Tax planning ― be it income tax planning for the current year, estate and gift planning, or planning for retirement ― is initiated using the current knowns. The knowns are usually identified from the last income tax return filed or the most recent financial statement. They are also the tax rates, rules and laws in place when the most recent return was filed or on the date of a personal financial statement. The known information will grow less dependable as the years in the plan stretch out, creating the unknowns.
For example, income tax planning for tax year 2022 can be taken on with a reasonable amount of certainty. Since 2022 is an election year and given the current political environment, it would not seem likely that significant tax legislation will occur in 2022. Tax legislation is driven by social, economic and political winds. Can there be anything more unknown than what the social, economic and political winds might hold over the next two or three decades? Long-term planning for retirement or estate and gift tax planning is all about managing the unknowns.
Consider individual income tax planning. We can determine a client’s marginal and effective income tax rate from the 2021 return that we will be preparing for many clients in the coming weeks. The marginal rate is the tax rate that applies to the next dollar of ordinary or capital gains income. The effective rate is the total tax liability over taxable income. For many clients, these two numbers drive a great deal of planning around topics such as withholding on required minimum distributions (RMDs), Roth conversions, pros and cons of selling an appreciated asset, or taking a long-term loss on an asset that has failed to meet expectations.
On the other hand, consider retirement or estate and gift planning. You start with what you know in terms of the applicable credit amount, net worth, income needs, current tax rates, rates at retirement and projected inflation rates. As the years in the plan stretch out over decades, the need for continual follow-up is obvious. Who knows how the estate and gift tax system or rules regarding retirement plan distributions will change over the next 20 to 30 years (or the next two to three years for that matter)? The mechanism to address these unknowns is a regular and thoughtful review and update of your long-term plans with your Parsec advisor.
Tax planning unknowns are a given, and at Parsec it is our hope to reduce your anxiety over the unknowns one meeting at a time.