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Legal Matters > Recover Lost Wealth
Get Your Own Bailout
The federal government won’t pay you just for the asking, but
you can recover investment losses with a variety of tax benefits.
By Carole C. Foos, CPA and david b mandell, jd, mba
The recent developments in 2008 have left many of us with less wealth than we
had just a year ago. Our home and stock market investments are likely worth a
lot less...and it may be years until the values of these assets return to
previous levels. The federal government has agreed to spend hundreds of
billions of dollars to bail out poorly run or mismanaged corporations. These
bailouts will ultimately result in significant tax increases for all of us. It
is natural for you to feel frustrated and upset that you will have to pay for
other people's mistakes. What you didn't know, until now, was what you could do
to get the government to help bail you out with some tax savings. Though our
firm has strategies for managing investments in this type of market, the
purpose of this article is to highlight a few tactics for regaining some of
your lost wealth. The strategy has two simple steps to help you make up for
lost wealth. First, you will reduce your taxes now so you will have more to add
to your short term investment portfolio. Second, you will focus on building
future wealth more tax-efficiently for the long term. Let's examine both ideas.
Reduce Taxes Now
If you can pay less in taxes in 2008 and 2009, you may be able to recover much
of the wealth you've lost over the past year or two. How can you reduce taxes
significantly? Consider the following techniques, which can be used even for
small and solo-owned businesses:
Utilize the right entity for your practice. Many physicians today are using the
wrong ownership form for ideal tax planning. Choosing the right entity among
"S" or "C" corporations, or limited liability companies, could turn into tax
savings of $10,000-$45,000 annually.
Consider non-qualified plans, in addition to pensions/401(k)s. Non- qualified
plans are relatively unknown to many doctors, despite the fact that most
Fortune 1000 companies make non-qualified plans available to their executives.
This type of plan should be very attractive to doctors, however, as employee
participation is often limited and inexpensive. Further, nonqualified plans
generally allow larger annual contributions for the owners than traditional
qualified plans do. Some plans can offer annual contributions as large as
$100,000 to $200,000 per participating owner or executive.
For larger practices, consider captive insurance companies. Closely-held Captive
Insurance Companies (CICs) are great tools for successful medical practices
looking for liability protection, risk management, tax, and wealth accumulation
benefits. The CICs we are discussing here are very small insurance companies
that primarily will insure your practice. These companies enjoy beneficial tax
treatment (made even better by a 2004 law signed by President Bush), allowing
the owners an opportunity to build wealth, as opposed to giving profits up to
insurance companies. Any of the above techniques, as well as numerous others,
could help you reduce taxes for 2008 or 2009. By doing so, you might recover a
percentage of the wealth you've lost as soon as this year. For longer-term
wealth recovery, longer-term tax strategies must be employed. We will discuss
this next.
Long term tax-efficiency for retirement and beyond
We spread our investments across different classes of investment so that, in the
event something bad happens that impacts one company or one industry, the total
portfolio is not significantly impacted by the event. With tax diversification,
a similar theory applies. If you have some investments that may be taxed as
ordinary income, some that may be taxed at capital gains or dividend tax rates,
and have some assets that may not be taxable at all, you have flexibility. The
concept is quite simple—a properly tax-diversified portfolio minimizes the risk of loss when taxes
increase and provides flexibility that can afford savvy taxpayers the
opportunity to minimize total taxes paid over a lifetime of investing. For this
reason, we advise our clients to have their wealth in multiple tax “buckets”—each with its own tax treatment. This provides flexibility that allows clients
to minimize long term taxes paid. In your case, this strategy may make up for
the wealth you may have lost recently—if you apply it properly.
Will tax rates rise or fall in the future? Tax diversification is especially important for the long term because taxes
today are extremely LOW. Study the federal income and capital gains charts (at
right) You will see that, given their history, income tax rates are close to
the lowest they have EVER been and capital gains taxes are the lowest they have
ever been. Given this, if you want to recover wealth from recent losses over
the long term, we think you must assume that tax rates will go up, not down.
Are most of your assets subject to future tax swings? Too many doctors have their wealth in only 2 buckets: (1) qualified retirement
plans, like pensions, 401(k)s or SEP IRAs; and (2) personally-
held taxable assets, like personal securities investments and real estate. The
problem with both of these asset classes is that they are both subject to
future increases in income tax rates, capital gains tax rates, or both. Whether
you are planning on taking funds out of a 401(k) or SEP IRA in retirement or
planning on selling stocks or living off bonds, you have no idea now what your
tax rates will be on that income in the future. If the charts above are any
indication, it may be at a much higher tax rate than today.
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You must use an investment “bucket” that is tax-immune. Unfortunately, far too few clients have diversified enough into a non-taxable
wealth “bucket.” By doing so properly, not only can you insulate much of your wealth from future
tax increases, but you can also help “make up” much of your recently lost wealth over the long term. What are such “tax immune” buckets? They may range from Roth IRAs, to non-qualified plans, to private
placement life insurance. As an example, one such non-qualified plan is
actually treated as a hybrid plan—with both qualified and non-qualified elements. It is a very flexible plan that
has numerous benefits for a practice. The contributions are partially
deductible and partially taxable at the outset. From a current tax perspective,
this is much more attractive than the “personally held taxable investments” which offer no deduction and less attractive than qualified plans that offer a
100 percent deduction. In the non-qualified plan, the funds grow tax-deferred,
which is the
same as the qualified plan and better than the “personally-held taxable investments” class. When you are ready to access the funds, you can access funds in a
non-qualified plan without any tax liability. This is better than the “personally-held taxable investments” and far superior to the qualified plan. In this way, such a plan avoids the
risks of future income and capital gains tax rate increases in a substantial
way—and can act as an ideal long-term recovery for lost wealth.
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In addition to playing the role as a future tax increase hedge and “recovery” wealth tool, the hybrid plan offers the following attributes:
• The plan can be utilized in addition to a qualified plan like pension,
profit-sharing plan/401(k) or SEP IRA.
profit-sharing plan/401(k) or SEP IRA.
• The funds in the plan can grow in the top (+5) asset protection environment in
most states and always in a good (+2) environment at minimum.
most states and always in a good (+2) environment at minimum.
• Maximum contribution levels are $100,000 per doctor in practices with 10
employees or less. In larger practices, these levels can be even higher.
• In a group practice, not every doctor need contribute the same amounts—extremely beneficial for group practices who have doctors who want to “put away” differing amounts. There are no minimum age requirements for withdrawing income
(no early withdrawal penalties). The transfer of assets at the doctor’s death is income tax-free to heirs.
Conclusion
We have all lost some wealth in the last year. The key to future financial
success is how you react to this lost wealth. If you would like to explore ways
to recover that wealth quickly for the short term and on an ongoing basis for
the long term, you should focus on tax planning. By doing so, you can get a
jump on all the people who will sit around complaining about what has happened.
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For assistance with tax planning, authors, David B. Mandell and Carole C. Foos,
will gladly accept your questions. Please call (877) 656-4362.
