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Friday, October 19, 2007

Tax Planning and other financial matters

I do occasionally help people out with financial planning. A surprising number of folks at work seem to already have one (I can't imagine justifying the expenditure on one, given that by the time you're knowledgeable enough to interview one you know enough to do it yourself), and I only do it for friends (liability reasons), but once in a while a topic will come out that I think is worth repeating.

The most important principle is that the tax tail should not wag the income dog. There is no such thing as a 100% tax rate in industrial world, so you'll always keep quite a bit of what you make. The best advise I was given by a tax accountant was: "Sell high. No matter what you do with your taxes, you can never beat selling high." I paid the guy $250 in 1995 to explain the AMT, and capital gains taxes to me and it's been worth every penny and saved me and some of my friends gobs of money. In fact, one day I ran into Niniane and one of her beaus and she introduced me as "the guy who saved her lots of money in taxes."

That said, it's surprisingly how little you can actually do to save on taxes:
  • Join a pre-IPO company and exercise all your stock options. This usually involves substantial risk --- I've written off thousands of dollars in bad stock. But a college professor in Computer Science and I were comparing compensation and it turned out that he got paid about the same as I did, and the big difference was that I was able to convert most of my income into capital gains through this maneuver while he couldn't do so through his consulting business.
  • Move to a low state tax. For me to give up California weather, that would be silly. I have friends who have done so, but if I wouldn't consider myself wealthy if I couldn't live some place with good weather. The folks I know who've done this don't consider an outdoor life important to them. If you're not a US citizen you can even move somewhere with zero capital gains taxes (like Singapore) and pay no capital gains on US stock. Pretty nice, huh? Except I've lived in Singapore and I moved away for very good reasons that are still valid.
  • Use tax managed funds and indexed funds whenever possible for your taxable portfolio when investing
  • Max out your 401(k) plans
  • Buy a house (but not too much house that it destroys your finances). But frankly, buying a house is a consumption decision, not a tax decision. Do not let people talk you into owning a house because of tax savings! Someone I know had this happen to her and deeply regrets it. Fortunately, she won't be affected financially by this, if at all, but many others will not be as lucky!
And that's it! There are a few other minor things you can do (such as playing around with when you pay state taxes if you have a year that's going to be huge on AMT due to one time gains), but those are very minor and don't actually save that much money compared to the above.


Doug Orleans said...

I wish I had sold high and ignored taxes. I rationed out my RATL stock to keep myself in the starving-grad-student tax bracket, when I should have just sold it all before the bubble burst and taken the tax hit. But that's a lot easier to see in hindsight-- at the time it looked like it might keep going up, so it felt like cost-averaging (in reverse).

Isn't the tax tail wagging the income dog pretty much the fundamental premise of the Laffer Curve? In other words, most economists would agree with you, but most politicians wouldn't. Oh well.

Piaw Na said...

I never thought of it that way, but I think you're right! If you look at the state income taxes, you'll notice that the states with the highest income taxes have the best economies, while the ones with the lowest taxes are the economic basket cases, at some point, you're not providing sufficient infrastructure for economic development, and that truly is being penny wise pound foolish.

Suresh said...

I very much like your posts on finance.

Is it possible to get a separate rss feed just for your articles labeled finance?


Piaw Na said...

I'm afraid that's not a feature Blogger or Google Reader supports yet. In any case, I disabled full feeds because other sites were syndicating my articles without my permission and ended up getting most of my readership instead without attribution.

zany said...

i was just thinking about your "tail wagging the dog" thing and wondering if that is true, why does it makes sense to put money in tax-exempt funds?

I have been slashing my savings in CA tax-exempt MMF but I am confused if that is the right thing to do. Any suggestions?

Piaw Na said...

Your question is answered in this blog post.

Charles said...

I've lived in Singapore and I moved away for very good reasons that are still valid.

Could you say more about this? I have occasionally considered living in Singapore for a while, maybe a year or two. I've visited for brief periods, and I know there is not really any meaningful public participation in government, and some of the laws are repressive. Both of these are serious considerations but what else am I missing?

Piaw Na said...

The big one as an adult is the lack of recreational and cultural facilities. If you want to go skiing, you have to leave the country. If you want to go cycling, you pretty much have to leave the country. Culturally, the same repressive government has made Singapore a cultural desert. I doubt if I'd be blogging as freely if I was in Singapore. (Can you imagine someone blogging: "Lee Kwan Yee is evil"?)

And of course, the weather isn't even close to being as good as California's.