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Bail yourself out: Recover investment losses with tax benefits


The current financial crisis has left many Americans with less wealth than they had just a year ago. Home and stock market investments are likely worth a lot less ? and it may be years until the values of these assets return to previous levels. Investment advisers Carole C. Foos, C.P.A., and David B. Mandell, J.D., M.B.A., offer a strategy with two simple steps to help you start now to make up for your losses.

Recent developments have left many of us with less wealth than we had just a year ago. Our home and stock market investments are likely worth a lot less - and it may be years until the values of these assets return to previous levels.

What you didn’t know, until now, was what you could do to get the government to help bail you out with some tax savings.

Though our firm has strategies for managing investments in this type of market, the purpose of this article is to highlight a few tactics for regaining some of your lost wealth. The strategy has two simple steps to help you make up for lost wealth: First, you will reduce your taxes now so you have more to add to your short-term investment portfolio; secondly, you will focus on building future wealth more tax-efficiently for the long-term.

Reduce taxes now

If you can pay less in taxes in 2008 and 2009, you may be able to recover much of the wealth you’ve lost over the past year or two. How can you reduce taxes significantly? Consider the following techniques:

A. Utilize the right entity for your practice.

Many physicians today are using the wrong ownership form for ideal tax planning. Choosing the right entity among “S” or “C” corporations, or limited liability companies, could turn into tax savings of $10,000-$45,000 annually.

B. Consider non-qualified plans, in addition to pensions/401(k)s.

Further, nonqualified plans generally allow larger annual contributions for the owners than traditional qualified plans do. Some plans can offer annual contributions as large as $100,000 to $200,000 per participating owner or executive.

C. For larger practices, consider captive insurance companies.

Closely-held Captive Insurance Companies (CICs) are great tools for successful medical practices looking for liability protection, risk management, tax and wealth accumulation benefits.

The CIC we are discussing here are very small insurance companies that primarily will insure your practice. These companies enjoy beneficial tax treatment (made even better by a 2004 law signed by President Bush), allowing the owners an opportunity to build wealth, as opposed to giving profits up to insurance companies.

Any of the above techniques, as well as numerous others, could help you reduce taxes for 2008 or 2009. By doing so, you might recover a percentage of the wealth you’ve lost as soon as this year.

Long-term tax efficiency for retirement & beyondWe spread our investments across different classes of investment so that, in the event something bad happens that impacts one company or one industry, the total portfolio is not significantly impacted by the event.

With tax diversification, a similar theory applies. If you have some investments that may be taxed as ordinary income, some that may be taxed at capital gains or dividend tax rates, and have some assets that may not be taxable at all, you have flexibility.

The concept is quite simple - a properly tax-diversified portfolio minimizes the risk of loss when taxes increase and provides flexibility that can afford savvy taxpayers the opportunity to minimize total taxes paid over a lifetime of investing.

For this reason, we advise our clients to have their wealth in multiple tax “buckets” - each with its own tax treatment. This provides flexibility that allows clients to minimize long-term taxes paid.

In your case, this strategy may make up for the wealth you may have lost recently - if you apply it properly.

Will tax rates rise or fall in the future?Tax diversification is especially important for the long term, because taxes today are extremely low. Study the federal income and capital gains charts below. You will see that, given their history, income tax rates are close to the lowest they have ever been and capital gains taxes are the lowest they have ever been.

Given this, if you want to recover wealth from recent losses over the long term, we think you must assume that tax rates will go up, not down.

Federal Income Tax Rates

Year Top Marginal Federal Income Tax Rate

  • 1920 73.0%
  • 1930 25.0%
  • 1940 81.0%
  • 1950 91.0%
  • 1960 91.0%
  • 1970 71.0%
  • 1980 70.0%
  • 1990 28.0%
  • 2000 39.6%
  • 2008 35.0%
  • 2011 on 39.6%

Source: Citizens for Tax Justice, May 2004.

Year Top Federal Capital Gains Tax Rate

  • 1940 30.0%
  • 1942-1967 25.0%
  • 1970 32.3%
  • 1977 39.9%
  • 1980 28.0%
  • 1990 28.0%
  • 2000 20.0%
  • 2008 15.0%
  • 2011 on 20.0%

Source: Citizens for Tax Justice, May 2004.

Future tax swings

Too many doctors only have their wealth in two buckets: (1) qualified retirement plans, like pensions, 401(k)s or SEP IRAs; and (2) personally-held taxable assets, like personal securities investments and real estate. The problem with both of these asset classes is that they are both subject to future increases in income tax rates, capital gains tax rates, or both. Whether you are planning on taking funds out of a 401(k) or SEP IRA in retirement or planning on selling stocks or living off bonds, you have no idea now what your tax rates will be on that income in the future. If the charts above are indication, it may be at a much higher tax rate than today.

Tax-immune investment ‘bucket’Unfortunately, far too few clients have diversified enough into a non-taxable wealth “bucket”. By doing so properly, not only can you insulate much of your wealth from future tax increases, but you can also help “make up” much of your recently lost wealth over the long term.

What are such “tax immune” buckets? They may range from Roth IRAs, to non-qualified plans, to private placement life insurance. As an example, one such non-qualified plan is actually treated as a hybrid plan - with both qualified and non-qualified elements. It is a very flexible plan that has numerous benefits for a practice. The contributions are partially deductible and partially taxable at the outset.

From a current tax perspective, this is much more attractive than the “personally held taxable investments” which offer no deduction and less attractive than qualified plans that offer a 100% deduction. In the nonqualified plan, the funds grow tax-deferred, which is the same as the qualified plan and better than the “personally held taxable investments” class. When you are ready to access the funds, you can access funds in a nonqualified plan without any tax liability. This is better than the “personally held taxable investments” and far superior to the qualified plan.

In this way, such a plan avoids the risks of future income and capital gains tax rate increases in a substantial way - and can act an ideal long-term recovery for lost wealth.

Comparing Different Investment Options – Tax Diversification

Qualified Plan Personally Held Taxable Investments “Hybrid” Non-Qualified Plan

Contributions 100% deductible No deduction 40% deductible

Growth Tax-deferred Taxable (can be Ordinary income or Capital gains) Tax-deferred

Withdrawals Ordinary income Capital gains Tax-free

In addition to playing the role as a future tax increase hedge and “recovery” wealth tool, the hybrid plan offers the following attributes:

The plan can be utilized in addition to a qualified plan like pension, profit-sharing plan/401(k) or SEP IRA.

The funds in the plan can grow in the top (+5) asset protection environment in most states and always in a good (+2) environment at minimum.

Maximum contribution levels are $100,000 per doctor in practices with 10 employees or less. In larger practices, these levels can be even higher.

In a group practice, not every doctor need contribute the same amounts - extremely beneficial for group practices who have doctors who want to “put away” differing amounts.

There are no minimum age requirements for withdrawing income (no early withdrawal penalties);The transfer of assets at the doctor’s death is income tax-free to heirs.


We have all lost some wealth in the last year. The key to future financial success is how you react to this lost wealth. If you would like to explore ways to recover that wealth quickly for the short term and on an ongoing basis for the long term, you should focus on tax planning. By doing so, you can get a jump on all the people who will sit around complaining about what has happened. DT

If you would like some assistance identifying opportunities for tax planning, we would be happy to discuss this with you further.

For a FREE analysis of your situation to see you might reduce taxes in 2008, or to purchase our new book, For Doctors Only: A Guide to Working Less and Building More, contact us at (800) 554-7233.

David B. Mandell, JD, MBA is a principal of the physician-focused wealth consulting firm O’Dell Jarvis Mandell, LLC (www.ojmgroup.com). Carole Foos, C.P.A. is a tax consultant at the firm. They can be reached at 877-656-4362.

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