The Dollars and Sense of Tax Planning

By Ronald S. Niemaszyk

According to the Internal Revenue Service (IRS), tax returns showing more than $50,000 in adjusted gross income made up only 27 percent of returns filed for tax year 1999. But the individuals and families that filed these returns paid 77.8 percent of all income tax collected that year. Even with the supposed tax relief for 2001, the average family earning $65,000 paid approximately $5,000, or about 7.5 percent of its income, to the federal government. As income goes up, the percentage paid goes up – often dramatically and that does not count state income, Social Security, or real estate tax.

What did you pay last year? If I ask a group of people what they paid in taxes last year, the majority will say something like, “I didn’t pay anything, I actually got money back,” or “I paid a few hundred dollars.” With the government withholding from almost all types of income, it has successfully changed the focus from how much money is being paid into the system to what the last line on your tax return says.

As an accountant, one of my goals is to help my clients build both business and personal wealth. One element of building wealth is managing and controlling expenses. Given the fact that taxes are one of the largest expense items, they are often the best place to start in terms of financial planning. Income taxes, especially for business owners, are something that should be reviewed regularly, and a long-term plan should be put in place to ensure that tax expenses are minimized. In my experience, this planning can make the difference between an individual or family earning a good living and building wealth.

Changes: As unsettling as the numbers above may look, there is some good news. Last year, the government made a number of changes to the tax code and regulations regarding mandatory withdrawals from retirement accounts. These changes will reduce taxes for everyone, and create special opportunities for business owners because of the additional control they have over timing of expenses and revenue. If you already have a plan to minimize tax exposure in place, it needs to be reviewed. If you do not have a plan, now is a great time to put one together.

The changes are broken down into four major areas.

  1. Falling tax rates
  2. Reduction and repeal of the estate tax
  3. Increases in limits to retirement account contributions
  4. Special tax benefits regarding education

It is important to note that the majority of the changes are to be implemented gradually through 2010. In 2011, everything is scheduled to go back to the way it was in 2000. When the changes were first announced, most observers felt extremely confident that Congress would make the changes permanent, but many things have changed since then. The recent return of deficit spending leaves the Congress less than willing to act. At this point, the House has passed legislation to make the changes permanent, while the Senate recently voted it down. As long as questions remain, it is important that tax planning done today is flexible and easily adapted to whatever changes are made before 2011.

With the falling rates, some obvious steps should be taken. The higher the tax rate is, the more valuable the deduction. Therefore, you should attempt to incur expenses in the period with the highest rate. The opposite is also true. The lower the tax rate is, the more valuable the revenue. If it is possible to push expenses into future periods, this is the time to do it.

Estate Planning: The changes to the estate tax laws have received the most publicity. Given the dramatic nature of the changes, I have made it a point to review all of my clients’ will and trust documents. One common problem that I have noticed is that some of the older documents were written with references to the “credit amount” as opposed to a specific dollar amount. Due to the changes in the law, these references may have an impact on calculations. This can lead to a change in the way assets are distributed and betray the original intent of the will. It is important that these documents are reviewed and updated.

Often the importance of estate planning regarding tax benefits is stressed. I have often heard people say, “Since estate taxes won’t apply to me I don’t need to pay a lawyer to write my will.” While it is true that tax benefits are one of the primary considerations when preparing an estate plan, almost everyone should have the basic documents in place. This is especially true for parents and business owners. You should always have a will, durable power of attorney for property, and a power of attorney for healthcare. These documents will ensure that you are cared for in a manner that you choose and will protect your family.

The next area of changes is retirement planning. The increase in contribution limits will benefit everyone. The 50 and over catch-up rules provide even greater benefits to those nearing retirement. Tax deferred savings vehicles are the best retirement savings tools available. You should always contribute the maximum amount allowed.

Retirement: The biggest changes to the retirement rules also affect the estate planning rules. They involve the mandatory distribution from retirement plans when individuals reach age 70½. In the past, the government had an extremely confusing set of rules for calculating the mandatory distribution amount. Last year those rules were modified. The mandatory amount is much easier to compute and has decreased for most people. The changes also provide some options that assist the holders of these accounts to pass them on to their children and grandchildren. Structured properly, this will allow the money to grow in a tax-free environment for longer periods. It is a very complex area and each situation requires specific analysis, but this is a great opportunity for helping you to build wealth and pass it on to future generations.

There is one other thing to consider about retirement accounts. The falling stock market over the past couple of years has had a negative impact on many retirement accounts. A couple of years ago the government created an amazing retirement savings tool, the Roth IRA. Many people are familiar with the Roth IRA. The only difference between the Roth and a traditional IRA is that money put into a traditional IRA is deductible. Money put into a Roth IRA is not deductible, but when you take the money out of the Roth, you have absolutely no tax liability. That means any interest or capital gains are distributed free of any taxes. The Roth IRA makes sense for almost every investor. You are able to convert a traditional IRA to a Roth, but you will incur a tax liability. Now that account balances are low, it may be a good time to think about converting. This is another area that requires some detailed analysis to determine whether it is appropriate for you.

Education Options: Finally, consider educational saving. As I watch my daughters, Emma and Sophie, grow, I realize how important this subject can be. Here again, the changes are very powerful. The new 529 plans are an absolute necessity for anyone with children, grandchildren, nieces, nephews, or anyone who they expect to be assisting with education expenses. The accounts are very flexible and there are many different options to consider. Unlike many other saving vehicles, there are no income limits for individuals making contributions.

In past years, I have obtained a number of new clients from other accountants. Several of them have shared with me similar scenarios. The client complained about his taxes being too high, to which the accountant responded, “If you didn’t make so much money, you wouldn’t pay so much in taxes.” While this is true, I have found that many accountants hide behind this excuse, instead of doing the necessary legwork and planning to ensure that taxes are as low as they can be.

Sometimes it is the accountant’s fault and sometimes it is the client’s. I have had meetings with clients where I have outlined how I could save them substantial amounts in taxes. While most everyone is interested, some decline the offer because they do not want to pay the additional accounting fees that it would take to prepare the plan.

Developing a tax plan and strategy takes time, knowledge, and money. The plan may involve family members, partners, or key employees, and should address everything from how to maximize your after-tax income today, to how to build wealth and pass it on to as many generations as possible.

Ronald S. Niemaszyk is a Principal in Jordan/Patke & Associates, a certified public accounting firm in Deerfield, IL. He can be reached at 847-382-1627 or

[From Connection MagazineNovember 2002]