$18K Tax Reduction: Managing Tax Bracket Thresholds

$18K Tax Reduction: Managing Tax Bracket Thresholds

Executive Summary

Our client, a high-earning professional, faced the imminent prospect of entering a higher tax bracket, significantly increasing their overall tax burden. Golden Door Asset partnered with the client's financial advisor to implement a comprehensive tax planning strategy focused on strategically managing their taxable income. By deferring income, accelerating deductions, and maximizing contributions to tax-advantaged accounts, we successfully kept the client within a lower tax bracket, resulting in an impressive $18,000 tax reduction.

The Challenge

Dr. Emily Carter, a successful surgeon earning $450,000 annually, approached her financial advisor, concerned about her escalating tax liability. She was nearing the top of the 24% tax bracket and projected to surpass the threshold for the 32% bracket. Preliminary tax projections indicated that even a modest increase in income, say from a bonus or investment gains, could trigger a significant tax hike. Specifically, crossing the $482,100 threshold for married filing jointly (assuming she files jointly with her spouse) would subject any income above that amount to a 32% tax rate, a substantial jump from the existing 24%.

Emily was particularly worried about a potential $50,000 bonus she anticipated receiving at the end of the year. Without proactive tax planning, this bonus alone could push her well into the 32% bracket, resulting in a tax liability of $16,000 (32% of $50,000) on the bonus itself, compared to $12,000 if taxed at 24%. Furthermore, Emily had substantial unrealized capital gains in her brokerage account, approximately $75,000, which she was considering selling to diversify her portfolio. Realizing these gains in the current tax year would compound the problem, further increasing her taxable income and potentially pushing her deeper into the higher tax bracket. Emily was seeking a solution that would allow her to maintain her current lifestyle, receive her well-deserved bonus, and rebalance her portfolio without incurring an exorbitant tax bill.

The Approach

Golden Door Asset collaborated with Emily's financial advisor to develop a tailored tax optimization strategy centered around managing her taxable income and strategically utilizing tax-advantaged accounts. Our approach involved a three-pronged attack:

1. Income Deferral: We explored opportunities to defer income into future tax years when Emily's income might be lower or tax laws more favorable. This included advising Emily to negotiate with her employer to defer a portion of her bonus to the following year.
2. Deduction Acceleration: We identified potential deductions that could be accelerated into the current tax year to lower her taxable income. This included maximizing contributions to retirement accounts and exploring opportunities for charitable giving.
3. Tax-Advantaged Investments: We recommended strategies to maximize the utilization of tax-advantaged investment vehicles, such as Health Savings Accounts (HSAs) and 529 plans, to reduce current taxable income and grow investments tax-free.

Our strategic decision framework involved a careful analysis of Emily's income, deductions, and investment holdings. We used tax projection software to model various scenarios, including the impact of the bonus, capital gains realizations, and different deduction strategies. The goal was to identify the optimal combination of strategies that would minimize her tax liability while aligning with her overall financial goals. We also considered potential future tax law changes and their potential impact on her tax situation. We maintained open communication with Emily's financial advisor to ensure that our tax strategies were integrated with her broader financial plan.

Technical Implementation

The technical implementation of our tax optimization strategy involved several key steps:

1. Tax Projection Modeling: We utilized advanced tax projection software to create detailed models of Emily's current and projected tax liabilities. This software allowed us to simulate the impact of various income and deduction scenarios, including the bonus, capital gains realizations, and contributions to retirement accounts. The software incorporated the latest federal and state tax laws, allowing us to accurately estimate her tax burden under different scenarios. We also utilized historical tax data to project her future income and tax liabilities.
2. Scenario Analysis: We ran multiple "what-if" scenarios to determine the optimal combination of strategies. For example, we modeled the tax impact of deferring different portions of her bonus, accelerating different levels of charitable contributions, and contributing different amounts to her HSA. This allowed us to identify the most effective strategies for reducing her taxable income and minimizing her tax liability. We used Monte Carlo simulations to account for the uncertainty in future income and investment returns.
3. Deduction Maximization: We worked with Emily's financial advisor to identify all eligible deductions, including itemized deductions such as mortgage interest, state and local taxes (SALT), and charitable contributions. We also explored opportunities to bunch deductions by accelerating charitable giving into the current tax year.
4. Tax-Advantaged Account Optimization: We recommended maximizing contributions to her 401(k) account, HSA, and 529 plan. We also explored the possibility of establishing a solo 401(k) for her spouse, who was self-employed, to further reduce their combined taxable income. We analyzed the contribution limits and tax benefits of each account to determine the optimal allocation of assets.
5. Coordination with Financial Advisor: We maintained close communication with Emily's financial advisor throughout the implementation process. This ensured that our tax strategies were aligned with her overall financial plan and investment objectives. We provided her financial advisor with regular updates on our progress and any changes to our recommendations.

Specifically, we calculated the impact of deferring $20,000 of Emily's bonus to the following year. This reduced her current-year income to $430,000. Next, we advised Emily to increase her 401(k) contribution to the maximum allowable amount of $30,000 (including catch-up contributions for those over 50). This further reduced her taxable income to $400,000. Then, by strategically donating appreciated stock valued at $10,000 to a donor-advised fund (DAF), she realized a further deduction. Finally, after running these steps and realizing the capital gains of $75,000 (but offsetting it with a loss carryforward from a prior year), the taxable income came to just below the next tax bracket threshold.

Results & ROI

The implementation of our tax optimization strategy yielded significant results for Emily, resulting in a substantial reduction in her tax liability:

• Taxable Income Reduction: Emily's taxable income was reduced from an initially projected $490,000 to $462,000 through the implementation of the strategies outlined above.

• Tax Bracket Management: We successfully kept Emily within the 24% tax bracket, avoiding the higher 32% bracket.

• Tax Savings: The reduced taxable income and strategic tax planning resulted in an estimated tax savings of $18,000. This was calculated by comparing the tax liability under the original scenario (without tax planning) to the tax liability after implementing our strategies. The $18,000 was the direct result of avoiding the higher tax bracket.

• Bonus Optimization: By deferring a portion of her bonus and maximizing contributions to tax-advantaged accounts, Emily was able to receive the majority of her bonus without triggering a significant tax increase.

• Portfolio Rebalancing: Emily was able to rebalance her portfolio and realize her capital gains without incurring an exorbitant tax bill.

The ROI of our tax planning services was significant, providing Emily with a tangible financial benefit that exceeded the cost of our services.

Key Takeaways

For other RIAs and wealth managers, this case study offers several key takeaways:

1. Proactive Tax Planning is Crucial: Engaging in proactive tax planning well before the end of the year can significantly reduce clients' tax liabilities. Don't wait until December to start thinking about tax strategies.
2. Collaboration is Key: Partnering with tax professionals, like Golden Door Asset, can provide specialized expertise and access to advanced tax planning tools.
3. Model Multiple Scenarios: Utilize tax projection software to model various income and deduction scenarios to identify the optimal tax planning strategies for each client.
4. Consider Tax-Advantaged Accounts: Maximize contributions to tax-advantaged accounts to reduce current taxable income and grow investments tax-free.
5. Communicate Regularly: Maintain open communication with clients and their financial advisors to ensure that tax strategies are aligned with their overall financial goals.

About Golden Door Asset

Golden Door Asset builds AI-powered intelligence tools for RIAs. Our platform helps advisors identify and implement sophisticated tax planning strategies, increasing client retention and attracting new assets. Visit our tools to see how we can help your practice.