What Is Tax Planning?

DANO WEIR: Everybody knows if you make $20, you give five back to the government, give or take. But what you're telling me is that if I make $20, I can put some of that five in certain other accounts with various strategies, and maybe I don't have to pay as much back to the government. Is that Tax Planning, Clay?

CLAY DUNKLE CFP®: I would say that classifies as Tax Planning. Boo!

DANO WEIR: Episode done.

DAREN BLONSKI CFP®: It's a little bit more complex than that, Dan. Fair.

DANO WEIR: Welcome to It's All Money Hosts.

CLAY DUNKLE CFP®: I'm right here in front of you.

DANO WEIR: You're checking out It's All Money.

DANO WEIR: Welcome inside the Sonoma Wealth Advisors Conference Room. We're right off the Sonoma Square in Sonoma, California. How many times did I say Sonoma? My name is Dan O'Weir. I'm the Marketing Director and Podcast Host here of It's All Money.

DANO WEIR: I'm joined today once again by Daren Blonski, CFP, as usual. And for the first time on the podcast, our advisor who has particular interest in, he gets excited about taxes, Clay Dunkel, CFP. Welcome, Clay. Thank you, Dan.

CLAY DUNKLE CFP®: Glad to be on the show.

DAREN BLONSKI CFP®: Funny story about that, right? So it's Saturday morning. I think I'd just gotten back from a baseball game or a basketball game or a soccer game for one of my kids. And I get this note from Chris.

DAREN BLONSKI CFP®: And Chris says to me, Daren, Clay and I did this tax analysis and we calculated the lifelong tax expectation of this client. And if we do these Roth conversions on these in these years, we're going to save the client like a million dollars. And he was legitimately stoked about it.

DANO WEIR: On a Saturday morning.

DAREN BLONSKI CFP®: Saturday morning. And I'm like, Chris, man, I love that you're my partner because I love that you got excited about that. And that's Clay.

CLAY DUNKLE CFP®: That's what it's all about. Yeah.

DANO WEIR: That's right. Okay. Well, I always start with a really simplistic explanation to try to make things clear. What is Tax Planning, Clay? Because most people just think of taxes and they think of, okay, I needed to do my taxes. Tax Planning, tax service. What are they and what is the differences?

CLAY DUNKLE CFP®: Tax Planning. So I can't give you a super specific definition. It's going to be broad, so you might not like it. But I would say...

DANO WEIR: For educational purposes only.

CLAY DUNKLE CFP®: I would say Tax Planning is analyzing a client's situation and making sure that all of the different pieces involved are working together so that they're paying the least in taxes. And that could be short-term or that could be medium or long-term.

DAREN BLONSKI CFP®: They're paying their fair share of taxes.

CLAY DUNKLE CFP®: Fair share, sure.

DAREN BLONSKI CFP®: Correct. We don't want to say least, but it's the fair share of taxes that they appropriately owe.

DANO WEIR: And I think that's such a key point is because whenever you get into the realm, and I'm still new in the industry, which I think is a real benefit for me because I bring in what I think a lot of people presume about financial services.

DANO WEIR: So when someone starts goofing with their taxes and they start doing things to help improve their tax situation, the impression is there's a bunch of write-offs and you're going to get to zero. Ha ha ha, I did it.

DANO WEIR: What you're both saying is that no, everybody pays taxes, but there's a way to pay your appropriate amount of taxes and there's a way to pay way too much in taxes.

DAREN BLONSKI CFP®: Correct. I always say there's tax law for the informed and there's tax law for the uninformed.

DAREN BLONSKI CFP®: And there is, I mean, this be real. If you looked at the tax code in the United States, it would probably stack higher than this, paper to paper to paper, right? There's over 300 changes per year in the tax code. We're going to get a lot this year in 2025. And the nuance of that is complex. And whenever they create a law, it has unintended consequences.

DAREN BLONSKI CFP®: So the way I like to imagine, I remember growing up, there was this empty lot. Across the street from my house. And there was this old house and an old chicken coop that became a barn, which is very common in Petaluma. And then they started building all these different buildings against this old chicken coop. And eventually that chicken coop from internally fell over and everything else fell over.

DAREN BLONSKI CFP®: And I think about the tax code that way. Like it's all these like chicken coops and buildings built here and over here and it's over here and it's... Overwhelming. So our job in Tax Planning is to help you navigate with our CPAs and our EAs on staff and our CFPs on staff to pay your fair share of taxes, what you lawfully owe, but not to overpay in areas that you don't lawfully owe.

DANO WEIR: Okay. So tax service is... What everyone has to do every year, which is you have to file your taxes. So that is a tax service. You would typically do that with a CPA.

DAREN BLONSKI CFP®: Or EA or tax filer now.

DANO WEIR: EA enrolled agent. That is you show up with your W-2 and you fill out all your information and you get your documents and they process it, or perhaps use a software program for it and you do it yourself. That's tax service.

DANO WEIR: At that time when you're doing tax service, there are deductions that you can make which are going to affect your tax bill one way or another but what you're talking about is Tax Planning which would happen ahead of time and can you give an example of some of the strategies you use what for someone who's trying to conceptualize this what what strategies are used for Tax Planning what are some of your typical moves you might make for someone it's everything is specific but yeah that's a tough question you know nailing down something specific.

CLAY DUNKLE CFP®: I, I think we can talk about the different areas that are affecting Tax Planning and maybe, maybe go from there. So let's put it in an example, right? Let's say we bring on a new client. We're going to collect a few years of tax returns so that we can see what's going on under the hood up to this point, right?

CLAY DUNKLE CFP®: Last, last few years, here's their income, here's their deductions, here's what they own. You know, here's, here's some debt. Getting that picture of what's going on. Then we're going to ask some questions and really understand, you know, in their mind, how they have their assets and liabilities and their whole financial picture structured.

CLAY DUNKLE CFP®: How is that supporting them to get to their goals? And what are their goals going forward? So we're talking about, you know, personal goals and personal information in general. Do you have a family? Do you have kids? Are you married? Are you all in good health? Parents, are they in good health?

DANO WEIR: Do you want to move somewhere in the next five years?

CLAY DUNKLE CFP®: Yeah. Do you want to get out of town?

DANO WEIR: Do you want to start a small business? Do you want to retire?

CLAY DUNKLE CFP®: Tons of stuff.

DANO WEIR: All of these are things that people will share and that greatly affect what the financial plan might be.

CLAY DUNKLE CFP®: Absolutely. Absolutely. So that's on the personal side.

CLAY DUNKLE CFP®: Then there's the business side. Do you own a business? How is it structured? Is it an LLC? Is it an S-corp? What state is it? Are you incorporated in?

CLAY DUNKLE CFP®: Do you have an exit plan? Do you know what an exit plan is? Do you have employees? Then you can go to other investments. Do you own real estate? Do you have investment property? Do you own your own house, right? Or are you a renter? Then there's retirement. Are you doing a traditional retirement plan, utilizing accounts like a 401k? Well, I'm a realtor.

DANO WEIR: I'm a realtor. I can't have a retirement plan.

CLAY DUNKLE CFP®: Or are you... You... Going that route where you just buy a bunch of real estate and you're relying on the cash flow to fund your retirement.

DANO WEIR: But a realtor could have a solo K, could they not, right? Yeah, they could. It's something they may not know, right?

CLAY DUNKLE CFP®: Yeah, but just getting that picture, right? What are you doing today and how can we optimize that going forward?

CLAY DUNKLE CFP®: And then other investments, right? It's not all just retirement assets. You might have a brokerage account or a trust account with some assets that you've been putting away. Understanding what those are earmarked for in the client size. Is it a source of potential down payment on a property?

CLAY DUNKLE CFP®: What's the cost basis? What did you pay for the assets and what are they worth? Is there any flexibility there? How are they being managed? Are they being managed in a tax-efficient way for the client situation? So I think all in all, hopefully that gave you kind of a taste of how complex it is as a whole.

CLAY DUNKLE CFP®: And for us, we're trying to bring all those pieces together, put the scenarios together and say, okay, here's the base case. Here's where you're at today. And here's what your tax plan has looked like up to this point. Here's what we think you could do better to save some money and help you achieve your financial goals as well.

DANO WEIR: Save some money in the taxes that you're paying.

CLAY DUNKLE CFP®: Right. Yeah.

DANO WEIR: Darren, it's kind of counterintuitive that a financial advisor would go, would be the person who's doing my Tax Planning because people are so hard coded to think tax CPA. But in fact, Tax Planning can kind of be a wealth building strategy as well, can it not?

DAREN BLONSKI CFP®: Absolutely. So there's an old saying that says it's not what you make that matters. It's what you keep that counts.

CLAY DUNKLE CFP®: I knew that was coming. Yeah.

DAREN BLONSKI CFP®: One of my favorite sayings with people, right? Like, it doesn't really matter if you made a bunch of money, if you're going to pay most of it to the government. Like that's just paper.

DANO WEIR: I made a million dollars this year. I paid 500,000 in taxes though. So I only made five. This is what I do on these NFL stories all the time. They're like, so-and-so got a $320 million contract. I'm like, well, it's actually not that much.

DAREN BLONSKI CFP®: That's right.

CLAY DUNKLE CFP®: Cut that in half.

DAREN BLONSKI CFP®: And so we have to think about those options. And when we look at how people structure, the way they receive the income they receive, whether it's from...

DAREN BLONSKI CFP®: A windfall, whether it's from the income from working, whether it's from an inheritance, there's ways to navigate how you receive that income and then how you invest that money to benefit you and keep more in your pocket. And that's the essence of Tax Planning.

DAREN BLONSKI CFP®: What we've seen is that it's one incredibly difficult to pass the CPA exam and doing tax prep work is a very difficult job because of the impact it has on the lifestyle of the individual who does taxes for a living. And because of that, we're seeing a massive shortage in the number of people in the workforce actually going in to become a CPA or EA.

DAREN BLONSKI CFP®: Very, very difficult to find those people that want to do that. And it's because it's a lifestyle thing. It's not a very good lifestyle. I mean, you think about it from January to April 15th, the 60, 70, 80 hour weeks, and then they get some time off after.

DANO WEIR: But you got the October extension deadline too, right? So you got a second little mini stress period.

DAREN BLONSKI CFP®: We actually found through COVID, more people are on extension now than used to be, right? So now the tax season is getting stretched. So it's making it even worse. So it's a very difficult lifestyle thing. So a lot of people going into it and the tax code doesn't seem to be at this point getting simpler, more complex.

DAREN BLONSKI CFP®: So you need that person to discern that for you. And help you through that process. And what ends up happening is CPAs, EAs, they get overworked. There's just too many clients. They don't have the time to sit there and say, well, Dan, had you done this differently in December, you would have paid less in taxes. They're more reactive now. Taxes go in.

DAREN BLONSKI CFP®: It is what it is. Here's my 1099s, et cetera. And the person just has to deal with it. So what we do in Tax Planning, to the degree our licensing allows us to, to guide the client in a way that says, well, if you do this, it's more efficient than if you do that. Or if you convert a bunch of pre-retirement IRA money now to a Roth, you'll pay less taxes over the long term.

DAREN BLONSKI CFP®: Those would be two instances where we would help an individual sort through that. A tax professional in theory might have the time to do that, but it's very difficult nowadays and costly. Prices on paying a tax person are going up because there's so much demand and very little supply.

DANO WEIR: And you're, again, speaking to the idea of appropriate tax. The IRS is never going to tell you once you send your taxes in, you know, over the lifetime of your investment, you could have actually used these types of accounts and saved yourself some taxes. We just wanted to let you know.

DAREN BLONSKI CFP®: Most definitely not.

DANO WEIR: They're never going to tell you that. So you can do it the expensive way with the IRS or you can do it the appropriate way with the IRS. As long as it's within legality, they're going to let it pass with your taxes.

DANO WEIR: You know, they're going to hopefully not going to get audited. But I mean, you're it's with as long as it's within the bounds of the law, they don't particularly care necessarily, but they're never going to come back and tell you, gosh.

DAREN BLONSKI CFP®: You could have been more efficient.

DANO WEIR: Just so you know. So it seems like this Tax Planning is the work that you do on the front end ahead of time, a year, even years ahead of time, that ultimately when the moment comes, you're going to pass through the door with lower tax bill than if you had just not worried about it at all. Is that true?

CLAY DUNKLE CFP®: Yeah, that's fair.

DAREN BLONSKI CFP®: It's actually interesting, too, because as an advisor, we're always very focused on creating value for our clients, right? And so if we do our Tax Planning right. We'll save that client a lot of money over time. They won't necessarily know it because it's what they've come to know.

DAREN BLONSKI CFP®: Had they just not planned and paid the taxes as they thought they should have, then they'll have a very different experience. And that's what they'll have come to know. And so it's interesting when we're always trying to memorialize value for the client and saying, well, because we utilize strategy A instead of strategy B. This is the benefit to you over a long-term relationship with us.

DANO WEIR: Which is different than their expectation with a financial advisor, which is like to have a graph and I go, look. Up and to the right.

DAREN BLONSKI CFP®: Yeah, that's right.

DANO WEIR: In the Green Area. That's right. Percentage number? That's right. That's a win, right? Yeah. It's harder to say, okay, well, actually we didn't pay as much as this went down. The tax bill went down and that's a good thing. Down and to the right is also good.

DAREN BLONSKI CFP®: Yeah.

DANO WEIR: Counterintuitive. Yeah.

DAREN BLONSKI CFP®: You don't get to put the tax saving on the performance report.

DANO WEIR: Correct. Correct. We've got a couple of slides. This is an educational only scenario. I wanted to put a couple of numbers to this. Just so you could wrap your brain around this if you're trying to conceptualize what Tax Planning is.

DANO WEIR: So today we're going to meet John Doe, because John is not Tax Planning yet. He hasn't been until this point. And for the first time, John's saying, I'm going to do some Tax Planning with whoever, not even necessarily with Sonoma Wealth Advisors.

DANO WEIR: So John makes $579,000. His deductions are $44,000. His taxable income is 534. His marginal tax rate, which is what people would consider typically what you would call your tax bracket, is 35% at that large number. His average tax rate, Clay, will you want to explain marginal versus average tax real quick?

CLAY DUNKLE CFP®: Yeah, average tax rate is going to be the total tax bill for the year divided by the total income. So by definition, right, that's an average. A marginal tax rate is the bracket that you fall in where your next dollar of income will be taxed. So that's the difference.

DANO WEIR: So the percentages of the dollars that you make, say zero to zero to 10,000, I don't know the brackets, then brackets off the top of my head is going to be a different percentage than say.

DAREN BLONSKI CFP®: Okay, cause they're going to change.

DANO WEIR: The first $10,000 that you make is going to be a different tax percentage than the a hundred thousand to $200,000 that you make. Right. And so when they calculate that with the average tax. So right now, John Doe is paying a total tax of $137,000.

DANO WEIR: So when you do Tax Planning, tax returns are analyzed. Some more notes about John Doe. John takes Social Security. John's on Medicare. John donated $20,000 to charity. He claimed $14,000 on his mortgage interest. And John has an annuity.

DAREN BLONSKI CFP®: Sold by a broker.

DANO WEIR: So.

DANO WEIR: Let's take a look at our notes. Some observations that you might find in this generic educational situation that we've described is that John's income is too high to contribute to a Roth IRA, so he might consider the feasibility of a backdoor Roth strategy. Clay, what is a backdoor Roth strategy?

CLAY DUNKLE CFP®: Well, the IRS does not allow you to fund a Roth directly if you exceed a certain level of income. So one of the quote unquote loopholes in the tax code is that it's not a loophole.

DAREN BLONSKI CFP®: It's a planned usage of the tax code.

CLAY DUNKLE CFP®: Yes. Yes.

CLAY DUNKLE CFP®: What you're allowed to do is make a non-deductible contribution to an IRA, which is a pre-tax, right? There's the pre-tax and there's the Roth. So you can make a non-deductible contribution. The reason it's non-deductible is because the same limits apply to the Roth contributions, right?

CLAY DUNKLE CFP®: So you're over that income limit. You make the contribution to the IRA. It's non-deductible. You turn around and do a conversion into the Roth, effectively doing the same thing as making a Roth contribution.

CLAY DUNKLE CFP®: I have a question. Is John, I thought I saw that he was a handyman. Was that on the last slide?

DANO WEIR: Yeah, John has a small handyman. Okay, gotcha.

CLAY DUNKLE CFP®: So So So that's a strategy, right? Looking at the backdoor. But also, because he's self-employed, he might consider one of the retirement plans that's available for self-employed individuals, like a solo 401k.

DANO WEIR: So backdoor Roth is they put it non-deductible donation to an IRA, and they're able to immediately then, once they've created that account, roll it to a Roth?

CLAY DUNKLE CFP®: Right.

DANO WEIR: Charitable contributions over $10,000. If more is planned in the future, consider a donor advised fund. Darren, what is a DAF or a donor advised fund?

DAREN BLONSKI CFP®: So in 2018, in the Tax Job Act, they raised the standard deduction, we call it, for an individual, which made giving to charities on the federal side less meaningful from a deduction standpoint because you had to achieve a certain threshold.

DAREN BLONSKI CFP®: So one of the strategies that you can deploy is you gift. So say I'm going to give to charity over the next five years, $10,000 a year, so $50,000. Should you have the cash set aside, you can give $50,000 into a DAF, a donor advised fund, take the deduction in the year that the $50,000 was.

DAREN BLONSKI CFP®: Given to the DAF, the donor advised fund, but then dole out the gifts to the charitable of charity of choice over a period of time, thus raising that deduction because you go past that standard deduction. So it's a way to qualify some charitable intent for deduction that otherwise would not be because it was under that standard deduction.

DANO WEIR: So if it's under the standard deduction, so if I was going to give $10,000 a year for five years, every time I did that, I would be under the standard deduction.

DAREN BLONSKI CFP®: And you wouldn't get federal credit.

DANO WEIR: And I would get no federal credit. But if I did it 50 all at one time, then I would get the credit that year.

DAREN BLONSKI CFP®: Because you exceeded the standard.

DANO WEIR: And then the DAF is able to distribute the money to that same charity. So nothing changes for the charity. The only thing that changes is you're able to get the tax credit for it.

DAREN BLONSKI CFP®: Yeah, and you can control the DAF, right? You can say, I want to give X amount when you want to give it to that charity. You can even change the charity and say, I want to give it to a different charity now or whatever.

CLAY DUNKLE CFP®: And you can invest the money.

DAREN BLONSKI CFP®: You can invest the money and let it grow. That's right.

DANO WEIR: So John's loving these insights so far. Let's get to the next one. A portion of your annuity distribution.

DAREN BLONSKI CFP®: First question I have is, why does John even own an annuity at this age? But that's not here or there.

DANO WEIR: This suggests some after-tax basis in the account, a rollover, a tax-free Roth distribution, or a qualified charitable distribution.

DANO WEIR: What can you say to that particular assertion, Clay?

DAREN BLONSKI CFP®: When it says a portion of your annuity distributions was not taxable. So you have to go into, here's the tax code again. We have something called first in, first out, and last in, first out. And so annuities have a taxation of such that if you put your money in it, that's called basis, just like you would invest in a real estate property. And you invest that money and it grows in the annuity.

DAREN BLONSKI CFP®: If that money grows from what you invested in, the portion that it grew by and it comes out of the annuity is taxable. First in. That's the first in, first out. The last in, first out is the annuity rule, right? So it's coming out of the annuity and you're paying taxes on that income. But this says a portion of your annuity distributions was not taxable. That's because some of your basis came out of the annuity.

CLAY DUNKLE CFP®: That would tell us that it's annuitized, right? They're getting payments and then there's, they, they calculate it as a ratio of what you put in versus what the earnings are. And each. Distribution that you receive is going to be taxed according to that ratio, correct?

DAREN BLONSKI CFP®: Yeah. So there's a portion that's not being taxed, a portion that is being taxed, right? So you can utilize different strategies when that money comes out and it, which will impact, we talked about earlier, the marginal tax rate and how we distribute at where on that marginal tax rate, right?

DAREN BLONSKI CFP®: So planning how income comes out of annuities is pretty important. So Unfortunately, a lot of people have been sold a lot of garbage annuities over time. I know. And so part of the job we do is we can't make bad, you know, there's not much you can do and bad is bad, bad is bad, but we can make it a little bit better for you.

DAREN BLONSKI CFP®: And so planning how we distribute income out of those annuities in the most strategic way that's beneficial to you to not pay a higher tax rate on it is part of the Tax Planning process.

DANO WEIR: Speaking of real estate. You mentioned real estate earlier. This is something to consider if you own a home. It's kind of annoying, but this last suggestion analysis I think is important. Keep track of your home improvement expenses for cost basis adjustments in the event of home sale.

DANO WEIR: This is a pain in the butt because you got to keep all the receipts, but it can help you in the come time of sale. If you've made capital improvements to that house, it can reduce your tax bill, which is not something that everyone knows. And not something everyone's necessarily keeping active track of.

DAREN BLONSKI CFP®: So to think about it this way, Clay, so if I buy a house for 500 and I sell it for a million and I have $500,000 profit on that house, it's not a trick question.

CLAY DUNKLE CFP®: Are you married?

DAREN BLONSKI CFP®: Am I married? Exactly. Why? Why are you asking that?

CLAY DUNKLE CFP®: Well, that affects the calculation, right? Because if I'm not married.

DAREN BLONSKI CFP®: How much is taxable?

CLAY DUNKLE CFP®: If you're not married, you have a $500,000 gain. No matter what right that's your gain now what can be excluded depends on whether you're married or not if you're single you can exclude 250 000 of that gain if you're married each of you gets the 250 exclusion for a total of of 500. So in your scenario if you're married you bought the place for 500 sold it for a million Not really a taxable event there.

DAREN BLONSKI CFP®: But if I sold it for $1.2 million and there's $200,000 in gain that I can't use the exemption for, and I've got $50,000 in receipts that I've raised my $500,000 basis to $550,000.

DANO WEIR: I put it into HVAC. I did fence work around the property. I did.

DAREN BLONSKI CFP®: Maybe. Not everything qualifies. Yeah, not everything. And that's where the CPA is going to come in and make sure it's right. But like, you know, some paint does, but not all paint per se, right?

CLAY DUNKLE CFP®: Like maintenance versus it.

DANO WEIR: Actual property improvements but what would be considered capital improvements so i didn't just let this house sit there and gain and appreciate i put in money into this house yeah and i save the receipt that can reduce your tax yeah yeah exactly nobody thinks about it until they're considering selling and the CPA says well do you have do you have your receipts I can't tell you how many times I have clients come in.

DAREN BLONSKI CFP®: They'll be like, hey, I want to sell my house. What's my taxes going to be like? Well, I can't answer what your taxes are going to be. But let me ask you this question. What's your basis in the property? And the client goes, what's that? Yeah. And I say? Out. This is going to be painful. Yeah.

DANO WEIR: So that's Tax Planning. If you have an advisor currently, if you're working with no one, perhaps you might ask, hey, I'm not getting that.

DANO WEIR: Hey, I've never done tax conversation like that before. I've never known that you should be planning a year ahead of time for taxes. We do that at Sonoma Wealth, and you can learn more about us at sonomowealth.com. You can work with Clay, Darren, and our staff and get some of these same observations on your situation. Clay, thanks so much for joining us today. Appreciate it. First time on the pod.

CLAY DUNKLE CFP®: Yeah. Thanks for having me. It was a blast.

DANO WEIR: You survived. If you're new to the channel, your first time watching, make sure to subscribe and SonomaWealth.com for more on.

DANO WEIR: Sonoma Wealth Advisors.

DANO WEIR: Although it should not be relied upon as such. Any statements or opinions are subject to change without notice. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated are not guaranteed.

DANO WEIR: Information expressed does not take into account your specific situation or objectives. And is not intended as recommendations appropriate for any individual. Viewers and listeners are encouraged to seek advice from a qualified tax, legal, or investment advisor to determine whether any information presented may be suitable for their specific situation. Past performance is not indicative of future performance.