Winning at the Tax Game Takes Forward Thinking (Opinion)

Will Rogers once said, “Even when you make a tax form out on the level, you don’t know when it’s through, if you are a crook or a martyr.” Let me suggest that in the near future, most of us will feel much more like martyrs. The Tax Foundation found that during 2007, the top 1 percent of income earners paid more in federal income tax than the bottom 95 percent. The National Tax Union found that in 2007, the bottom 50 percent, paid less than 3 percent of the total IRS tax revenue.

In the last two years, those making more than $250,000 per year understand who the government considers wealthy. No one I know that makes over $250,000 feels they are wealthy. The government is clearly targeting this group. Whether the Bush tax cuts are extended, increases in tax rates for the newly defined wealthy are coming.

Ronald Reagan once said “Government’s view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it.” 

• If it moves, tax it. The current Internal Revenue Code has more than 70,000 pages. The IRS also has over 3,385 publications that help explain the rules. These estimates do not include the newest legislation like health care reform, which will be implemented over the next 10 years and add an additional tax of 3.8 percent for payers with adjusted gross income over $200,000.
• If it keeps moving, regulate it. The recently passed Dodd-Frank Wall Street Reform and Consumer Protection Act is more than 2,300 pages long. That is almost twice as big as Leo Tolstoy’s epic novel “War and Peace.” It has 243 new rules that will impact 10 federal agencies. So far there is not direct legislation that increases taxes. However, the added costs to financial institutions to keep up with the new regulations will inevitably be passed on to consumers.
• If it stops moving, subsidize it. Government bailouts of the auto and banking industries in 2008 and 2009 are recent examples. The Associated Press and NBC estimated the maximum costs of the $700 billion Emergency Economic Stabilization Act alone would be $2,295 per American OR $4,635 per working American.

It should be clear our current budget deficit and national debt demand there will need to be more government revenue generated in the future. Cutting waste doesn’t seem to be an option, so raising taxes on the wealthy will likely be the easiest for congress to implement.

So, what’s the solution?

Insurance, next to taxes, is probably the second most-hated word in our financial culture. However, structured properly, life insurance products have great tax savings ability the truly wealthy understand and take advantage of. Take a hint from the wealthy and educate.

There are a lot of tax incentives currently available for purchases of energy efficient products. If you are planning to upgrade home appliances, remodel your home or purchase equipment for your business, review the current tax credits for going green. These incentives offer up to 30 percent of the expenditures as a tax credit, though many end this year.

401(k) plans are well-known and most commonly used but represent only one type of plan in over a dozen described by the IRS. Each of these has different designs and a variety of ways to accomplish an employer’s goals.  

Let’s look at a simplified illustration:

Bill is 55 years old and a small business owner with six employees. His business consistently generates over $1 million, of which he nets between $500,000 and $600,000 a year from salary and profits. In a traditional 401(k) plan, he might be able to contribute the maximum $54,000. However, Bill implements a more complex retirement plan customized for his business, age and payroll that has allowed him to contribute and deduct more than $150,000 a year. This has saved Bill an additional $40,000 a year in income taxes over the widely used 401(k).

Unlike high-income W2 wage earners, a business owner has much more opportunity to maximize tax deductions and diversify the tax laws like we see in the example. Historically, the tax laws on the books were put there understanding that behind consumers, small business drives the economy. You need professionals that stay on top of the tax changes and are continually educated in cutting-edge strategies. The value they can provide far outweighs what you pay them.

IRS publication No. 1 states, “You are responsible for paying only the correct amount of tax due under the law – no more, no less.” This is very subjective. Therefore, play the game. If you don’t believe it’s a game, notice when you put “The IRS” together, its spells “THEIRS”. If you make over $250,000 a year, it’s clear the government views this as theirs. It’s not what you earn, it’s what you keep that counts. The more you keep, the better chances you have to win. 

(Troy A. Kestner, CFP, is a financial advisor with Arvest Asset Management and vice president with Arvest Private Banking in Fayetteville. He can be reached at 479-684-4232 or [email protected])