Debt and Taxes, Part 2: How to make friends with the US Tax Code

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[Note: Today’s e-Newsletter, Part 2, will be followed tomorrow and Friday by parts 3 & 4. Part 1 is available here. In part 3 we discuss taxation of your business, and part 4 focuses on retirement plans.

Also, for those of you who have asked, we welcome you to forward our newsletter to anyone who may be interested. We also invite them to e-mail Adam ( if they would like to be added to our recipient list.]

Global stocks fell -2.6% on Tuesday, their biggest drop since November. There’s no particular catalyst, just the same old worries about European debt and slowing Chinese growth. As unpleasant as they are, days like Tuesday are a necessary part of any bull market, scaring away the marginal investors and setting the stage for the next move up. I don’t think the drop signals the start of another market correction such as we had last year.

Let’s talk taxes

As we move closer to Election Day, taxes will figure ever more prominently in political rhetoric. Conservatives apparently hate taxes; liberals supposedly love them. The reality, of course, is far more complex, but you’d never know it from listening to the pundits on CNN or Fox.

Whatever your economic beliefs, taxes are here to stay. Fight all you want for a “fair” tax code, but in the meantime let’s make the best of what we have. As a wealth manager, helping clients pay the lowest taxes (legally) possible is part of my job. Using the tax code to minimize your tax bill isn’t unpatriotic: it’s just good business. (Cheating on your taxes, on the other hand, is both unpatriotic and risky.)

In my last eNewsletter, I wrote about using debt to reduce taxes and make inflation work in your favor. Today, I’ll discuss other ways to use the tax code to give Uncle Sam only that to which he is entitled, and not a penny more.

Don’t let the taxman into the driver’s seat

One mistake I see over and over is letting potential tax savings drive investment decisions. Not infrequently, an otherwise financially sophisticated person will purchase an investment product almost entirely on the basis of its tax characteristics, without looking at whether the investment as a whole makes sense. I strongly encourage looking at the tax aspects of all investments, but as just one of the many components of risk and return. You should consider all of an investment’s characteristics and not focus on tax savings exclusively. And you certainly don’t want to pay many $thousands to the IRS when your “tax shelter” is disallowed!

At the margin

We all know that tax rates are going up, perhaps as soon as next year. Currently, the top rate is 35%, and most expect it to increase to the 39.6% that existed under Clinton. (It may seem like eons ago, but the top tax rate was 50% for 6 of the 8 years that Reagan was President, and 70% from 1965 to 1981!)

You often hear pundits argue about how high tax rates have to go before “rich” people decide to work less because so much of their income goes to the government. This idea comes from the Laffer Curve, which suggests that government revenue decreases once tax rates exceed a certain threshold.

Unfortunately, nobody knows what that threshold is. Also, the argument that wealthy people work less as their tax rates climb seems specious: how many wealthy people that you know are even capable of “taking it easy?” More likely (and I speak from experience), as tax rates rise, people divert more of their energy toward tax avoidance and away from more productive pursuits. Eventually, they may start cheating en masse (as in Greece).

But to the individual taxpayer, higher rates are not all bad, because it’s the total tax bill that counts, not what you pay on that last dollar. In fact, higher tax rates make deductions more valuable and tax planning more effective (and important). Here’s a real life example: When I was in college, a wealthy friend wanted to make a donation to the Lowell House Opera. He told me that he could give much more if the donation was tax deductible, because the IRS would foot 70% of the bill. So if rates really do go up next year, it’s a chance to save even more with creative tax planning (proving that even taxes can have a silver lining).

Dr. Ken Waltzer MD, MPH, AIF, CFA
Founder and President – Kenfield Capital Strategies (KCS)