March 18, 2024 – It's not often we recommend a book on taxes, but "The Investment Tax Guide: How to Slash Your Taxes" by Bill Harris, co-founder and former CEO of PayPal now at Evergreen Money, is an exceptional resource for investors seeking information on tax reduction and tax optimization strategies. This newly released book covers everything you need to know in an easy-to-read format and is also particularly helpful if you reside in a high-tax state and wish to gain insights on the comparative cost of living and tax efficiencies (or inefficiencies) for each state in the US. Jim Puplava, founder and president of Financial Sense Wealth Management, who interviews Bill in today's Lifetime Planning show, says The Investment Tax Guide is "a book every investor needs to own if they truly want to invest tax efficiently."
Purchase the book on Amazon: The Investment Tax Guide
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Transcript:
Jim Puplava:
[00:00:00 - 00:00:17]
Well, it is that time of the year. You're probably filing your income taxes and you're probably not too happy with the results that you're paying. Well, that's the topic of today's show. We're going to talk about how to bring down your tax bill. Joining me on the program is Bill Harris.
Jim Puplava:
[00:00:17 - 00:00:33]
He's the founder of Evergreen Money. He's a founder and former CEO of PayPal, Turbotax and Intuit. And his new book is called The Investment Tax Guide: How to Slash Your Taxes. And Bill, I want to begin. I love your book, by the way.
Jim Puplava:
[00:00:33 - 00:01:03]
You don't have to be an accountant or a major in finance to understand the way you present it. You've got ten strategies to lower your taxes, from tax loss harvesting to donor advised funds. And what I'd like to do is I'd like to take those ten strategies and let's break them down for many of our listeners. And I want to give you a couple of scenarios. One would be a working couple that works at a company.
Jim Puplava:
[00:01:03 - 00:01:32]
They're just employees. Another scenario, you're upper management or an upper professional. You could be a doctor, a lawyer, or a manager or CEO. Somebody that runs their own business that has a considerable net worth, and then somebody that's getting ready to retire. So we can give you a chance to talk about how those ten strategies fit in to no matter who you are.
Jim Puplava:
[00:01:32 - 00:01:54]
So let's begin with, let's say I'm an average guy, both husband and wife, working at companies. We're employees. Most people have a mortgage on their home. Maybe they contribute to a 401(k). But what other things can a working couple do to bring down their taxes, given the ten strategies you outline in your book?
Bill Harris:
[00:01:55 - 00:02:26]
Well, first of all, thank you very much for inviting me on. I've been following and listening to your work for some time, and you're really doing a great service for the people who listen. For my part, I've been in the digital finance business for some time and started a number of companies. One of the ones that I started that you didn't mention, but it's germane here, is Personal Capital.
Bill Harris:
[00:02:26 - 00:02:52]
Personal Capital is a digital wealth management firm and RIA, and we went from zero to $23 billion, which made us the 9th largest in the country. And one of the things we tried to do there was tax optimization. Today, that was ten years ago. Actually more than that.
Bill Harris:
[00:02:52 - 00:03:38]
Today, the opportunities to optimize for tax are even greater. And so that's why I'm so excited about this. That's why I wrote the book and let's do what you asked, which is turn to the top ten tax strategies and think about how they apply. So if we take the employee, someone who is making a good salary, working for a living, starting to put some money away, first and foremost, obviously, the 401(k) only up to the employee match or the employer match, always take advantage of 100% of the match because it's essentially free money.
Bill Harris:
[00:03:39 - 00:04:11]
And then don't do a penny beyond that because you typically have better opportunities with an IRA at a financial institution, often less expensive, certainly more selection of investments. So that's the number one. Check that off. Then one of the things you need to think about is asset location. Where do you put your funds and which assets do you put in which accounts?
Bill Harris:
[00:04:11 - 00:05:03]
It's interesting. Many people think, well, my 401(k), my IRA, my Roth, that's long term money, and therefore I should put my long term investments in there, predominantly growth stocks and other capital gain assets. In fact, that is backwards, because two things. First of all, capital gain assets and even dividend assets have lower taxes than interest. And so if you put your low tax assets into the tax deferred or tax exempt accounts and put the high tax assets, interest generating assets in taxable accounts, you're missing the boat.
Bill Harris:
[00:05:04 - 00:05:43]
And it gets even worse than that. If you put capital gain assets or dividend generating assets into a tax deferred or tax exempt account, they come out as ordinary income. So you're converting low tax assets to high tax assets and then, of course, not with dividends, but with capital gains. There's so many opportunities to do market to tax timing, and you can only do that if those assets are in the taxable side of the ledger. So there are many things to pay attention to.
Bill Harris:
[00:05:43 - 00:06:01]
But if I was in that position, the predominant thing I would be thinking is maximize the 401(k) and then maximize what you do with your 401(k), your tax deferred capability, and put the right assets in the right place.
Jim Puplava:
[00:06:02 - 00:06:25]
Let's talk about asset allocation personally, and talk about the low taxation of capital gains and dividends. So if I own, I don't know, I own IBM or Procter & Gamble or Coca Cola, I own that personally, I'm going to pay a lower tax rate. And depending on your income, you may not pay any tax depending on what your income is.
Bill Harris:
[00:06:25 - 00:06:57]
That's right. Ordinary income is taxed at relatively high rates. The highest ordinary income rate is 37%, the highest rate on dividends and qualified dividends and capital gains is 20%. Now you've got an additional 3.8% for the net investment income tax. But that applies to any investments, whether it's income generating or capital gain.
Bill Harris:
[00:06:57 - 00:07:26]
So the thing to remember is this. Ordinary income interest is the highest tax rate. Then dividends, they come out at the long term capital gain rate, which is both lower in general. And as you have pointed out, there's a tier that comes out at zero taxation. And then finally, capital gain.
Bill Harris:
[00:07:26 - 00:08:14]
And capital gain is really where you have a lot of opportunities. Even if you sell it today, as long as you've held it for at least a year, it's the same long term capital gain rate as dividends. However, there are tremendous opportunities to defer to tax loss harvest so you can offset the taxes. And ultimately, if you have highly appreciated capital gain assets and then you put them into gifting to your kids or to charitable uses, there are situations where you never pay taxes on that appreciation at all. So that's the order of things.
Bill Harris:
[00:08:14 - 00:08:25]
Be very careful about interest income and really work to maximize the flexibility that you have with capital gain.
Jim Puplava:
[00:08:25 - 00:08:40]
All right, let's go to the next situation. Maybe you are upper management at a company. Maybe you're a professional, like a doctor or lawyer. So you're making big bucks. What does that person do?
Jim Puplava:
[00:08:40 - 00:08:59]
Because now these are the kind of people that are going to run into the tax rates. You're talking about the 37% tax rate, 35% tax rate. What do those people do that maybe is more applicable to them? Do they have more opportunities, or are there other strategies that they can use to lower taxes?
Bill Harris:
[00:09:00 - 00:09:38]
Well, there are a number of things. First of all, you're much more likely to itemize and itemize deductions. And when you itemize, then many more things are available to you. Certainly the mortgage interest deduction and charitable deductions. Charitable deductions become very valuable because if you donate your appreciated securities, as opposed to donating cash, you will not be taxed ever on the appreciation on those securities.
Bill Harris:
[00:09:38 - 00:10:29]
And at the same time, if you itemize, depending upon certain limits, you get a write off, a deduction of the entire amount, not just the appreciation, but the entire amount of the gift. So it's a double benefit from a tax point of view. Now, the other thing there is that it's difficult to donate appreciated securities. Many charities aren't set up to take it, and even those that are, it's quite a project to try to get that done. So just about everyone should have a donor advised fund.
Bill Harris:
[00:10:29 - 00:11:14]
And the great thing about a donor advised fund is that you can time the donations you make to the charity and then the distributions to the people that you want or the organizations you want to have the benefit of that. You can separate the timing of those two. And that means that at the end of the year, as you're looking at your tax situation in December, you can make a contribution to your donor advised fund and get the tax benefit this year. But you don't actually have to make the contribution to the charity right now. And in fact, you don't even have to say to whom it will go.
Bill Harris:
[00:11:14 - 00:11:32]
And you have the opportunity to keep control of that money. It's no longer your money. You can't spend it. You have to give it away. But you have control of it indefinitely and can, over time, decide where it's going to be delivered.
Bill Harris:
[00:11:32 - 00:11:51]
So it's a tax bonanza, and it's got a tremendous flexibility in terms of how you use your charitable capability. In fact, it's even better and more flexible than a private foundation, and it's very easy to set up.
Jim Puplava:
[00:11:51 - 00:12:06]
Want to talk about somebody in that category that would earn, they earn too much income to do a Roth, but what about a backdoor Roth or a Roth conversion for somebody in that kind of bracket?
Bill Harris:
[00:12:06 - 00:13:00]
I think it's a marvelous idea. And first of all, IRAs and Roths, and Roth in particular, will come back to that, are hugely beneficial. And you're right, there are caps on how much various people, high income people, can contribute. But just as you said, if somebody has built up a large position in an IRA or 401(k) that can be converted to an IRA, that can be converted to a Roth, and that's what the backdoor Roth is. And so you have an opportunity to put a large amount of money to work in a Roth where the annual limitations don't apply.
Jim Puplava:
[00:13:01 - 00:13:17]
All right, let's move on to the situation. I'm a business owner. I have substantial wealth. I'm making a
Bill Harris:
[00:13:17 - 00:13:45]
Well, there are a couple of things. First, to the extent that you have lots of bucks, some amount of that is going to be in fixed income. On the fixed income side, really think hard about tax exempt securities. And so the easy one is municipal bonds.
Bill Harris:
[00:13:46 - 00:14:46]
And particularly if you're in a high tax state, think about triple tax free municipal bonds. A triple tax free municipal bond, which is free of federal, state and local taxes, is a marvelous recipe. Now, they typically carry lower interest rates than taxable bonds, but if you are in the highest brackets, it pays to be pretty heavy in municipal bonds, then the other one that is rarely thought about as a personal investment is treasuries. And once again, if you are in a state with high tax rates, treasuries are exempt from state and local taxes. And so they can be hugely beneficial vis-a-vis CD or any bank deposit or even corporate bonds. And in fact, and we may talk about individual states in a moment, but if you live in California and you're at the top tax bracket in California, which is 13.3%, the tax equivalent yield on a T-bill, which today the pretax rate is 5.4%, the tax equivalent yield, because it's exempt from the California tax of 13.3%, the tax equivalent yield is about 7%. You would have to have a 7% bank account or corporate bond in order to do as well after taxes. And to get any kind of corporate bond that was paying 7%, you'd take significantly more risk than you have when you're in short term T-bills.
Jim Puplava:
[00:14:47 - 00:15:20]
You mentioned something that's very key there on the municipal bonds, because Larry Lotzebucks, he's got so much income, he's not going to be able to do a Roth conversion. Because if you're in a 37% tax bracket, trying to do a Roth conversion just doesn't make a lot of sense. And if you throw like California just raised, I just found out they raised this year, the 13 three tax bracket goes to 14 four, and they have a bill, I think it's AB 25 53 to raise it to 16 eight, which is insane. So you can imagine, Larry, lots of bucks, if he lives in California, he can't do a Roth conversion. Let's say if he's got a large pension plan, defined benefit, whatever it is.
Jim Puplava:
[00:15:20 - 00:16:01]
But as you mentioned, you take those tax rates, federal, state, and you go into a tax free bond. If you take a 4% tax free bond to Larry, that's got to be like 8% or 9% if you're equivalent. If you're living in California, yes, and...
Bill Harris:
[00:16:01 - 00:16:28]
It's not quite that much, but yes, there's a huge advantage. And again, so in California today, at the 13.3% tax T-bills, currently at 5.4, the tax equivalent yield is about 7%. But where can you get 7% money risk free?
Jim Puplava:
[00:16:29 - 00:16:34]
None that I can think of other than treasury bills. So it's a good point.
Bill Harris:
[00:16:34 - 00:16:35]
There you are.
im Puplava:
[00:16:35 - 00:17:35]
Let's move on to something that I think that really stands out in your book, by the way, and you and I were talking before we went on the air, we were going to do a show called where you live is what you keep, talking about, state taxes. And one thing I really was pleased to see in your book, you took all 50 states, and you analyze those states, not just from whether what their tax rates or they were tax free, but you also talk about the other things that come into play. Sales tax, property tax. Like Texas doesn't have any income tax, but they have high property taxes. And some states, like Washington state, even have estate taxes. So let's move on to, let's say the couple, a very successful couple, they've got maybe two or $3 million in an IRA. If they live in California, their home's probably worth multiple millions of dollars. They're thinking of retiring. What would you do and where would you go? I mean, we're putting retired California clients into Arizona, Nevada.
Jim Puplava:
[00:18:16 - 00:19:01]
Some have gone to Texas. We got one that went to Florida, but that was mainly because they had kids there. But what would you do with a retired couple and bring in what you talk about in your book about states? Because I was really pleased to see you did that because most people just think of income taxes. There's more to it.
Bill Harris:
[00:19:02 - 00:19:26]
Yes. Well, in California, of course, Nevada is the closest zero tax state. Arizona is, of course, good. Texas and Florida are the big opportunities in both. Zero taxes, income taxes.
Bill Harris:
[00:19:26 - 00:20:03]
There are a lot of other taxes, as you said, that impact the overall tax burden. But Texas and Florida tend to have relatively low cost of living as well. The one other thing I mentioned is many people who retire think about going overseas. Maybe it's the coast of Mexico or Costa Rica or Europe. If you're going to do that, make sure that you move to a low tax state first as your primary residence and then go overseas.
Bill Harris:
[00:20:04 - 00:20:41]
And if you're moving, pay a lot of attention because a lot of attention to the details. States like California and New York will try to hold on to you pretty strongly. And so all of the indicia of having moved, selling your house one place, buying it the other, moving your cars, making sure that you are not spending the majority of your time in your old state, and then documenting all that is very important.
Jim Puplava:
[00:20:42 - 00:21:07]
Yeah, that's key, because California is building walls, but they're the wrong walls. They're the walls to keep taxpayers in the state. There's a bill that wants to talk about, I think it's 0.4% exit tax, and they've got that. And whether it'll pass or not, I don't know if that would even stand muster. Most people don't understand that California up until about 1998 used to tax your pension.
Jim Puplava:
[00:21:07 - 00:21:40]
If you moved from California, let's say you worked for the utility here, you got a nice pension, and you moved to Arizona or Nevada. California taxed your pension until they lost that battle in the Supreme Court in 1998. So they're at it again, building a wall, as you just mentioned, trying to keep people in the state and hold on to them. And they also track people with their utilities, their credit cards. So my CPA was telling me about a guy that moved to Reno and they tracked him.
Jim Puplava:
[00:21:40 - 00:21:46]
He was basically still living in California and they tracked him through his credit cards and his utilities.
Bill Harris:
[00:21:47 - 00:22:06]
Yes. And the phone is also an important way that that is discovered. However, I will say this. Anyone who actually does not move should not attempt to claim the tax residency elsewhere.
Jim Puplava:
[00:22:07 - 00:22:37]
So given that in tax states, as you were doing the research and looking at the states, are there any out there besides some of the obvious like Nevada, Texas and Florida that really stand out? Not just, let's say from tax point of view, but you also cover like lifestyle access to things like medical things that are important. If somebody is, let's say, retiring, don't just look at just the income taxes alone.
Bill Harris:
[00:22:39 - 00:23:12]
You bet. Well, so I will point out an anomaly. One thinks of the West coast as being a high tax area. Actually, the state of Washington is a real opportunity. Colorado is a nice place to live, relatively low cost of living for a urban and developed area, and their state taxes are relatively low.
Bill Harris:
[00:23:14 - 00:23:21]
But the main opportunities are Nevada on the west coast and Florida on the east coast.
Jim Puplava:
[00:23:22 - 00:23:51]
And you see that, you hear about a lot of these, let's say, hedge fund managers in New York that are moving down to Florida. And I would say almost 50% of our clients that are leaving California are going to Nevada because it's about a four hour drive. If you live here from Nevada to get back to the coast and you've got the weather. What about bill, what's your thought of, let's say I move out of California. I move to Nevada.
Jim Puplava:
[00:23:51 - 00:24:11]
I have a home there. I register my car, I register to vote there. But Nevada or Arizona gets hot during the summer, so we've recommended that. Well, if you want a vacation here during the summer, just rent a place. Don't buy a resident because you don't want to give California the idea that you really sort of live in here.
Jim Puplava:
[00:24:12 - 00:24:13]
What's your thoughts on that?
Bill Harris:
[00:24:13 - 00:24:36]
Oh, absolutely. Do not do that. Do not buy a place. Do not continue to own the house that you lived in previously because you were just guaranteed to get into a other. The other thing is this.
Bill Harris:
[00:24:37 - 00:25:05]
If you're looking at the heat in Arizona, well, the heat in Arizona is perhaps four months. Even if you end up renting in California for that four months, you can make sure that it's less than six months in a day. More importantly, why not enjoy the variety of life? Why not try different places? Why not travel?
Bill Harris:
[00:25:05 - 00:25:23]
And it's a great opportunity. If you spend significant amount of time in California after recently having moved, you're just asking for trouble.
Jim Puplava:
[00:25:24 - 00:25:48]
Yeah, we had a client that they moved from California to retire. We were doing Roth conversions. So they moved to Arizona because it was close by, and they moved close to a retirement community. And the way they handled the heat, they bought a motorhome, and they're doing exactly what you're talking about. When the summer heat comes around June, they take off in their motorhome, they go across the country, they get to see the country.
Jim Puplava:
[00:25:48 - 00:25:51]
And they're not coming here to California that often.
Bill Harris:
[00:25:52 - 00:25:55]
You bet. Used to be snowbirds. Now it's sunbirds.
Jim Puplava:
[00:25:55 - 00:25:56]
Yep.
Bill Harris:
[00:25:56 - 00:26:19]
So as you take a know, now that we're talking about the states, let me just take the other end of that spectrum for a moment. Do you know the geography, the particular area where the top state and local taxes are the highest in the nation?
Jim Puplava:
[00:26:41 - 00:26:44]
No idea where. I was thinking California, but I got a feeling it's different.
Bill Harris:
[00:26:44 - 00:27:08]
Well, New York City is slightly higher than California, and particularly that's for high income. But let's just say that you're, let's say, single and have a million dollars of income, you've had a very good year. You're going to pay 13.53% in New York City. But even that is not the highest.
Bill Harris:
[00:27:08 - 00:27:41]
And you'd never guess it, but the highest is Portland, Oregon. Because if you combine Oregon state tax with the Portland metropolitan region tax with the Multnomah county tax here at the top rate, that's 13.9% on every bit of interest income that you've got, actually, on all types of income.
Jim Puplava:
[00:27:42 - 00:28:09]
So I have a client right now that we're thinking of moving, and he's in Washington. He was thinking, well, maybe I would move kind of stay close to where he runs his business in Oregon. I'm going to tell him Oregon is not a possibility. That would not be good for Larry Lotzebucks. As we close here, Bill, looking at taxes and your history of working in the tax industry, with various companies.
Jim Puplava:
[00:28:09 - 00:28:20]
What would you say are some of the biggest mistakes or maybe missed opportunities that taxpayers make?
Bill Harris:
[00:28:22 - 00:29:16]
Well, there are many mistakes that one could make, and there are many mistakes that can cost a lot of money. But if you look not at an individual taxpayer, but you look across all taxpayers, I think the single biggest thing is the detrimental impact of holding mutual funds. And there are many aspects to it. First, you end up with higher fees than you would with an ETF for just buying individual securities. You end up with less diversification than you will have with an ETF, which really means that you have the same expected return, but you're going to have higher volatility, which means you're getting uncompensated, you're taking uncompensated risk.
Bill Harris:
[00:29:17 - 00:30:00]
But then if you turn to tax, you will receive every year the underlying tax activities of the mutual fund. You'll also end up with taxes, capital gain taxes, when you buy and sell the fund itself. And what happens in a mutual fund is that the managers trade. And they trade both because that's their job. They're trying to beat their index, but they also trade because at the end of the quarter, if Apple had a run, at the end of the quarter, they're going to buy some apples so that it shows up on their quarterly reports and it looks like they've been smart.
Bill Harris:
[00:30:00 - 00:30:32]
And so all of this generates short term capital gain. And as you know, whereas long term capital gain is taxed at low rates and can be timed, short term capital gain, if you sell before you've held for a year, that goes right back to ordinary income. And so all of those things combined make tax, make mutual funds an outmoded, outdated way to hold securities.
Jim Puplava:
[00:30:32 - 00:30:58]
And not to mention one of the things I don't like about mutual funds, you're trying to plan your taxes for the year, and especially if you're retired, you're making quarterly estimates. And if you own mutual funds, all of a sudden November, you get this big check that they sent you on short term capital gains, long term capital gains plus the dividends, and you weren't planning on that. But that's what happens because that's what they're required to report.
Bill Harris:
[00:30:59 - 00:31:21]
That's right. And if you go from a mutual fund to an ETF, there are a number of advantages, but one of the easy ones is that there's just less trading. There's very little trading within an ETF that's following the index. As long as it's market weighted, then that's easy. And if you really want to dig in.
Bill Harris:
[00:31:21 - 00:31:44]
And if you really want to maximize your after tax return, now you start doing things like tax loss harvesting, tax gain deferral, and a series of other strategies which take more work or more help, but ultimately can provide the best result of all.
Jim Puplava:
[00:31:45 - 00:32:26]
Well, I want to compliment you on your book, the thing that I like, and I'm going to recommend it for our listeners listening to this show. Number one, it's easy to understand you don't have to be a CPA or got a master's degree in finance. It's very applicable and I think most people understand it. But my favorite part of it, as I said, you saved me doing a show, was that you completed the tax picture because everybody talks about federal taxes. When you're talking about taxes, you really also have to talk about where you live, the state taxes or as you mentioned, if you live in New York or if you live in Portland, the city tax, the regional tax.
Jim Puplava:
[00:32:26 - 00:32:37]
You add that all together and this gives you a better guide. So if you are thinking of making a move or making a decision, you can look at the big very, very well done, Bill.
Bill Harris:
[00:32:38 - 00:33:07]
Thank you so much. And I do say this. This is a book for investors as opposed to a book for tax professionals or practitioners. And I am not that I ran Turbotax for ten years, and so I'm pretty well steeped in tax. But from the customer's point of view, I build software that help the customer get the end result.
Bill Harris:
[00:33:08 - 00:33:32]
And I think to the extent that it's a readable book on taxes, I think that is partly due because I do not have that type of tax education in my background. Rather, I have the experience of working with real people, real portfolios and real challenges.
Jim Puplava:
[00:33:32 - 00:33:46]
Well, once again, my compliments. Very well done. The name of the book is called the Investment Tax Guide: How to Slash Your Taxes. And we've been speaking with its author, Bill Harris. Bill, thanks so much for coming on the program.
Jim Puplava:
[00:33:46 - 00:33:51]
And once again, my compliments on a very well written book that is going to help a lot of people.
