Nobody looks forward to tax planning, but it’s something that everyone, at some point, must do.
However, instead of looking at tax planning as a burden, look at taxes as part of the cost of a transaction. The focus, therefore, should not necessarily be on the minimization of taxes but on the maximization of the net present value of after-tax cash flows, says John T. Alfonsi, CPA, ABV, CFF, CFE, CVA, managing director of Cendrowski Selecky PC.
“As an example, if a transaction can be structured multiple ways, the alternative that produces the least amount of taxes may not be the most advantageous with respect to after-tax cash flow,” says Alfonsi. “You should be willing to incur a greater amount of taxes if it will ultimately result in greater after-tax cash flow.”
Smart Business spoke with Alfonsi about tax planning, how to perform it properly and what challenges come along with it.
Are there certain tax planning strategies that always apply?
Nothing fits every scenario. There are certain general tax planning strategies, such as deferring the recognition of income and accelerating deductions, but even these have exceptions. When you know, or are fairly certain, that tax rates will increase, the opposite may be more advantageous — accelerating income and deferring transactions.
For example, absent any legislation passing in the next six months, the top marginal income tax rate on ordinary income for individuals is increasing from 35 percent in 2010 to 39.6 percent in 2011. Similarly, the maximum capital gains rate is increasing from 15 percent in 2010 to 20 percent in 2011. Accordingly, taxpayers may want to consider taking advantage of the lower rates in 2010.
What should be considered when it comes to tax planning?
Timing of the transaction is critical to the analysis. Accelerating a deduction from 2011 to 2010 may make sense, given the rate differential, if you would otherwise have incurred that expense in early 2011. The time value of the money used for that expense needs to be considered; it may not make sense on a present value basis to accelerate that deduction if you would have otherwise incurred it in late 2011.
Stated alternatively, the lost time value of the money used to fund the expense may more than offset the incremental tax savings realized with respect to the rate differential. Each transaction and alternative needs to be analyzed, again, with a goal of maximizing the client’s present value of after-tax cash flow.
