Parkside Advisors serves its clients through three integrated services: financial planning, investment management and tax planning. When a client engages Parkside Advisors, we review their recent federal and state tax returns and associated documents. Together, our tax and financial advisors check for accuracy and look for opportunities, while raising questions to understand the client’s total financial picture and goals.
Here are seven areas where we often discover opportunities.
- Planning for employer equity compensation including incentive and non-qualified stock options, restricted stock units, performance stock, employer stock purchase plans and common stock grants. We track and maintain option and RSU grant and vesting schedules with clients to plan the optimal exercise and diversification plan for their goals while considering tax implications.
In one recent example, we reviewed a new client’s tax return, to discover that her stock option sales were incorrectly reported as both W-2 wage income AND short term capital gains, overstating her taxes by more than $100,000! There are significant opportunities to maximize the after-tax value of employer equity compensation.
- Capital gains. We are surprised by the frequency with which capital loss (and net operating loss) carryforwards get dropped, often when the client switches tax preparers. Capital loss carryforwards offset gains in future years. In California, at the highest Federal and state tax rates, capital loss carryforwards can be worth 37% of future long term gains and 54% of short term gains.
Gifts of appreciated securities to young adult children are often an opportunity. Single filers with less than $38,600 and joint filers with less than $77,200 of taxable income pay 0% federal tax on capital gains. High income taxpayers pay Federal capital gains tax at 20% plus 3.8% net investment income tax, so in certain cases, gifts of appreciated securities can save significant taxes.
Has the client been harvesting capital losses in their taxable investment accounts? Harvesting losses to offset realized gains at year end defers tax and can create an opportunity for tax arbitrage, pushing gains into years with lower tax rates while allowing the money saved in taxes to remain invested.
- Tax-deferred retirement savings. We look at retirement savings options available to clients. Is the client taking full advantage of employer plans such as 401(k)s, 403(b)s and 457 plans? Are they making after-tax contributions, such as after-tax contributions allowed by their employer’s 401(k) plan and/or non-deductible IRA contributions?
If they have made after-tax contributions in the past, are they maintaining those records by filing Forms 8606 with the IRS or by meticulous record-keeping of past contributions to employer plans? If not, they will be double-taxed on those after-tax contributions when they withdraw funds in the future.
If they are self-employed, are they maximizing contributions with a combined Defined Benefit Plan and Solo 401(k)? These plans allow for much higher contributions than a SEP IRA, in some cases up to $255,000 per year.
Are they considering their tax rate now compared to what is expected in retirement, and deciding whether to make traditional 401(k) contributions or Roth 401(k) contributions based on the differences?
- Managing charitable donations for tax benefit is one of the best opportunities for tax reduction for clients with charitable goals. The standard Federal deduction has been increased to $24,000 for joint filers, and the deduction for state and local taxes has been limited to $10,000. Therefore, joint filers with little or no mortgage interest will receive little or no benefit for incremental itemized deductions of up to $14,000.
In these cases it can make sense to front-load donations for multiple future years into a single year using a donor advised fund (DAF). DAFs allow for bunching several years of donations to 501(c)(3) organizations into a single year, while parsing out the distributions to the organizations you support over as many years as you want. You can (and should!) use appreciated securities with embedded long-term gains to fund donations and avoid Federal and state taxes on appreciation of those assets. You can reinvest the donated assets into a diversified investment portfolio. DAFs eliminate the need to keep track of donations and acknowledgements from the organizations you support.
- Take-home earnings vs. budgets. We start by comparing take-home earnings to what we’ve learned from the client about their spending and saving habits. If take-home pay is higher than spending, do investment accounts reflect that? If not, have the surpluses been used for one-time expenses, such as a home remodel, or for lump-sum savings for college? If not, perhaps the client is spending more than he or she is aware.
- Business income and expenses. We look at business income and expenses to see if clients are deducting all allowable expenses, including, for example, those associated with a home office. Common opportunities include accelerating or deferring income and expenses for greater benefit, whether to capitalize or expense certain purchases and, if clients own rental property, whether they are aware of energy credits for home energy equipment.
- Health insurance and medical expenses. Is the client reporting health insurance and long-term care insurance premiums to their best advantage? We recommend clients make the maximum allowable contribution to a Health Savings Account (HSA) to get an above-the-line deduction and then leave the funds in the account. The HSA can be invested for maximum growth and distributed tax-free for healthcare expenses later in life. After age 65, funds withdrawn and not used for medical expenses are subject to ordinary income tax, as if they were coming from an IRA.
This is only a partial list of what Parkside considers when reviewing a new client’s tax return. If you know someone that could benefit from this type of review, please introduce them to us!