Year-end is here and you’re probably thinking about what you want to do with your money. You might be considering gifts to family, charitable contributions, investments in tax-deferred accounts and other options.

What you may not realize is that the taxation picture has become more complicated than it’s ever been with the Alternative Minimum Tax (AMT), the new tiers for capital gains rates and the new Medicare taxes on investment income. What often seems like the obvious choice may not, in fact, be the best option for your unique situation.

This is why you need to be talking to a professional to get good tax advice. I’d like to show you in this article some case studies where the obvious choice may not be the best choice.

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"There are many investment options today for affluent families. I enjoy digging in, doing the research and bringing solutions to the table."


Options for wealthy families

To build substantial wealth, it’s not all about how much money you earn on your investments. Often it is equally or more important to focus on how much you can keep after taxes. To build and maintain wealth, it is critical to pay attention to your tax rates and understand how your investments are taxed and where they are located.

But this may not be as straightforward as a lot of people assume. For wealthy families, the options for mitigating taxes can be plenteous. Yet with the alternative minimum tax, capital gains and the new Medicare tax on investment income, the picture is not always entirely clear. Choices that people make at the end of the year could have a huge bearing on how much wealth they retain versus pay out to the government.

This is why we use software tools that allows us to model different choices and their implications. I’d like to show you four case studies where the options require careful analysis to arrive at the best possible outcomes.


Case Study 1 – charitable giving

Let’s assume that you and your family have decided to make a year-end charitable gift of $10,000. Your intention is to bring joy to a charitable organization and support their mission. But the question you should probably consider is this: do we give the gift in December or January?

Most people assume that giving the gift in December is the best option both for charitable purposes and taxation purposes. But this may in fact not be the case. Here are the key points you need to consider as you are thinking about when to make your gift.

What tax bracket will you fall into this year versus next year? This can change from year to year. If you change jobs or sell a lot of stocks, these factors can impact your tax bracket, moving you from a higher to a lower bracket or vice versa. This is why you need to analyze your tax bracket as well as your charitable intent.

Here are reasons to consider making a contribution in December:

  • If your tax bracket in 2015 is much higher than in 2016, you’ll likely benefit more from making the gift this year.
  • If you are in the same tax bracket in 2015 and 2016, consider making the gift in 2015 so you can get the tax benefit earlier and put it to work for you sooner.

However, if you think your tax bracket will be higher in 2016, then you should consider making the gift in January to maximize the tax benefit against your higher income status in 2016. 


Case Study 2 – AMT planning

Everyone’s tax is calculated in the traditional way and the alternative way. The AMT tax does not allow you to deduct miscellaneous itemized deductions, state income taxes and real estate taxes, among other things. The more of these items that you pay, the greater the likelihood that you’ll be impacted by AMT.

I had a client who exercised options of his company’s stock in 2015. Each year, the client was normally in the AMT, and realized no benefit from his state income tax or real estate tax payments. In 2015, however, due to the additional stock option income, his income rose to a level at which he was now out of the AMT and in the regular tax bracket. Because this was expected to be a one-time event, the client expected to be back in the AMT in 2016 and beyond.

The client had two AMT items that were due to be paid in 2016: his large state income tax bill, due in the spring, and his real estate tax bill, due in the summer. Instead of waiting until then to pay them, he made a fourth quarter state tax payment of $30,000, and lived in a county that allowed him to prepay his 2016 real estate taxes of $20,000 in December, 2015.

Because he paid the $50,000 in bills in 2015, and was in the top 40% tax bracket, he was able to get a tax benefit of $20,000. However, if he had waited until 2016 to pay the taxes, he would have realized no benefit because he would have been in the AMT.

So, it is important to know when you are in and out of the AMT so you can realize the maximum tax benefits from paying state taxes and real estate taxes.


Case Study 3 – tax-loss harvesting

Investors in emerging markets might be seeing losses on their investments. At year-end, a lot of people think it’s the best course of action to take the losses in the current calendar year. However, I prefer to ask this question: is it better to take losses this year or wait until next year? A careful analysis demonstrates why this question is important.

There are different federal capital gains tax brackets: 0% for low-income, 15% for medium income, 20% for high income, and an additional 3.8% Medicare tax for those above certain income thresholds. It’s very difficult for people to know what capital gains tax bracket you’re in based on your income. You need to run analyses to understand which year is best to claim your losses.

Let’s assume you are planning to retire next year but are working this year. You look at your income and see that you are earning $200,000 a year and you are married. You look up your tax bracket on TurboTax and discover that you’re in the 15% capital gains bracket.

However, this analysis fails to take into account the fact that you’re in the AMT, which means you are actually in the 20% capital gains tax bracket.

Let’s assume that by next year you’ll be in the 0% tax bracket. In this scenario, you would be better off taking your losses this year because by next year, you will not get the benefit of tax losses because you’ll be in a much lower tax bracket. How do you do this?

This is called tax-loss harvesting and it’s a fairly simple process. Let’s assume that you have an energy stock that has lost value. You can sell that stock and take the loss but reinvest all the proceeds back into another energy stock.

The net effect on your asset allocation is essentially nil. However, the net effect on your tax burden for this year is a substantial reduction in taxes paid. This is about capturing your losses at a time when you can benefit from them as opposed to a future time, down the road, when you cannot benefit from them.


Case Study 4 – donor-advised funds

Donor advised funds are a way for you to realize double deductions on your taxes. See the article from my colleague Brian Henderson about similar types of strategies.

A donor-advised fund is a financial vehicle established at a public charity. It allows you, the donor, to make a charitable contribution, receive an immediate tax benefit and then recommend grants from the fund over time.

A donor-advised fund is like a charitable savings account: a donor contributes to the fund as frequently as they like and then recommends grants to their favorite charity when they are ready.

Not only do you get the charitable deduction for the fair market value of the stock at the time of the gift, but you also avoid paying capital gains taxes on the gains of the stock. You can use this strategy for long-term giving, over several years.

You can contribute additional funds to the charitable giving account during high tax years, and then use the excess you contributed to skip contributing in low tax years – without affecting the timing on when your favorite charity gets their gift from you.

Is a donor-advised fund right for your family? Maybe, but this will depend on a lot of factors. We can explore this in greater detail in a meeting.


Next steps

As you can see, from these four case studies, there are probably more options available to you than you might have realized. More than that, the choices about when to execute these strategies can have a huge bearing on the outcomes you realize. This is one of the primary reasons we use sophisticated software to model different outcomes based on different approaches.

As you think about your year-end situation, I’d appreciate an opportunity to discuss how to help you retain more of your wealth. If I can be of assistance, let’s have a conversation.


The information contained in this article is provided for informational purposes only. No illustration or content in it should be construed as a substitute for informed professional tax, legal, and/or financial advice.