More important than tax planning

“A rising tide carries all ships” – Dave Mallach, my boss and mentor at Merrill Lynch in the early 1980s

A group of accountants discussed a financial planning strategy using a cash value life insurance policy to accumulate wealth for a variety of family and charitable purposes. These strategies often incorporate the use of a charitable trust to further leverage the financial benefits. Midway through the discussion it became clear to me that tax accountants can easily lose track of something that is more obvious to investment advisers. The merits of any such financial planning strategy are only as good as the performance of the underlying assets. In other words, it really doesn’t matter if the tax aspects are optimized if the investment flops.

Is is likely true that some individuals have built wealth through such a strategy. Certainly the strategy is tax effective. However, it makes more sense for us to focus on the large number of individuals who have been financially hurt by the collapse of cash value life insurance in the past two decades of falling interest rates.

My own family is among those that planned a multi-generational trust based on 8% interest rate assumption only to have a life insurance policy collapse with disastrous consequences when rates of return fell dramatically. Many clients have been similarly affected.

Investment professionals know that a rising market makes all financial planning strategies look good and a falling market makes even genius tax planners look like idiots. Of course, we only like to talk about the first case. My mentor at Merrill Lynch instilled this lesson in my first year of working at his firm. I was studying portfolio management in an MBA program and he was explicit in his opinion that all this education was ultimately worthless in a declining market.

The message should be clear: focus on solid investment strategies first, then look at tax efficiency and other financial planning factors as secondary goals.

The problem with your business expense records

Non-profit organizations are subject to the same substantiation requirements of business expenses as for-profit firms.

The problem with your deductible business expenses for travel, meals and entertainment is that you believe that you can support the tax deduction in an audit. The IRS knows that you can’t. As a result, tax professionals report that they are seeing more of these audits and are often unable to prevail on behalf of their client.

IRS regulations require a concurrent log containing specific information that most taxpayers do not have available. It is not permissible under the law to create these supporting documents later in the event of an audit. Taxpayers are often surprised to learn that the strict IRS-required documentation rules have been tested and upheld in tax court.

As a practical matter few of us have time to separately record details like who we were with and what was the business purpose of our activity each and every time we travel for business. More likely we say “I meet Bob every Monday morning over coffee to review sales of the past week”. Therein lies the problem. It makes sense. It is legitimate and fair business expense and certainly meets the ‘ordinary and necessary’ standard. Yet without a concurrent log, you cannot legally deduct the cost of your travel and coffee meeting.

This post skips the details of the tax requirements but I would be pleased to review them and help devise a personalized audit defense plan for your business.