This week’s story takes us to Verkhoyansk, a frozen flyspeck of a town with 1,300 shivering souls deep inside Siberia, six miles from the Arctic Circle. The local delicacy is a version of a Russian favorite called pelmeni: minced reindeer fat rolled in a thin dough, seasoned with horseradish and deep-fried on a stick. (Editor’s note: not entirely true.) The town’s main claim to fame is its record winter cold, with temperatures dropping as low as -90 Fahrenheit. Tripadvisor.com rates the local Pole of Cold Museum as the town’s #1 attraction. (#1 out of 1, to be precise.)
Last weekend, Verkhoyansk made headlines when the temperature soared the other direction to 100.4 degrees, the hottest ever recorded in the Arctic. Children splashed in local ponds to cool off — and who can blame them, considering how far they probably are from the nearest central air conditioning. Environmentalists cite the heat wave as more reason to reduce what they believe to be humanity’s “carbon footprint” — the total amount of greenhouse gas emissions caused by an individual, event, organization, service, or product.
The whole thing got us to thinking: since carbon footprint is claimed to be such a helpful concept for understanding the impact of our activity on our physical environment, could “tax footprint” be just as useful for understanding the impact of our financial activity on our tax bill?
It turns out that “tax footprint” really just describes the concept of taxable income — the amount of income on which you pay tax. The higher that footprint, the higher your bill. And just as environmentalists identify ways to reduce the supposed carbon footprint (use more renewable energy sources, travel more efficiently, and eat less meat), we focus our tax-planning efforts in four areas:
- Timing-based strategies, like traditional IRA and qualified plan contributions, involve deferring tax on that particular “footprint” to later years, when your tax rate is hopefully lower. Conventional wisdom usually recommends taking that sure thing every day and twice on Sunday, whether you need it or not. (Of course, sometimes that conventional wisdom means paying more tax down the road!)
- Shifting-based strategies, like family business gift-leaseback arrangements, involve shifting part of your tax footprint to lower-bracket family members who pay less on the same footprint. Think of this as the tax equivalent of driving your hipster daughter’s Prius instead of your usual SUV.
- Code-based strategies involve finding the tax code’s opportunities to convert income that would otherwise wind up in your tax footprint into nontaxable forms, like medical expense reimbursement plan benefits. They also involve opportunities to avoid tax when you sell big-ticket assets like investment real estate or a business, and charitable gifts that let you keep valuable strings on your gift. (Think of this as ditching the Prius for a Vespa or a bicycle.)
- Finally, product-based strategies, like tax-efficient stock portfolios and cash value life insurance, involve positioning your investments where their return misses your tax footprint entirely.
Our job, then, is to help you reach your financial goals with the smallest tax footprint possible, both today and tomorrow. This includes managing your footprint through predictable changes (such as transitioning from work income to retirement income) as well as tax “climate emergencies” like higher future rates, which many expect in the wake of trillions of new spending for coronavirus relief. We can’t control the climate, or the weather, but we can make sure you don’t go out into the Arctic heat without sunscreen!