How the Tax Code Affects
Planning for Individual Taxpayers
Armond Dinverno, JD, CPA, CFP
Co-President
Balasa Dinverno & Foltz LLC
Itasca, IL
President’s Advisory Panel on Federal Tax Reform
March 16, 2005
Chicago, Illinois
Introduction
• Balasa Dinverno & Foltz LLC started business
in 1986
• Financial Management firm for individuals,
business owners, and pension plans
• 20 employees: 8 Certified Public Accountants, 2
Attorneys, 2 MBAs, and 8 Certified Financial
Planners
• Approximately $830 Million in assets under
management
How Do We Keep up With
Tax Law Changes?
• Constant amount of reading and research
• Specialists in our firm follow tax rules – it is
too difficult for generalists to maintain a tax
knowledge base
• We purchase specialized tax research and
software
• 2 of every 3 professionals in our firm are CPAs
as a result of our desire to be experts at how
income taxes affect our clients
The Tax Code Makes Achieving a
Simple Objective a Difficult Task
• Our Objective Is Simple → Maximize after-tax dollars
• Unfortunately, the complexity of the tax code makes
our job very difficult
• Because of the complexity, we must address numerous
issues before we advise clients on the best investment
alternatives. These issues include the following– Family tax filing status (and number of exemptions)
– Amount and sources of income
– Nature and amount of current financial assets
• Investments in taxable accounts vs. tax deferred accounts
– Real Estate
• Mortgage debt
• Home equity loans
• Rental property
Additional Planning Considerations
• Asset Placement – The right investments in the
right accounts to minimize the effect of income
taxes
– Can we maximize tax-deferred growth by using 401(k)
plans, IRAs, Roth IRAs, profit sharing plans, ageweighted plans or defined benefit plans?
– Place capital gain assets in taxable accounts and
high-income assets in tax-deferred accounts.
• Tax Loss Harvesting – Utilization of losses
associated with investments that have not
performed well
– Match losses with gains on investments that have
performed well
Differing Tax Treatment for
Investment Alternatives
Type of Investment
Taxable Bonds (held to maturity)
After-tax
Current
Returns
Tax
Zero-Dividend Stocks
After-tax
No Tax
Tax at Capital
Gains Rate
Dividend-Paying Stocks
After-tax
Tax at Dividend
Rate
Tax at Capital
Gains Rate
Municipal Bonds (held to maturity)
After-tax
No Tax
No Tax
After-tax (int.
deduction)
No Tax
No Tax
(up to $500K)
Roth IRA
After-tax
No Tax
No Tax
IRA
Pre-tax
No Tax
Tax at Ordinary
Rate
401(k)
Pre-tax
No Tax
Tax at Ordinary
Rate
Housing
Contributions
Sales/ Withdrawals
No Tax
Tax-Advantaged Accounts
Navigating Complexity
•
•
•
Because of differing tax rates, tax treatment and favored tax
status, it is difficult for taxpayers to choose the investment
alternative that would maximize after-tax returns
Due to the various sunsets of tax provisions, taxpayers are
challenged to plan for the future, i.e., whether the current tax
treatment will stay in effect
For example, a simple decision of what to do with an additional
$250 of savings creates the following dilemma driven by the tax
code:
–
–
–
–
–
–
–
–
Apply it to the mortgage
Apply it to credit card debt
Save it in a 401(k) plan
Contribute it to an IRA
Contribute it to a Roth IRA
Save it for college in a 529 plan
Invest it in a taxable account
The easiest solution but maybe not the best – spend it
Common Mistakes Taxpayers Make
• Due to the complexity of the tax law,
taxpayers have difficulty navigating
through the rules to determine the best
investment alternative
– Not saving enough for retirement because
they don’t know whether to save in a 401(k)
plan or other contributory plan
– Using municipal bonds in taxable accounts
– There are approximately 100 different
college savings plans
Common Mistakes Taxpayers Make
• Taxpayers let the tax tail wag the dog
instead of making good economic
decisions (the complexity of the tax
law leads to poor decisions)
– For example, not selling assets for fear
of paying taxes when sound economics
encourage a sale
Other Common Mistakes
• Failing to compute after-tax performance due to the
complexity of that calculation
• Paying additional taxes by not increasing the cost basis by
mutual fund dividend reinvestments
• Forgetting about carry-over items from previous years
• Not meeting deadlines for setting up qualified retirement
plans
• Failing to name (or naming the wrong) beneficiary to an IRA,
401(k) or other retirement plan
• Converting short-term debt into long-term debt with a Home
Equity Loan
• Not planning for the Alternative Minimum Tax (AMT)
• Failing to claim deductions or tax benefits due to not knowing
what is deductible
Conclusions
• The time and money spent on figuring out the
tax code could be more productively used by
taxpayers thereby making their lives simpler.
• Simpler taxes and an easier application of the
tax law will help taxpayers make better
economic decisions.
• Better economic decisions will help maintain
the economic growth engine of the United
States.
Appendix
Tax Treatment of Income and Investments
Also Creates Compliance Burdens
• If a professional firm prepares a client’s
return, the client must complete a 15-page
data questionnaire with 150 questions.
• There are at least 14 possible tax forms to
collect in the preparation of a tax return: W2, W-2 G, 1099-MISC, 1098, 1099-S, 1099INT, 1099-OID, 1099-DIV, 1099-B, 1099-G,
1099R, 1099-E, 1099 RRB, 1042S RRB.
• Even taxpayers who use a return preparer
face complexity.