By Ranga Srinivasan and Ramprasad Satagopan

As financial advisors in Cupertino, CA, Everest strives to provide guidance and education on wealth management matters. We hope this article sheds some light on your questions and concerns. 

Taxes in various forms (capital gains, ordinary income, at both the federal and state level, as well as estate taxes) erode household wealth continually. Investors face these forms of taxes in an ongoing manner, during transitions from one type of investment to another, as well as during estate transfer to their heirs. Let’s explore some key issues related to taxes and effective strategies available to mitigate their impact. 

The Capital Gains Tax Challenge

Capital gains taxes are levied on the profit you make when selling an appreciated asset. For many investors, these taxes can eat into their returns, especially in years of strong market performance. When investors try to diversify out of highly appreciated stocks (often accumulated through employment), they face the challenge of forking over up to 35% (23% federal + state taxes + net investment taxes) of the gains to Uncle Sam. Capital gains taxes can also be levied passively without any investor action, due to underlying mutual funds in taxable accounts trading and generating tax liability. 

Key Strategies for Mitigating Capital Gains Taxes

  1. Tax Efficiency: The easiest way to minimize tax impact is through Smart Asset Location by holding tax-efficient investments (like index funds) in taxable accounts, and tax-inefficient investments (like bonds or commodities) in tax-deferred accounts such as IRA/401(k) accounts. 
  2. Tax Deferral: Tax deferral is a powerful tool that allows you to control the timing of your taxable income. Delaying taxes owed to the IRS allows faster compounding of wealth due to the time value of paying a dollar in the future as opposed to now.
    1. A pooled exchange fund and separately managed accounts (SMAs) that implement direct indexing techniques can be great vehicles to diversify out of highly appreciated stock(s).
    2. Delaware Statutory Trusts (DST) can be a great choice for diversifying out of investment real estate property that has appreciated in value. 
  3. Tax-Free Earnings & Growth: Certain investment vehicles allow your money to grow tax-free, providing significant long-term benefits.
    1. Roth IRAs and mega-backdoor Roth opportunities within 401(k) plans can be great vehicles to compound wealth. 
    2. A health savings account (HSA) is another vehicle to avoid paying capital gains as long as proceeds from the account are used for legitimate healthcare expenses.
    3. Municipal bonds provide tax-free interest income.
  4. Tax Credits: Certain investments can provide tax credits while also benefiting the community.
    1. Qualified Opportunity Zones (QOZs): Investing in these designated areas can defer and potentially reduce capital gains taxes.

Can Something Be Done About Ordinary Income Taxes? 

When it comes to mitigating ordinary income taxes, the choices available become very limited. Wealthy investors in high tax brackets can combine charitable goals and get tax deductions to reduce ordinary income taxes, using vehicles like a Donor-Advised Fund or Private Foundation. IRS allows ordinary income tax deduction for cash donations made up to 60% of adjusted gross income (AGI). Gifting highly appreciated assets (like stocks) receive AGI deduction as well, but limits may be lower. Please consult with a tax professional to discuss suitability.

What About Mitigating Estate Taxes? 

For high-net-worth individuals, estate tax planning is a critical aspect of overall financial and legacy planning.

  • Most families can plan to give $18,000 per year per child and move up to $36,000 per child out of their estate without having to file any gift tax paperwork to the IRS.
  • Utilize Irrevocable Life Insurance Trusts (ILITs) to move assets out of your taxable estate. Opening insurance accounts inside ILITs allows you to pass on wealth to beneficiaries devoid of capital gains taxes and estate taxes—a two-in-one advantage.
  • Consider leaving behind appreciated assets to heirs, who may receive a step-up in their cost basis upon your death.

We’re Here to Help

By implementing these strategies, you can potentially reduce your capital gains tax burden and improve your after-tax returns. However, tax laws are complex and subject to change. It’s crucial to consult with a qualified tax professional or financial advisor to determine the best approach for your specific situation. Remember, while tax considerations are important, they should not be the sole driver of your investment decisions. Always consider your overall financial goals, risk tolerance, and investment timeline when making portfolio decisions.

The Everest Management Corp team is here to help. And because we employ a fiduciary wealth management model, your interests will be prioritized above all else. Schedule an introductory, no-obligation meeting by contacting us at 408-502-6015 or emc@everest-mgmt.com.

About Ranga

Ranga Srinivasan is co-founder and principal at Everest Management Corp, an SEC-registered wealth advisory firm based in Silicon Valley and serving clients across the United States. After graduating from the University of Cincinnati in the field of engineering, Ranga, witnessed the dot-com collapse in the early 2000s and sought to manage his own personal finances. He realized that many of the options available were unsatisfactory for a myriad of reasons. Knowing it could be done better, Everest was founded in 2007 to provide comprehensive wealth management. Ranga and the Everest team are dedicated to caring for the financial needs of the families they serve. With an emphasis on building trust and holding to the fiduciary standard of putting clients first, Ranga strives to offer financial solutions that inspire confidence. 

In his free time, Ranga is passionate about staying active; you can often find him swimming, golfing, biking, and playing tennis. He also has a great love for charity and philanthropy work. To learn more about Ranga, connect with him on LinkedIn.

About Ramprasad

Ramprasad Satagopan is co-founder and principal at Everest Management Corp, an SEC-registered wealth advisory firm based in Silicon Valley and serving clients across the United States. As a self-made, highly educated first-generation immigrant, Ramprasad became passionate about investing after witnessing the dot-com collapse in the early 2000s. He created Everest to help his peer engineering community to build household wealth in a systematic way. Everest has grown over the years while staying true to its fiduciary commitment. Ramprasad and the Everest team take pride in being a firm that brings a reputable, honest, and caring approach to all its clients.

Ramprasad graduated from both the University of Cincinnati and the University of Phoenix with a master’s degree in science and business administration, respectively. When he’s not helping families build a strong financial future, Ramprasad can be found enjoying traveling and reading. To learn more about Ramprasad, connect with him on LinkedIn.

Disclosures

The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.

The views expressed in this commentary are subject to change based on market and other conditions. These views may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

Investing in REITs involves certain distinct risks in addition to those risks associated with investing in the real estate industry in general. Equity REITs may be affected by changes in the value of the underlying property owned by the REITs, while mortgage REITs may be affected by the quality of credit extended. REITs are subject to heavy cash flow dependency, default by borrowers and self-liquidation. REITs, especially mortgage REITs, are also subject to interest rate risk (i.e., as interest rates rise, the value of the REIT may decline).

No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. All investments include a risk of loss that clients should be prepared to bear. The principal risks of Everest Management Corp. strategies are disclosed in the publicly available Form ADV Part 2A. 

Everest Management Corp. is a registered investment advisor. Advisory services are only offered to clients or prospective clients where Everest Management Corp. and its representatives are properly licensed or exempt from licensure.