Clever, Effective, and Legal
From philanthropy to pre- and post-immigration planning, if you have an investment, there's a financial strategy tailored to tax savings.
Just don't call them tax shelters. That rubric conjures up those egregious deals-synthetically created entities designed to eliminate $100 million write-offs-that fell off the radar screen a few years ago faster than you can say KPMG.
Indeed, one tax attorney says criminal indictments against overreaching tax professionals are expected in the near future.
"Corporate America's ability to avoid taxes gives a black eye to the high-net-worth individual," Ethan Eden, president of Diastole Wealth Management in Guilford, Connecticut, notes.
"Things like cross leasing never come up in conversations with my clients," he adds. "Even with offshore activities, people are not that excited about sneaking money into a country. Our clients are trying to stay on the right side of the law. The typical wealthy client doesn't want to be associated with things that won't let him sleep at night."
Protecting one's hard-earned wealth is no picnic, especially with government watchdogs on alert. So it's not surprising that the methods for protecting income and keeping the tax man at bay have made a sharp turn toward the fundamental and traditional: charitable giving, forming family partnerships, and, yes, real estate.
And while income, capital gains, and estate taxes are key concerns, watch out for state taxes. New York State is considering a millionaire's tax-something tried in New Jersey with mixed results.
"People picked up and moved," Jack Meola, a tax attorney and partner at Amper Politziner & Mattia says of the New Jersey experience. "The rich are the most mobile people in the world. I have clients with no state domicile. They're doing business all over the world. They've put their homes in trusts, so they personally have no jurisdiction. One client lives on a boat. Most move to nontaxing jurisdictions, like Las Vegas and Florida."
These mobile individuals set up trusts so that when their businesses are sold, they don't feel a tax pinch.
For the state, the effort backfires, he notes. Diminishing populations of wealthy individuals result in a trickle-down effect that builds pressure on low-income people to carry the tax impact.
A growing part of his business is international planning. "You have three kids: One studies abroad, stays, and marries someone from yet another country. That's a massive international tax issue," Meola says, one usually handled by establishing trusts under U.S. rule.
But other parts of the world are tightening their tax policies too. Britain recently overhauled its tax system to impose a charge on wealthy foreigners who live there but are nondomiciled for tax purposes. That may result in a migration of people to the U.S., enlarging demand for pre- and post-immigration planning.
"It's now becoming an international play," Meola says. "In New York, people come for five to six years to work and accumulate wealth. They have tax issues."
Eden sees a strong trend in teaching the responsibilities of wealth to the next generation, especially entrepreneurs. Many of them were so busy making money they didn't have the time to stop and enjoy the philanthropic activities they employ to preserve it.
"It's a tough topic to broach, to explain to the next generation how much money they have, let alone how to deal with it," Eden says. "People are increasingly concerned about being set apart as different, that their kids enjoy life for themselves, feel self-sufficient, live in their own reality. Replace a group of trustees with family members and you're excited about getting everybody to work together."
Estate-tax savings can run from 15 to 45 percent, with a median 30 percent, advisers say. The trick, according to tax attorney Steven H. Seel, a partner at Thorp Reed & Armstrong L.L.P. in Pittsburgh, is to create a plan that provides for participation as well as gifting when the time is right.
Many of his clients own closely held businesses. To deal with estate-tax issues, they're putting properties in partnerships and trusts to move assets down to the children.
Never put all the beneficiaries' inheritance in the partnership, Seel warns. With $20 million, for example, put half in the partnership, half in cash. That may form more solidarity among siblings. And avoid a backlash at the parent's death from an unhappy sibling or, worse, his dissenting spouse.
When it comes to philanthropy-the most favored destination for tax savings-charitable-remainder trusts, charitable-income trusts, donor-advised funds, and, especially, foundations all get high marks.
Meola notes that clients are seeking to maximize retirement plans to preserve money-cash benefit plans and defined benefit plans-especially for small businesses. One client is looking to buy a series of hotels through a retirement plan in a five- to seven-year turnaround, all tax-free.
"Do these people need their retirement plans? No," Meola says. "If you hit a grand slam, that's great. The trade-off is that it all comes out of ordinary income. The buildup down the road is so substantial. You take out a minimum distribution and pass it down to your heirs."
Real estate still has a strong draw. Investing in historic preservation enables the investor to write off depreciation and interest expense and receive historic-preservation tax credits on a dollar-for-dollar basis of up to 20 percent. Historic buildings are less vulnerable to the vicissitudes of the real estate market. "As we're watching the real estate market tank, you're looking at an asset that's not going to disappear," Eden says.
Moreover, good-value real estate is hard to find, especially in the Northeast, Meola says. "We're almost at the point of saturation, and urban sprawl is not weighing favorably for the developer," he says.
There may be value in brownfield sites-abandoned or underutilized commercial and industrial properties with some environmental contamination. "Brownfield sites are on the comeback trail," says Meola, whose office is on an old brownfield site. "It's an opportunity if you have enough wherewithal and guts and money."
"Our clients are getting excited about investing again," Eden says of real estate. "They're not ready to pull the trigger today, but they're getting ready to put the pieces together for the intermediate term."Visit Portfolio.com for the latest business news and opinion, executive profiles and careers. Portfolio.com© 2007 Condé Nast Inc. All rights reserved.