Broker Check

No Good Deed…

By:  James C. Denton, CFP®, EA, Managing Partner

March 19, 2022

I’m going to let Aaron write our quarterly market-focused newsletter again since he did such a good job last time.  But it is the tail-end of a difficult tax season, and I want to say something to all you taxpayers out there …

I’m sorry!

There’s an old saying, “no good deed goes unpunished”.   (No, I’m not talking about Aaron, he really likes to write.)  But I never knew how true that old saw was until just this month.  I never got into so much trouble in my life for simply doing my job.

Actually I missed a warning a couple of months back when one my long-term clients called and he was mad.  I mean really teeth-gritting, fist-clinching (probably red-in-the-face, I couldn’t see him over the telephone) mad.  Being the good Christian man that he is, he had the good graces to not yell, cuss or fuss (too much) but it didn’t take me more than a few seconds to realize that my initial thought that he was just messing with me was wrong, and I needed to get serious and take him the same way.  Here’s what happened.

My client, I’ll call him “Greg”, calls me, I think, from his accountant’s office where he is discussing last year’s tax return.  He is trying to understand why he owed so much in taxes, and why he needed to pay significant quarterly estimated taxes.  The reason was an unexpected and abnormal amount of investment income, and the accountant did exactly what I would probably have done under the circumstances; he threw the other guy under the bus.

Enter the afore-mentioned “other guy”.

My answer was, “Greg, I’m just doing what you are paying me to do.  Just like you, working your tail off trying to get ready for retirement, I’m doing the same thing … everything I can do to give you a comfortable retirement.  And I think I’m doing a pretty darn good job, even if I do say so myself”.  The conversation went on from there, I’m still not sure how much of Greg’s skepticism I was able to allay, but I should have learned something from that, that I did not finally really “get” until just the last couple of weeks.

During tax season, I sit on both sides of Greg’s discussion.  I’m the tax guy for some, the investment guru for others, and for some both at the same time.  And this year we’ve had more of those conversations than ever before.  Do you wonder why?

You may have noticed that the stock market, up until a couple of months ago, has been pretty good to us of late, and as I told Greg, I’ve been doing a pretty good job playing that winning hand.  It’s actually been going on for about 10 years now and those really good market conditions have done something that makes this tax guy (and taxpayer!) uncomfortable. 

First, our accounts have grown significantly and as a result are throwing off more taxable income than they would be with slower growth.  (And I have to tell you, you haven’t lost anything because of Powell,  Putin or Pelosi; you’ve just given a little bit back, and that only temporarily.)  Second, some positions have grown more than others to the point where they have to be trimmed to keep them from becoming too large compared to others (diversification and risk management).  And third, some positions have really done exceptionally well, and we have to take some profits before they get away from us.  The stock that goes straight up can and often does turn around and go straight down.  All three of these entirely reasonable, in fact essential investment manager imperatives generate reportable/taxable gains, and drive the tax guy nuts because when he tries to explain this to you as the positive event it is, he knows what you are thinking is that he’s trying to put lipstick on a pig.

What did I learn?  Well, I’m not going to apologize for making money for you.  If you don’t like that get yourself another advisor.  But I will apologize for not getting out in front of this in a more meaningful way.  We need to do a better job of alerting you to the possible tax impact if, and as it develops.  We send out quarterly summaries to folks who may have tax problems developing, but we’ve never touted them as being for that purpose.  You probably take them more as chest-thumping than anything else, but that’s mainly because it’s been so easy to thump the chest over the last few years.  Those of you who have been around a while will remember we sent these statements out just as faithfully when the news was “not so good”.  Just trying to keep you informed.

Here's a lesson some of you need to learn, and I say this in all humility and with entirely appropriate professional intent.  It is our job to keep you abreast of where you stand financially, but what I have found is that sometimes you are much more attentive to the information we send out when the news is bad, than when it is good.  Or maybe it’s just that the good news goes down a whole lot easier, and you don’t feel a need to call and say, “what’s going on, and what do I need to know or do?”  Maybe it’s my fault again because my answer is always, it seems, “stay the course”.  You need to realize, however, that often the good news comes with a tax obligation attached.   

I just did something that I am almost never able to do … I cut three paragraphs because I got off on a side trip about how “stay the course” is almost always the correct advice; I’m not giving investment advice here, I’ll leave that to Aaron for just a minute, I’m writing about income tax situational awareness.  But I’m happy to have that conversation if you need it.

So let’s wrap this up.  What are the desired take-aways?

For meI need to spend more time thinking about the tax consequences of what we are doing.  Yes we try to keep more of the active management in IRA accounts when we can but not everyone has an IRA and for some others that’s not where the money is.  Sometimes there is a benefit of having high-growth stocks in a non-qualified account, where you can take advantage of capital gains tax rates, rather than in a retirement plan where all income when taken is or will be ordinary income.  In any event, we have to be careful to not allow the tax tail to wag the investment dog.  We’re going to do what makes the most sense from an investment perspective and let you pay the taxes.  If you owe taxes it’s because you have made money.  Praise the Lord for the money and cuss the devil (not me) for the taxes.   (And if capital gains are the reason, then there is nothing wrong with taking the money to pay the tax from the accumulated gains.)

On the other hand, we will try to take a more active role in advising you through the year if we reasonably see a large tax obligation accumulating.  Here’s your first warning by the way, are you listening? 

This year has significant potential to surprise a lot of you again at tax season.  I’m not prognosticating on market performance here, that’s Aaron’s job.  But remember what I said earlier about accounts growing rapidly.  Your IRA’s have benefited greatly from that better-than-normal growth, and with growth comes increasing required distributions.  Regardless of whether Putin quits, dies or pushes his red button, regardless of what the Federal Reserve does about inflation and interest rates, regardless of what the knuckleheads in the congress do or don’t do, (that’s all another discussion I’m dying to have but you’re going to have to call me to have it) your RMD this year is going to be based on the account value at the end of LAST December.  Regardless of this year’s market performance, your RMD for 2022 is going to be greater than last year.  So to the extent that your IRA income was a factor for any tax payment issues you had last year, be prepared for more of the same.

Your take-away, I hope – Having to pay taxes is a blessing.  There are many among us who do not pay their fair share, but only the poor and criminals do not pay taxes.  More to the point of this article, if I am doing my job, I am increasing your income tax responsibility.  If the market is doing well, and it has been and my expectation is that it will continue to do so present circumstances notwithstanding, if you are not seeing an increase in taxable income, that can be a significant red flag and you need to ask me about that.  There are some things that can be done under the rubric of tax-managed investing, but in my experience these programs are better left to the very wealthy.  For the rest of us, I have found that investment programs marketed for their tax-saving characteristics often will cost you more in investment return than you will realize in tax benefits.  This is one area that for most of us is best kept simple; as I said earlier, don’t let the tax tail wag the investment dog.

The opinions expressed in this article are those of the author and may not reflect those of LPL Financial.  This material is for informational purposes only and should not be considered as investment, tax, or legal advice for any individual.  You should consult with your personal advisors before making any decisions from this material.  LPL does not give tax or legal advice.

Past performance does not guarantee future results.  The economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful.