Ever wondered why you had to pay Alternative Minimum Tax (AMT)? Have you considered buying tax-free Muni bonds but need advice on how to avoid ones with AMT income tax? Tried to get a tax deduction with a huge mortgage only to be told the deduction is not allowed on the 1040 income tax form? Tried to buy a rental (investment) real estate property in hopes of getting a tax deduction and then found you could not deduct the losses? Found that you had to pay extra income tax because of mutual fund “distributions” for capital gains that you never got? Paid extra capital gains income tax because an investment owned over a year did not qualify for the 15% Long Term Capital Gains rate?
Planning for income tax is something that should be done in concert with planning for investments, designing an estate plan, education planning, retirement cash flow planning. There are tax traps that cost investors money. For example: getting a capital gains distribution from a mutual fund that is going down in value, losing capital gains treatment for assets in IRA’s, buying allegedly tax-free Munis only to find that they have AMT tax, getting a big mortgage on their residence and then finding later that the interest deduction is not allowed for cash-out refinances exceeding $100,000 over the original purchase mortgage, buying rental real estate with a negative cash flow and then being denied the tax deduction because AGI was too high, using borrowed money to fund a money losing business and then having the tax deduction denied due to basis rules, paying higher than expected tax on capital gains for commodities and collectibles.
When someone has a large employee stock option, planning for it is best done using integrated financial planning instead of looking solely at either taxes or investment strategies. When someone suddenly cashes in an enormous option that means they may now need advanced estate planning using irrevocable trusts, ILIT’s, FLP’s. They need to plan for a reversal of fortune where their newly acquired shares (after they exercised the option) may carry a huge risk of sudden irreversible loss of wealth. The client needs to plan for income tax, AMT, and proper diversification without giving up too much of his beloved stock, or reducing his retirement cash flow.
There are many reasons why a financial plan can help prepare you in advance for income tax.