Why Do Corporate Executives Believe Taxes are Out of Their Control?

Corporate executives often assume that a high tax bill is unavoidable. This is a partial truth. Yes, you are a high earner in a progressive tax code - in the U.S. tax rates increase as income increases - but the notion that you have no control over how much you pay in taxes needs to be challenged because overpaying taxes is a major risk to reaching your wealth and retirement goals. After all, taxes are your biggest expense!

Why Do Executives Feel Reducing Taxes Is Out Of Their Control?

Before delving into some simple tax savings strategies, let's explore why corporate executives may perceive that there are limited options for reducing taxes. Based on my experience, here are 3 reasons why I believe this notion persists:

1.) Tax Professionals Focus On Preparing Your Taxes, Not Saving You Taxes.

Accountants and tax preparers often focus on past data as opposed to forward-looking tax planning. This is not a knock on tax preparers because they typically only receive client information in March of the following year. This limits their ability to recommend and implement tax-saving strategies for their clients.

Tip: Check in with your accountant mid-year on any recommendations to reduce taxes for the current year. If given the opportunity during a slower time of year, they'll likely have some ideas. In my experience, tax preparers/accountants are different people outside of tax season!

2.) Investment Professionals Do Not Prioritize Reducing Your Taxes.

Investment managers may not fully consider the tax implications of their investment decisions and are usually not held accountable to after tax returns by clients. As a result, most investment professionals only focus on and discuss pre-tax investment returns with clients when after tax dollars are what matter, of course. Taxes are just for the accountants, right? No.

Tip: Many tax saving opportunities occur at the intersection of taxes and investments. If you have a money manager tell them you are focused on after tax returns. Make sure they have a process to implement tax loss harvesting and asset location (more below) strategies. Also, generating a large amount of short-term capital gains and non-qualified dividends are a red flag because these are taxed at your ordinary tax rate which is a terrible deal for high earning executives.

3.) The Pain Of A High Tax Bill Does Not Translate To Motivation.

Corporate executives may experience the pain of a high tax bill, but it typically only occurs once per year and that jolt of motivation to problem solve quickly fades. Busy schedules, the passage of time and a complex U.S. tax code make it attractive to rationalize the notion that taxes are unavoidable and just come with the C-Suite territory.

Tip: To develop an effective tax strategy, it is essential to consider the tax implications of all your personal finance decisions including investment allocation, deferred compensation elections and gifting to charity (more below.)

A Little Tax Savings Can Accelerate Your Retirement.

Now, let's explore a few tax-saving strategies that a corporate executive can implement today. Keep in mind that saving $1 in taxes today could grow to approximately $4 ($3.87) in 20 years and close to $8 ($7.61) in 30 years, assuming a 7% annual growth rate. Even small savings can make a significant difference over time and accelerate your ability to retire. Your future self will thank you!

1.) Deferred Compensation Plans: The Sharpest Tax Cutting Knife In Your Tool Kit.

Utilizing an employer's Non-Qualified Deferred Compensation Plan is a powerful strategy to minimize taxes both now and during retirement. These plans enable participants to defer income and taxes during their high-tax-rate years and recognize the income in the future, likely during lower tax-rate years. For instance, if you are in the 35% marginal tax bracket today and defer $100,000 until retirement when you're in the 22% tax bracket, you not only save $13,000 in taxes but also earn a return on the deferred taxes. When properly structured, these plans can significantly accelerate your ability to retire!

For more information, you can read the post, Walmart DCMP: 3 Decisions to Get Right. The post focuses on the specifics of the Walmart Defer Compensation Matching Plan, but the general concepts translate to those of other companies. Of course, you will want to confirm with your employer's official documentation before implementing.

2.) Asset Location: Shelter Highly Taxed Securities In Tax Advantaged Accounts.

While Asset Location may sound similar to Asset Allocation, it is a distinct concept. Asset location revolves around the varying tax treatment of certain account types (IRA vs. Brokerage) and investment income (Dividends vs. Interest vs. Capital Gains), presenting an opportunity for tax savings. Asset location involves placing highly taxed securities in tax-advantaged accounts and vice versa. For instance, interest income, subject to ordinary tax rates that can exceed 35% for many corporate executives, offers a clear advantage when placed in tax-advantaged accounts. The interest accumulates tax free, then you take distributions in retirement at a sub 20% tax rate. That is Tax Alpha!

Corporate Executives are a group that stand to benefit the most from asset location because of their access to several tax advantaged accounts and their current tax rate is much higher than their expected future tax rate. Unfortunately, despite its simplicity and potential benefits, many investment advisors avoid this strategy it is tedious to implement over several client accounts (many advisors manage 100s of clients account) and clients typically do not hold the investment professionals accountable for the taxes generated with investments.

3.) Donor Advised Fund: Give More To Charity And Reduce Your Taxes By Cutting Out Uncle Sam.

Corporate executives seeking charitable gifting options can benefit from opening and contributing to a Donor-Advised Fund (DAF). A DAF is a dedicated account designed for holding funds destined for charitable donations. Rather than donating $10,000 annually for a decade, with a DAF, you can contribute a lump sum of $100,000 in year one and deduct the full amount from your taxable income. Subsequently, you can instruct the DAF to distribute funds to charities over the next ten years. You still are able to gift $10,ooo annually for 10 years, but you take the full deduction up front and the capital gains generated in the DAF are not taxed!

Highly appreciated stock presents an excellent opportunity for gifting to a DAF because you can deduct the full current market value from your taxes and avoid paying capital gains tax on the appreciated amount. This strategy enables corporate executives to optimize their charitable giving while maximizing tax deductions in their highest tax years.

National Philanthropic Trust has a good summary on the mechanics and advantages of DAFs.

Wrap Up And More

These are 3 ways that a corporate executive can pro-actively reduce their tax bill. If you would like to learn more, you can request a copy TFP's white paper "The Corporate Executive Guide to Paying Less Taxes" here (or just send me an email and I can send it over.) It discusses the above strategies in more detail plus a few others such as Net Unrealized Appreciation, Stock Options and Tax Advantaged Accounts.

Mark Chisenhall, CFA is the founder of Taurus Financial Planning, a wealth management firm specializing in helping high earning corporate professionals reduce taxes, optimize investments and accelerate retirement. If you are interested in learning more about the firm, you can schedule an introductory call here.

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