Here's another excerpt from Wealth by Stuart Lucas. I liked the book -- giving it 6 stars. So it's my pleasure to offer this excerpt from Chapter 8:
It should come as no surprise to you that taxes rank as either #1 or #2 on the list of expenses for the wealthiest Americans. In 1998, for example, my family paid seven times in taxes what we earned in profits in one of our investment entities! Today, taxes are our second biggest leakage behind spending, and without careful planning they would be the biggest.
By comparison, many institutional investors—pension funds and endowments, for example, that have billions of dollars in investments—don’t pay any taxes at all.
So what can you do to responsibly minimize your taxes?
While tax efficiency is a critical element in your investment strategy, most investment managers don’t concern themselves much with tax minimization because doing so doesn’t reap them any bottom-line benefits. After all, they are evaluated on pre-tax performance by almost everyone. But I’m here to tell you that evaluating your after-tax results is important. I will also tell you that, managed well, taxes can be your ally in the wealth management planning process.
The way the U.S. Tax Code works, the wealthier you become, the more control you have over how much you pay in taxes and when you pay them. There are also numerous incentives in the tax code that work in your favor to reduce risk and to help your assets grow more quickly.
Take-Away #1: U.S. Taxing Authorities Are Your Investing Partners
In previous chapters, I’ve talked about your partners in the wealth management process—accountants, lawyers, and investment managers. I have not included the Internal Revenue Service or your local taxing authorities in this list of wealth management partners—until now.
Today, federal income taxes are the largest source of federal government revenues, about 45% of the total. This is over 10 times the revenue typically generated by capital gains taxes. If the government needs a large revenue boost, it traditionally (and will likely again) raises income taxes significantly.
It may increase capital gains taxes at the same time, but the likelihood that they would ever equate with income tax rates is highly unlikely. Most likely, capital gains taxes will continue to be significantly lower than income taxes.
All that said, I prefer to think of U.S taxing authorities as investment partners, as opposed to adversaries. I also view that partnership in unconventional ways, which I describe in the following paragraphs.
First, when designing a wealth management strategy, it’s important to remember that, although the government sets the rules for how to calculate taxes in the tax code, the government in fact acts like a silent partner. Each taxpayer is left to apply the code’s rules to his or her own advantage. (More on this in Take-Away #2.) Our actions and decisions have an enormous impact on our tax liabilities!
Second, unlike accountants, lawyers, and investment managers who make money off your assets through fees, regardless of how well your investments do, tax authorities only benefit if you generate profits. If there are no profits, or profits are deferred, Uncle Sam doesn’t get paid.
Third, in exchange for taxing you, the government provides you with a wide range of services including defense, emergency services, a system of law, economic management, social security, and community infrastructure, such as roads, schools, and the like. All these are critical to ensuring a stable society, guaranteeing free commerce, and enabling you to get wealthy in the first place. Just how many billionaires do you know in the Sudan?
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A couple comments on this:
1. Evaluating your after-tax gains on investments is the proper way to evaluate them. In fact, you should deduct taxes, fees, and any other costs to get your bottomline return, then compare investment options to each other. After all, you want to make decisions based on what each investment puts in your pocket -- not what it earned you before a lot of other items were deducted.
2. Looking at the government as a tax partner (rather than an adversary) is one of the most interesting, unique, and compelling ideas from this book. Obviously the book gives greater detail than this excerpt, but this at least gives you a taste of what it says.
I want to thank Stuart Lucas for sharing these parts of his book. They've been quite enjoyable to me and I trust to you as well.
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