent the IRS from taking up to 50% in one generation, up
to 75% in two generations and up to 91% in three generations. Basically,
estate planning isn't done for your own benefit. It's done for your children.
The current estate tax can be avoided until the death of both parents. Thus,
the estate tax is virtually a tax on orphans. When you are both gone,
the IRS gets a big chunk of what's left from your kids. That is, they will
unless you are willing to spend a little time and money now to find legal
ways to sidestep the problem. It's very easy to avoid the federal estate tax
on a total estate of up to $3 million. Beyond that, it requires a little bit
of effort. For estates above $3 million, the federal estate tax can
consume 40% to 50% of the total estate in excess of the available
exemptions.
The combined impact of various taxes can be hard to
believe. When you compare the results of a long term conservative investment
program, no family income shifting and no estate planning to a more tax
enlightened approach, the difference can be dramatic.
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