The Tax Hike Bullseye

Right or wrong, depending on your view of the world, we are losing more and more rights every day in a move towards bigger government in the United States and ultimately the bill for what that entails.  The left calls this justice, the right socialism, but the fact is that the current progression will affect you in one way or another in the future no matter your income level.

We cannot continue to print money to hand out for entitlements and not have repercussions somewhere!  The entitlements we do have, like Social Security, are already in trouble.   Adding even more entitlements, such as Universal Basic Income (UBI), as so many want, will surely win votes, but will ultimately bankrupt our fine country.
 
The greatest example of this slipper slope, we now find ourselves on as a country, is the Social Security Trust Fund, which is projected to be depleted by 2034.  If you are like me, and getting older every day, those are funds you have factored into your retirement plans.  What will we do if we no longer have a surplus from which to pay such payments to our nations retired?
 
The answer is one of three not very palatable choices: 1) cut Social Security benefits by up to 25%, 2) raise taxes, or 3) inflate away the entitlement debt and the value of the Social Security you do get.  My guess is that they will do all three when their backs are against the wall!
 
How about the current proposed $3.5 trillion Infrastructure package?  The Biden Administration has promised that this yet to be approved bill will have “zero cost.”  The fact of the matter is it will have a cost.  Nothing has a “zero cost” but instead taxes will have to be raised to offset or zero out these costs.
 
Right on que, the House Ways and Means committee just that last week announced their plan to pay for the Infrastructure Bill.   Here is their official list of possible tax increases on the table.
 
What they plan is to tax the rich and effectively close some loopholes in the tax code to pay for most of this bill.  Notice I said “most.”  They could not even figure out how to get the entire $3.5 million needed without moving to on to the Average American for the rest of the dollars.  They instead conveniently pretend the math will somehow work out!
 
Higher Taxes for Everyone
 
Let me tell you where this is going.  The House Ways and Means Committee list of tax increases gives us a big hint.  There is a tax that currently applies to net investment income (NIIT) under section 1411 of the Internal Revenue Code.  The NIIT applies at a rate of 3.8% to certain net investment income of individuals, estates, and trusts that have adjusted gross income above $250,000 for married taxpayers filing jointly and $200,000 for single taxpayers.
 
Now this tax initially was only on net investment income such as interest, dividends, royalty income, non-qualified annuities distributed earnings, and income from businesses trading financial instruments or commodities that are passive to the shareholder.  It also includes capital gains such as the gain from the sales of stocks, mutual funds and bonds, distributions from mutual funds, the gain on the sale of investment real estate and also on the gain on the sale of partnership or corporate interests.  The tax is fairly narrow and applies mostly to investment incomes.
 
However, the House Ways and Means Committee is suggesting this tax be applied to all types of income for those about the income thresholds mentioned above.
 
Do you see what just happened?  They got us used to the tax and then expanded it.
 
What happens next year or the year after when they are forced to deal with the Social Security Trust fund depletion?  Will this tax, as an example, now apply to all income levels?
 
The Time to Plan is Now
 
So why do I mention this?  Is it to get embroiled in a political discussion?  Heck no!
 
It’s to impress upon all our loyal readers and clients the urgency with which tax planning must now be part of your annual process if it is not already.  Whether you are for the change or against it, someone has to pay for it!
 
Margaret Thatcher famously said, “the problem with Socialism is that you eventually run out of other people’s money.”  You may not agree that we are headed towards Socialism, but no one can deny that there is no such thing as a “zero cost” program.  Someone must pay and that is going to be those with the ability to do so, no matter their income level ultimately!
 
It will start with the rich, but believe me, it’s coming your way too.
 
The solution is to be tax aware and to spend more time in the future arranging your affairs to minimize it’s drag on you and your family.  This is not un-American; this is just smart planning!
 
Some Ideas to Take Away
 
As a start I want to give you three simple ideas that anyone can use to lower their tax burden:

1. Own a business.  The business allows you to deduct costs that would otherwise be non-deductible and get a partial or full deduction for them.  This must be a real business with a profit motive, but assuming it is, you can deduct the cost of computers, office supplies, internet and more in the business, thereby reducing your overall family income.
2. Use the Right Bucket.  Here is one I see all the time.  How many Reddit traders have you heard about that have made thousands of trades and did not realize at the end of the year those gains required they pay taxes.  I can think of reams of stories of such traders.  What if they instead were buying and holding in their taxable account, but trading in an IRA?  Bingo, we have tax deferral and much less in the way of current year taxes.  The right bucket is critical! Other examples might be taxable bonds in tax deferred accounts, hedge funds in private placement insurance and so on. 
3. Insurance for Tax Deferral.  Insurance has a long history in the U.S. and a strong lobby.  Where the rules around traditional tax deferral vehicles such as IRAs, Roth conversions and traditional retirement plans will continue to evolve and loopholes close related to such structures, insurance will continue to be a place to find tax deferral or, if structured properly, tax free investment build up.

Let me give you an example:  In the past I had a client who sold out of his technical school for many millions of dollars.  He contracted with an insurance company to purchase a private placement variable life solution and then used those dollars to pay a series of premiums to the insurer that included most of his funds from the sale. 

What he got for this was tax free account build up, the ability to borrow his funds back and the funds automatically pass to the next generation when he passed.  The only thing missing in his planning was it was a part of his estate for estate tax purposes, at least the portion I managed as investment advisor.  However, he would not have been able to borrow against the policy had he moved it out of his estate.

So, this client, used this policy as his piggy bank.  He borrowed from it when he needed funds and repaid policy loans when he had an excess of funds.  Because all his money was in this policy, he had limited income annually and therefore paid little in taxes (and he lived in a very high tax state).  He mitigated the single insurer risk by having more than one carrier underwrite the risk (it was shared).

I could see more of this happening in the future as loopholes close and rates start to rise.
 
The Bottom Line
 
I believe taxes in this country are going to go up substantially in the years to come.  This post is obviously not about tax evasion.  Everyone should pay their fair share!
 
However, there is also nothing wrong with arranging your affairs in such a way as to minimize what your fair share is and that is the point of this post.  It is time to start thinking about it as I believe the forces of taxes, inflation and more will make it harder and harder for average Americans to make ends meet!
 
This post is for educational purposes only.  Please consult your tax professional before using any of the ideas presenting in this post.

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