Income Tax Planning
Effective Tax Planning and the Implications of Tax Changes for High Income Earners
For years, relatively low overall income tax rates and relatively high wealth transfer tax rates (the estate, gift, and generation-skipping-transfer or “GST” taxes are the wealth transfer taxes) meant that estate planners were primarily focused on ways to reduce wealth transfer tax exposure. This was true even where the transactions needed to reduce wealth transfer tax exposure could result in higher income tax costs.
Beginning primarily in 2013, significant changes in both the income tax and wealth transfer taxes have resulted in low (or no) wealth transfer tax exposure for many (if not most) clients, and much higher income tax exposure for higher income taxpayers, as top marginal income tax rates have risen and the new Medicare income surtax and 3.8% net investment income tax (“NIIT”) have taken effect.
Top overall state and federal income taxes for many higher-income clients in Georgia now approach 50% on ordinary income and 30% on capital gain (in some states, like California, with high state income taxes, the overall rates can be closer to 60% and 40%). This means that income tax planning has become a much bigger part of estate planning. We have effectively been transported back to before the 1986 Tax Act, when income tax rates were very high and income tax planning was a significant practice area for many professionals.
Goals of Income Tax Planning
Income tax planning generally focuses on ways to reduce, avoid, or defer the income tax effect of a taxpayer’s activities. This can include finding ways to keep current and future income from being included on an annual income tax return. It can also include finding ways to reduce the recognition of taxable income in any particular year, planning with the character of the income, and ways to increase tax deductions and credits. It can also mean shifting taxable income to lower-income taxpayer(s) while still allowing the family as an entity to continue enjoying the benefits of the income.
In focusing on the goals of income tax planning, however, you should always keep three important points in mind.
- This is a complex area of the law that requires the assistance of high level tax professionals.
- Follow the law or you may live to regret it.
- You always need to consider the effect of the Alternative Minimum Tax, which is ever present and sometimes surprising in its effect.