With evolving tax codes and complex planning vehicles, the high-stakes game of tax strategy can seem daunting for even the savviest investors. However, the rewards for skillful navigation are well worth the effort. Advanced tax planning presents high-net-worth individuals and families with lucrative opportunities to actively minimize tax exposure, unlock savings and optimize wealth transfer.
By employing an evolving, personalized tax strategy aligned with your distinct financial objectives and legacy goals, you can confidently navigate regulatory shifts, seizing advantages at every turn. This article explores key tax planning approaches available to high-net-worth taxpayers, equipping you with an informational foundation to begin your journey towards a more tax-efficient future. Let's dive in.
Deciphering the Tax Landscape
Evolving Federal Legislation
Recent changes in tax codes and legislation have had a profound impact on the financial strategies and outcomes of high-net-worth individuals. For example, adjustments in federal as well as state income tax brackets, both upward and downward, directly affect near-term tax burdens.
Meanwhile, proposed modifications to long-term capital gains tax rates and associated income thresholds could substantially influence future investment behaviors and planning approaches. Additionally, recent alterations to the federal gift and estate tax exemption amount (now over $13 million per individual) along with continued uncertainty over the exemption's future makes legacy and philanthropic transfer planning tricky.
Global Taxation
Adding further complexity is the global nature of taxes for individuals and families with multinational investment holdings or business activities. Laws such as FATCA have intensified reporting requirements to the IRS concerning details on assets held abroad, with steep penalties acting as enforcement mechanisms.
Meanwhile, double taxation agreements (or DTAs) between countries present opportunities to avoid or reduce getting taxed twice on the same stream of income. But successfully leveraging DTAs requires intimate knowledge of treaty specifics as well as careful structuring of assets, accounts or foreign business operations.
Tax-Smart Investing
Tax-Advantaged Accounts
Leveraging retirement accounts like traditional and Roth IRAs is a foundational tax planning strategy. Traditional IRAs provide tax-deferred growth, meaning you avoid paying taxes on investment gains annually and only owe tax at withdrawal—potentially at lower rates in retirement. Meanwhile, Roth IRAs are funded with after-tax dollars but then grow and can be withdrawn from completely tax-free (in most cases), creating a source of tax-free income in retirement.
Municipal Bonds
Investing in municipal bonds allows you to preserve capital while generating a stream of income free from federal (and sometimes even state) income taxes. Their tax-exempt status makes “munis” especially appealing for high-net-worth investors already in higher income tax brackets. However, the tradeoff is that municipal bonds typically offer lower nominal yields compared to taxable bonds. Careful analysis is required to weigh the tax benefits against the opportunity cost of accepting a lower yield.
Strategic Timing of Asset Sales
Capital gains tax can take a significant bite out of investment returns. By strategically timing when you sell appreciated assets to align with years in which you expect to be in lower income tax brackets can help capitalize on lower long-term capital gains tax rates.
Another tactic is tax-loss harvesting, which involves realizing capital losses to offset recognized capital gains, thereby reducing total tax due. However, loss harvesting requires navigating complex IRS wash sale rules, making expert guidance invaluable.
Real Estate Deductions and Credits
Real estate investments can present lucrative opportunities to reduce tax exposure through various deductions and credits, which is why property often forms a key component of high-net-worth investment portfolios. For example, rental real estate owners can accelerate depreciation deductions on buildings through detailed cost segregation studies, enhancing near-term cash flow.
Investing in opportunity zones may allow for the deferral and reduction of taxes on prior capital gains. Energy efficiency investments and upgrades can also qualify for valuable tax credits.
Transferring Wealth
Strategic Trusts
Trusts provide a customizable structure to lock in asset protection features, minimize estate taxes and enable efficient intergenerational wealth transfer. There are two main types of trusts:
- Irrevocable life insurance trusts (ILITs) cannot be altered after being set up, with the grantor surrendering control. In return, they allow high-value life insurance policies to be kept out of the taxable estate upon death. This means that premium payments escape gift and estate taxes even as heirs can receive substantial tax-free payouts later.
- Grantor retained annuity trusts (GRATs) retain some limited income for the grantor but allow for all the future appreciation of assets placed in the GRAT bypass estate tax.
Gifting
Implementing a consistent gifting strategy is another way that high-net-worth donors can simultaneously reduce their tax burden while immediately supporting causes they care about. Taking full advantage of the substantial annual gift tax exclusions along with effectively leveraging lifetime gift and estate tax exemptions allows for significant wealth transfer without incurring gift taxes.
Life Insurance
The unique structure and treatment of whole life, universal life and other policies allows them to fulfill roles in minimizing taxes paid out both during the insured's life and beyond. As such, insurance should be considered not in isolation but holistically across the entire wealth management and estate planning spectrum for high-net-worth individuals.
Charitable Strategies
(See our previous blog post for an in-depth exploration of charitable giving tax strategies.)
DAFs vs. Foundations
For philanthropic planning, high-net-worth individuals can choose Donor-Advised Funds (DAFs) or private foundations. DAFs allow immediate tax deductions and flexible granting without administrative burdens. Private foundations, on the other hand, enable greater control but come with higher costs and stricter deduction limits.
Charitable Trusts
Vehicles like Charitable Remainder Trusts and Charitable Lead Trusts integrate giving into planning. The former provides donor income with the remainder going to charity, potentially increasing deductions and savings. The latter provides donations upfront and then passes the remaining assets to heirs, reducing estate taxes.
Strategic Bunching
Bunching multiple years of donations into one tax year can help high-net-worth donors maximize itemized deductions for their generosity via savvy planning aligned with financial goals.
Advanced Tax Reduction Approaches
Captive Insurance
High-net-worth individuals and families can realize tax advantages by creating their own captive insurance company structures. These private self-insurance vehicles allow greater control in covering risks faced across business, investment and personal domains while also generating tax deductions. Premiums paid to fund the captive are normally tax deductible, thereby reducing overall taxable income for the premium payer. Captives can also provide asset protection features and allow for potential long-term investing tax shelters.
Conservation Easements
For high-net-worth landowners with significant acreage, donating perpetual conservation easements restricting future development rights while preserving ecological or historical characteristics can fulfill philanthropic and environmental goals. At the same time, properly structured easement contributions meeting requirements can generate significant one-time income tax deductions.
QSBS Exclusions
Under Section 1202 of the U.S. tax code, certain investment gains derived from sales of qualified small business stock (QSBS) held for a requisite period can qualify for preferential capital gains tax treatment. Eligible investors in startups can exclude as much as 100% of gains accrued from taxable income. So not only does this provision incentivize and reward investment in young companies; it presents a highly attractive tax planning option for eligible high-net-worth angel investors or VC backers.
Next Steps
In the realm of wealth management, strategic tax planning is not just about compliance—it's about seizing opportunities to enhance financial well being and secure a lasting legacy. The key points discussed in this article serve as a foundation, but the journey to tax efficiency is ongoing and ever evolving.
With ETS as your partner, you can confidently navigate changes, knowing your tax strategy safeguards and enhances your wealth. Contact us today to begin crafting a tailored tax approach reflecting your distinct legacy goals. Let's build your enduring legacy, together.
